Banks get fewer and fewer . . . and bigger and bigger. Regulators should try to imagine what would happen if one of them went bust. The consequences are unthinkable

As I write, a "For Sale" sign has been hoisted above Egg and a bidder is expected to offer £1.4bn or so any day now. Royal Bank of Scotland, Lloyds TSB and the American credit card group MBNA are the front-runners to buy the online bank. An established bank is destined to swallow another morsel.

Our banks are getting ever bigger. Not just in absolute terms, but also in comparison with other businesses and with the economies they serve. Twenty years ago, there were no banks among Britain's ten biggest listed companies by stock market value. Barclays was 14th, NatWest 16th, Lloyds Bank 28th. Today, five of Britain's ten biggest companies are banks. HSBC is second, Royal Bank of Scotland fifth while Barclays, HBOS and Lloyds TSB are eighth, ninth and tenth respectively. Banks dominate the UK corporate landscape, elephants matched in size only by a handful of oil majors and drugs giants.

Over in the States, the domination by the banks is less well advanced. But J P Morgan Chase - itself the product of a mega-merger - has just announced plans to buy the huge, Chicago-based Bank One for $58bn. The combined group will be the second-biggest bank in the world. Measured by assets, profits or stock market value, the noughts go on and on.

Does it matter? Not to shareholders, who lap up each merger because of the cost savings (the Bank One deal will lead to 10,000 job losses). Perhaps a little to customers, who see branches closed. But what about governments and taxpayers? Has anyone considered the potential damage if something went wrong at one of these new leviathans?

Banks are not like other companies. They are inherently unstable. They borrow short-term and lend long-term. If the depositors all turned up asking for their money, the banks would go bust. Cue depositor panic and a domino effect of runs on other banks. Result: financial Armageddon and a new economic ice age.

That is why banks are carefully licensed and policed. It is why every country has a regulator to ensure banks keep a hefty cushion of emergency capital. It is why every developed nation has a system of depositor protection guaranteed by the government. But the entire system is underwritten by taxpayers.

True, size lessens the chances of failure. Giant loans that go wrong are no more than a mosquito bite to the biggest beasts. Citigroup, the biggest bank of all, has just written off $242m against the Parmalat scandal, yet barely paused for breath, still able to report profits of $17bn. Even quite big frauds can easily be absorbed. National Australia Bank - best known in the UK as the parent of Yorkshire Bank and Clydesdale Bank - has admitted that four rogue traders have cost it anything up to £255m. There is no serious damage to its financial strength.

But if a big bank does go bust, the damage to the financial system and the cost to taxpayers are barely imaginable. J P Morgan Chase, even before the Bank One deal, has derivatives contracts outstanding with a face value of $22.4 trillion - equivalent to twice the US GDP. Even Uncle Sam would struggle to mop up if something went badly wrong there.

Supervisors need to ask themselves what they would rather share a room with - a firework with a one in 100 chance it could explode, or a bomb with a one in 1,000 chance?

Patricia Hewitt, the Trade and Industry Secretary, has to decide whether to clear the merger of the Littlewoods catalogue business with the GUS home-shopping division. Nothing difficult about that, except the businesses are both owned by the Barclays, the twins in the process of taking control of the Telegraph papers. The Barclays could face nasty losses if they were forced to divest one of the two businesses. They paid £590m for GUS last May, intending to merge it with Littlewoods. But the deal was referred to the Competition Commission and its report now rests with Hewitt.

Is it a coincidence, I wonder, that within hours of the Telegraph deal being announced, Sir David Barclay let it be known in a Guardian interview that the Conservatives could no longer rely on the papers' unquestioning support?

Tom Glocer, chief executive of Reuters, has coined a nice little neologism that could be adopted by any minister in a hole. "I am confident that we have now passed the inflection point in our recurring revenue decline," he told investors at the company's results. He meant sales were still plunging, but not as fast as the last time he had to face the City. Investors lapped up the flavour of progress achieved and scientifically measured. I commend the formula to ministers. As in: "We've reached an inflection point on hospital waiting lists/violent crime figures/the public sector deficit" - or any other indicator still moving in the wrong direction.

Patrick Hosking is deputy City editor of the London Evening Standard

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