Scottish bank fires first round in interest war

Bank of Scotland fired its shot to challenge the dominance of the "big four" banks yesterday by undertaking to increase the interest rate it pays on current accounts by some 30 fold - to 3%.

In a move which will bring it in line with the Halifax, with which it will merge later this year, BoS described the decision as "the first clear illustration that its proposed merger with the Halifax will bring a new competitive edge to UK banking".

Combined to form HBOS, the bank is pledging to become a "fifth force" on the high street to topple the "big four" - Royal Bank of Scotland/NatWest, Lloyds TSB, HSBC and Barclays - which control some 75% of the current account market.

If the big four, which pay 0.1% on balances, follow suit and up their interest rate it could dent their combined profits by some 20%, according to analysts at Fox-Pitt, Kelton.

Yesterday, though, Royal Bank of Scotland was adamant that it would not change its stance. As Royal Bank reported a 37% increase in interim pre-tax profits to £2bn, chief executive Fred Goodwin said: "It doesn't seem to be a compelling competitive threat".

Rattling Royal Bank is regarded as crucial in persuading all the big four to follow. It jostles for dominance in the Scottish market with BoS and as owner of NatWest would be expected to cause a domino effect in the rest of Britain if it upped interest rates in Scotland.

But Royal Bank insisted its position had not been damaged by Halifax, citing 500,000 new current account customers in the first six months and a market share of 21%.

Halifax, though, insists that its move to pay 4% from the beginning of this year has already allowed it to win half of the 600,000 "switchers" in the first six months of the year.

Next year, when it is part of HBOS, BoS will follow by pledging to pay two percentage points below base rates. But, as with the Halifax its higher rate will only kick in for customers paying in more than £1,000 a month.

Mr Goodwin at Royal Bank insisted yesterday that customers looking for interest on balances did not usually do so through their current account.

He played down the possible impact of a combined Halifax/Bank of Scotland in both current accounts and small business - where Royal Bank has a market share of more than 25%. "We're competing with them already. I don't see that by merging they are giving us any bigger competitive threat".

Royal Bank's shares rose 45p to £16.85 yesterday - well above the £14.75 at which new shares were placed with investors three weeks ago to fund the acquisition of Mellon bank in the US by its Citizen's operation.

Confirming the profits estimate released at the time of the acquisition, Mr Goodwin indicated that would increase its promised cost savings and extra revenues from last year's takeover of NatWest.

So far, Mr Goodwin has cut 16,000 jobs as part of the goal to save £1.3bn in costs by 2003 and boost profits by £380m.

While he has pledged to conduct "mercy killings" of underperforming rivals, Mr Goodwin indicated that such moves were unlikely this year. Instead he pointed to the possibility of expanding its share of the savings, personal lending, credit card and mortgage markets.

Hugh Pye, banks analyst at BNP Paribas, saw a "microscopic deterioration" in asset quality as a potential area of concern.

Royal Bank will pay an 11p dividend, up 16%.