Europe's biggest banks are preparing for a merger war that most see as inevitable but few are urgent to fight.

The battle will be fought, in the words of one chairman, "for all the wrong reasons" - namely to cull a tier of unprofitable competitors incapable of restructuring and to seize as much territory as possible, regardless of the strategic compromises. "The fittest and the biggest will survive, and the smallest and the weakest will be bought," said the board member of one top-10 European bank.

This is precisely the thinking behind Bank of Ireland chief executive Mr Michael Soden's floating of the idea of a defensive merger with AIB Group.

His proposal is based on the fact that, individually, both AIB and Bank of Ireland will prove snack-sized bites for larger European rivals. He also hopes to retain the national character of the top Irish banks, which sceptics of cross-border amalgamations cite regularly as a blocking factor.

In interviews this month, executives in Europe's banking capitals say they expect the shooting phase of the merger war to start in mid-2003 at the earliest and perhaps not before 2005. Some even say 2007 - in any case, much later than was predicted earlier this year when the introduction of euro coins and notes fuelled speculation that Europe's banks were striving toward borderless operations.

Senior executives privately acknowledge that "everybody is talking to everybody", as elite teams of strategists seek allies, identify rivals and prepare battle plans.

In banking capitals across Europe, they deliver a similar message. Nobody admits feeling pressured to find a partner but, as one said, "We want to be at the table if something happens."

"In the medium term, there will be a multi-country player in western Europe," said Mr Alessandro Profumo, chief executive of UniCredito and one of Europe's most admired merger artists for combining 11 Italian and Eastern European banks.

"If somebody does something, it will be like an enzyme in the system, a catalyst in the market," said Mr Profumo, a rare optimist about the logic of cross-border operations who predicts a wave of new alliances in Europe within the next five years.

Executives disagree on whether the new constellations will emerge from "mergers of equals" palatable to provincial regulators and executives but perhaps lacking in business logic, or whether strong banks will simply absorb the weak.

"We will not see mergers of equals but winners and losers," said the chairman of one of Europe's biggest banks, speaking on condition of anonymity.

Expectations for huge, cross-border banking mergers were disappointed after the introduction of the euro as an accounting unit in 1999, and as hard currency in 2002, led to predictions that Europe's fragmented banking market would consolidate.

Standing in the way are protectionists seeking to create national champions, an economic downturn and the belated recognition by some that the economics of pan-European banking are questionable.

"Europe is not Europe for financial institutions. The euro is a common currency only in the nominal sense," said the top-10 board member.

Italy and France, for example, have been highly protective of their national banking champions. Their central banks have been wary of efforts by outsiders to purchase controlling stakes in France in Crédit Lyonnais or Société Générale and in Italy, BNL and Banca di Roma.

At the same time, an economic downturn has revealed the ugly reality that many banks are woefully unprofitable. Confronted with a dusty armoury of weak shares, many have beat a hasty retreat from the merger front.

Finally, bankers are reliving Europe's slow and painful political genesis by questioning the fundamental economic logic of cross-border operations. On one side is the promise of economies of scale and converging cultures; on the other is the local, private nature of the bank-customer relationship, similar perhaps to that between doctor and patient.

Europe still comprises culturally, politically and economically diverse nations and no common-currency facade will alter the fact that the vast majority of banking business takes place regionally or even locally.

"Banks are an integral part of society on a political and cultural level," said one executive. "You go home to your doctor when you are ill."

Unicredito's Mr Profumo is one of the more optimistic banking leaders, a firm believer of the "matrix" model superimposing divisional responsibilities on local networks while combining back-office and production activities.

"We will always have the market or the country as the dominant dimension but you must maintain the ability to bring in the capabilities such as know-how to the customer," he said.

All bankers are acutely conscious of the inevitable cultural and political clashes expected in a cross-border deal. A cross-border alliance that seeks to create a more efficient operation would, by definition, require layoffs and closures, sparking social issues that foreigners may find difficult to tackle in every market. "You can imagine just how difficult that would be with a foreigner. It is not possible," said one board member responsible for European strategy at a top-10 European bank.

The result may be that banks, either to seize territory or bolster their defences, may embrace mergers that make little economic sense - and which in the long run could prove a disservice to shareholders and the European economy.

Mr Gianluca Trombi, executive director at Morgan Stanley in Italy who oversees financial sector mergers and acquisitions, said the first big cross-border move would likely disappoint shareholders who overlook its long-term logic.

"For the first cross-border merger, the chief executives must accept little value creation," he said. "The first goal is to reach a size that is sufficient to give them the muscle to do a second move. . . For the second step, they could create value." - (Reuters)