Great Britain's "big bang" of the 1980s has gone bust. Four years ago, British banks were riding high. Today, they are struggling through one of their worst patches in years.

Even their attempts to boost income by raising service fees set off such a stream of public and political criticism that the banks backed off a bit.

Overenthusiastic lending in the booming 1980s bred a mountain of bad debts once the boom gave way to an economic recession deeper and longer than anyone foresaw. Property values tumbled, undermining loan collateral.

Part of the Problem

"The way in which we and our customers responded to the economic climate of the late 1980s contributed to the problem," admitted Lord Alexander, chairman of National Westminster Bank. "We shared in the optimism about continued growth that characterized that period, ad there were undoubtedly some departures from the principles of sound lending."

Many stricken borrowers come from the mass of small and medium-sized businesses, personal customers, and some bigger corporations like the Maxwell group of companies, which are at the heart of the banks' traditional domestic lending business.

"We got the economy wrong," said Midland Bank chief executive Brian Pearse. "We thought in 1986-88 that we were in a German-type economy: low inflation and low interest rates."

The problem is that the situation changed, and banks did not keep up.

In fiscal 1988, the nine biggest banks in the United Kingdom averaged a handsome 16% after-tax return on equity. Last year, they averaged a miserable 5.5%, barely enough to cover their combined dividends.

Some Bright Spots

A bright spot is the banks' strong capital position. Weak loan demand made it easier to shrink balance sheets. This helped boost Tier 1 capital ratios for the tope nine to an average of 6.3% by Dec. 31, 1991, comfortably above the 4% minimum they are required to meet.

And the banks now have less need to raise fresh capital from a skeptical stock market.

They have also got their problem-country debt exposure under control. A Bank of England analysis showed that the biggest banks' total exposure fell from $28.6 billion in 1988 to $19.5 billion last year. Of this, 60% was covered by bad-debt provisions, compared to 32% in 1988.

Indeed, problem-country debt provisioning may now be excessive secondary-market values for developing country debt stand well above net book values. In fiscal 1991, National Westminster, Midland, and Barclays were able to boost reported profits by releasing unwanted provisions.

But that is about all that can be said on the plus side.

Now, for the Negatives

Worries about offshore lending have been replaced by concern over shaky domestic loans, especially to the real estate sector. Writeoffs against domestic lending soared from $1.1 billion in 1988 to $11 billion in 1991. Total domestic loan provisions trebled, to 3.4% of the total domestic loan book.

Were it not for bad-debt charges, the top nine would have been able to report a sharp upturn in profitability, for they have all been pushing up revenues from fees and commissions and widening their interest margins as prime rates fell.

But that, perversely, aroused widespread public and political criticism. Bankers were charged with forcing their customers to pay higher charges and wider margins because of the banks' lending mistakes.

Today, further price increases are limited by competition from other financial institutions. Nor is economic recovery yet in sight. When it does come, the pickup is expected to be show because household and corporate debt are still historically high.

"We expect revenue growth to be sluggish throughout the 1990s," said Brian Pitman, chief executive of Lloyds Bank.

Another hindrance is low inflation, expected as a result of British membership in the European Community's exchange-rate mechanism.

The government joined this club because it sees low inflation as a prerequisite for sustained economic growth. But low inflation is no help to borrowers and their bankers struggling with overindebtedness.

In the past, when commercial and residential property prices were ravaged by recession, high rates of inflation could be counted on to float the real estate sector off the rocks. With low inflation, the wait will be longer.

Not all of the top nine U.K. banks have been equally hard-hit.

Caution's Payoff

Lloyds Bank, the fifth-biggest, wisely steered clear of the fashionable rush into securities dealing when the London stock market was deregulated in 1986 -- the so-called "big bang." It is now Britain's most profitable bank, with an 18.9% post-tax return on assets last year, despite hefty bad-debt charges.

Abbey National, until lately a building society but now the fourth-biggest bank, still eschews corporate lending. preferring to concentrate on home loans and life insurance sales. It achieved a 14.6% return on equity last year, after tax.

Standard Chartered, Royal Bank of Scotland, and Bank of Scotland are also ahead in the averages.

But all banks face the same underlying problem: how to make a satisfactory return in a overcrowded market where demand remains sluggish. One method is to boost noninterest income from insurance and other fee- or commission-earning financial services.

Revenue Redistribution

Barclays, National Westminster, Midland, and Lloyds all now earn more than 40% of their revenue from noninterest income.

National Westminster has reduced its major corporate client list from 2,000 to about 800 in four years while distributing a broader range of products through its costly branch network, winnowing underperforming services, and concentrating on more profitable activities.

Internationally, all the largest British banks are focusing on Europe. Worldwide, they stress wholesale and investment banking, private banking, treasury, and foreign exchange business.

The big challenge, however, is cost containment.

With the benefits of their huge investment in technology now coming through, banks are looking for big savings in jobs and overhead costs. Traditionally, said Shearson Lehman analysts, British banks have operated with very heavy cost bases, with high employment levels, and poor systems. But operating costs as a percentage of total income are now falling.

Barclays, National Westminster, Midland, and Lloyds aim to pare 15,000 jobs this year, having cut 22,000 last year. The layoffs include only a few of the lending officers responsible for today's harvest of dud loans. Instead, banks are tightening staff training and credit-sanctioning procedures.

Had Lloyds Bank succeeded in this year's aborted bid to take over Midland Bank, pressures might have eased a notch. Lloyds reckoned that merging the two banks would have generated about $1.2 billion in annual savings by making it possible to cut 20,000 jobs and close 1,000 branches.

Instead, victory went to Hongkong and Shanghai Banking Corp., the British overseas bank with only a tiny U.K. base. As a result, Midland, one of the weaker players in the market, will be strengthened, putting the rest under even greater pressure to rationalize costs.

Their response will be guided by some new leaders. Tom Prost is resigning as National Westminster's chief executive. He will be succeeded by Derek Wanless, his 44-year-old deputy.

Sir John Quinton is to hand over the chairmanship at Barclays to Andrew Buxton, now managing director and deputy chairman. Both Sir Jeremy Morse, chairman, and Mr. Pitman, chief executive, are to leave Lloyds. And Bank of of England governor Robin Leigh-Pemberton will retire next year.

A new generation is taking over Britain's banks as they face the challenges of the 1990s. [Tabular Data Omitted] Mr. Jones is a London-based freelance reporter.

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