When the dust finally settles on the British banking sector’s biggest shake-up in a generation, the competition authorities will face an unprecedented new challenge to keep customers safe.

The Office of Fair Trading (OFT), the UK’s primary competition watchdog, takes a keen interest in retail financial services. It spent months probing the personal protection insurance (PPI) market before referring it on to its bigger, more powerful brother, the Competition Commission.

More recently, the OFT picked a fight with the combined might of nine high street banks over bank charges and overdraft fees leading to the continuing High Court case.

Yet while these interventions were in response to markets that came about through gradual changes over a number of years, the OFT is now faced with an entirely different challenge: policing a market that is the product of a seismic – and Government-created – shift.

The exact nature of this new market is still taking shape, but, with a merged Lloyds TSB and HBOS, in addition to a combination of Abbey, Alliance & Leicester and some of Bradford & Bingley, the OFT is looking at regulating two big banks that ordinarily would not have been allowed to reach their size through mergers.

If parts of Bradford & Bingley are merged with Northern Rock, then the OFT may find another strange beast on its radar in the form of a substantial state-owned mortgage bank. Such a bank would be subject to the same competition restrictions as any other, but worried rivals have questioned whether the OFT – independent of but funded by the Treasury – might have the appetite to take it on.

Once the mergers have been waved through, they cannot be undone or appealed against, so the OFT cannot simply demand that these banks be split apart. Neither can it say, for instance, that Lloyds TSB/HBOS’s estimated 28 per cent combined share in residential mortgages is too large and, therefore, anticompetitive. A crucial aspect of competition law is that while the potential to have a large market share is a legitimate reason to block a merger in advance, if the deal goes through anyway, then the regulator cannot seize on that market share as a stick with which to beat the newly merged bank.

Despite this, Stephen Rose, a partner at Eversheds, the law firm, believes that the aftermath of recent changes will give the OFT a new opportunity to keep the banking market under review through its other powers of monitoring and investigating the market. These are less glamorous and slower than blocking mergers or ordering immediate divestments, but are just as effective. BAA’s recent decision to sell Gatwick is largely seen as a preemptive move ahead of a formal divestment order after a competition investigation.

While some experts believe that it will be business as usual for the OFT in the new banking paradigm, others are more suspicious. Stephen Tupper, a partner at Watson Farley Williams, the law firm, said: “The banking market is changing by the day and it’s impossible to predict who these new banks will be competing with and in what kind of regulatory system they will be operating in, both of which are crucial to determining how they will be regulated by the OFT.”

Mr Tupper believes that we are entering a new era of prescriptive banking regulation, which could have a substantial knock-on effect on competition regulation. If, for example, the FSA places limitations on certain basic savings products to the extent that it erodes competitive advantage and all banks are essentially offering the same product for the same price, then consumers may find themselves drifting towards Northern Rock with its Government-backed guarantee.

If Northern Rock gets too large a share of the market and it looks bad for consumers, then how does a government-funded regulator tackle a government-owned bank that got into its position of dominance because of government regulations?

What can the OFT do?

Outside a merger, the OFT can intervene when it suspects:

— businesses of price-fixing or other cartel activity – it can investigate and issue fines

— abuse of a dominant position (ie: through pricing) – again, it can fine

— consumers are losing out – it must pass its findings to the Competition Commission (CC). If it concurs, the CC can order remedies including forced divestments or a demerger

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