LONDON - Nationwide's 2.9 billion pound ($3.7 billion) play for Virgin Money is fuelling talk that Britain's biggest banks might pounce on smaller lenders, heralding an M&A watershed as competition to lend reaches new heights.

The all-cash deal proposed by the 140-year-old mutually-owned building society is potentially the biggest British banking takeover since the 2008 global financial crisis.

It is also a bold challenge to the dominance of Lloyds Banking Group, Barclays, HSBC and NatWest, after efforts by mid-size and challenger banks over the last decade to break their hold had little success.

Nationwide's proposed takeover would create the second-largest mortgage and savings provider in the UK with close to 700 branches, just as most rivals rapidly downsize in-person banking services.

Growing costs and falling margins for smaller lenders like Virgin - which joined forces with Clydesdale Bank in 2018 - have made Britain's banking sector ripe for consolidation outside the "Big Four".

Coventry Building Society, another mutually-owned lender, said in December it had entered exclusive talks to buy Co-op Bank, another example of how smaller players are teaming up to better their prospects.

Shawbrook, a specialist lender backed by private equity groups BC Partners and Pollen Street, approached Starling Bank about a deal last year but was rebuffed, two sources familiar with the matter told Reuters.

Shawbrook also bid for Co-op and made failed approaches for Metro Bank, sources previously said.

Shawbrook declined to comment. Starling did not immediately respond to a request for comment.

"This might be the time for consolidation in the industry," said Douglas Grant, Managing Director of newly-licensed Conister Bank, pointing to stock markets undervaluing banks and the appeal for lenders to deploy spare capital on acquisitions.

The FTSE 350 banks index has risen by around 10% since the end of 2022, compared with a 32% increase in the STOXX index of euro zone banks.

Morgan Stanley analysts highlighted the low valuations across European banking "which a player with cash can leverage".

Antitrust concerns have loomed over potential banking takeovers in the UK, especially as regulators sought to encourage newer entrants to promote competition and address "too big to fail" fears following the financial crisis.

But some analysts on Thursday said that Nationwide's proposed deal implied a warmer welcome from regulators, particularly if buyers can argue consolidation would enable them to offer better services and products to consumers.

"This does feel like a significant shift...We had previously assumed that regulators would not support the combination of incumbent challenger banks given their objective of promoting competition," analysts at KBW said.

An enlarged Nationwide would have a combined market share in mortgage lending of 15.7%, up from about 12%. Together with the Big Four and Santander, the combined share would rise to 80%.

Yet the UK mortgage market would remain highly competitive and in other products such as unsecured loans, Nationwide would have less than a 10% share, analysts at Peel Hunt noted.

"From the perspective of the bigger banks, the opportunity to acquire these mid-tier institutions gives them access to not only customers, but also talent and tools which would take time and investment to replicate," said Simon Kent, Global Head of Financial Services at consultant Kearney.



Despite the strategic rationale, there remain many impediments to potential deals, several banking sources said, and a massive flurry of takeovers is not inevitable.

Some banks have already moved to bulk up and are busy integrating new acquisitions.

Next week marks the first anniversary of HSBC's rescue of the UK arm of failed Silicon Valley Bank, while Barclays clinched a 700 million pound deal to buy the banking operations of retailer Tesco last month.

Some smaller banks are too niche to elicit interest and for others, owners and managers are likely to want too high a price, analysts say.

OneSavingsBank, Secure Trust Bank, Vanquis and Metro may all appeal to possible bidders, KBW analysts said, pointing to their relative valuations.

Representatives for the four banks declined to comment.

Conister Bank's Grant said mid-tier banks hoping to acquire their way to success should proceed with caution.

"(British banks) need to specialise in the products they sell, so Nationwide you think of mortgages, Shawbrook, you think of SME lending," Grant said. "So gaining more market share in your specialist market would make sense from a consolidation perspective." ($1 = 0.7844 pounds)

(Additional reporting by Amanda Cooper and Pablo Mayo Cerqueiro; Editing by Kirsten Donovan)