Watch out - the fat lady's clearing her throat

With debts rising and a recession looming, Britain's banks could provide the setting for an opera of

Wagner really should have written "The Bank Cycle", because it makes terrific opera: full of drama, irony and gore. The first act would consist of the shadowy figure of the governor of the Bank of England muttering darkly about a collapsing world, and warning its inhabitants to prepare for the worst. The second would feature a chorus of clearing bankers strutting about like Meistersinger with a pompous refrain along the lines of: "OK, we sometimes make mistakes, but we know our trade." Then the third would lead into a climax of clashing cymbals and crashing banks, as a swelling Rhine-like tide of bad debts swept across the scene, leaving death and destruction in its wake. As the curtain fell, we would see the chairman of the British Bankers' Association uttering weakly: "Ah, but wait till next time!"

The beauty of such an opera is that it would have a timeless quality, a permanent contemporary relevance. In fact, we are already well into Act 2 of the latest cycle. In July, David Clementi, the deputy governor of the Bank, did the muttering bit: debts were mounting, the economic sky was darkening, it was time for caution, he said. Then, in August, the banks sang their contented chorus when they produced their half-year results. Yes, they chanted, times were getting harder, but they knew the risks and were prepared.

So a keyed-up audience now awaits Act 3. Will it produce the familiar, dread climax, or has history delivered its lessons at last?

The prospects are not good, for a couple of reasons. One is that the banks have never, in recent history, escaped serious damage during a recession. The classic case was in the early 1980s, when they were swamped with huge debts from collapsing businesses and were forced to set up intensive care units to try and keep some of their debtors alive.

Shortly afterwards, they wrote off billions of pounds of bad loans to the developing world. And then, in the late 1980s, despite promises that they had taken the lessons of the last recession on board, they got walloped again, this time by bad property loans and mortgages.

Much analysis has gone into the causes behind this seemingly irrational behaviour. One is that banks like to be biggest (not necessarily best), and the way you do that is by piling on as many loans as possible. Barclays, traditionally the UK's biggest bank, was overtaken by NatWest in the 1980s and fought back with a famous cry: "Number one by '91!" The ensuing drive for growth led to huge losses and a major board-level clean-out.

Another cause is that successive staff purges and cutbacks have destroyed banks' corporate memories. Where are all those dull but canny bank managers these days? Gone, replaced by call-centres staffed by hired help and credit- scoring computers. (In 1993, the Centre for the Study of Financial Innovation asked directors of four leading banks to write down the lessons of the 1991-92 recession for posterity, and we published the results in a booklet. Maybe we should reissue it as a public service.)

The other reason for being sceptical is that the banking industry is being shaken about by tremendous change: structural, technological and cultural, and this is fundamentally altering the way banks do business.

Take structure. The banks are going through a period of huge consolidation: Royal Bank of Scotland has taken over NatWest; the Halifax and the Bank of Scotland are merging; Barclays bought the Woolwich; Lloyds TSB almost took over Abbey National. The purpose may be to save costs and generate greater profits, but the real effect is to weaken management. The bigger the banks get, the harder it becomes to control what people are doing out in the field.

And then technology. Bankers say that they can replace banking nous with sophisticated quantitative models to run their loan books. So it all becomes scientific rather than human. Maybe, but it also destroys diversity. One of the strengths of the old system was that bank managers took individual views, so even if some were getting it wrong there was a chance that others were getting it right. What happens if the central loan computer is wrongly calibrated?

And there's another aspect to technology. The looming recession, if such it is, catches the banks as they face very fundamental questions about strategy: should they go for the internet in a big way, or WAP telephone banking, or interactive TV? None of these technologies currently offers a profitable banking business, yet all banks feel they should invest heavily in some kind of new "delivery channel". So there's more money flowing out there.

And then there's competition. Whatever banks may claim about quality of service, banking is increasingly about market share: the more you have, the more opportunity there is to make a profit. The easiest way to increase market share is through price: basically, you "buy" as much market share as you can afford, and most banks have targeted credit cards or mortgages, or both.

The battle for market share has been intensified by all the new entrants to the field: the Eggs, the Tescos, the Standard Life Banks, which have mounted very aggressive campaigns by undercutting the high street banks. Actually, a lot of these newcomers are beginning to flag because buying market share is very expensive. But even if they fade from the scene, they will have left their mark. Thanks to them, customers are now able to get much better terms from their banks, and the clearers' margins are being squeezed.

But if the banks now look heavily exposed to the retail sector, there is also discomfort on the business lending side because of the parlous state of many companies and specific problems such as the over-indebtedness of the telecoms sector. Nor should one ignore that UK banks have a heavy foreign exposure, and things are not too bright in the Far East, the US or, for that matter, the rest of the EU.

Is all this painting too dark a picture? Possibly. There certainly are chinks of light. What numbers exist suggest that ratios of bad debts are not as high now as they were at the same stage of the last downturn. The consumer side is proving surprisingly robust, which is good news for retail credit. On the business side, the word from the Bank of England is that the picture is one of big but concentrated problems, rather than one of generalised malaise. And the banks themselves are strong: if anything, they have too much capital.

Also, one can always hope that lessons really have been learnt. It is easy to be cynical about banks and overlook positive changes, such as the growth of rigour, the decline of complacency and the determination to survive. These are not conditions in which banks want to display weakness. In the old days, there was usually a helping hand - a banking lifeboat or a bailout by the Bank of England. Now weak banks just get ignominiously gobbled up by their stronger brethren, which is exactly as Wagner would have liked it.

David Lascelles is co-director of the Centre for the Study of Financial Innovation, a City think-tank