Four years after the merger of Lloyds Bank and TSB Group, the staid world of British banks is stirring again. Talks between Alliance & Leicester, the former British building society, and Bank of Ireland could finally spark the long-predicted consolidation of the industry.

It has been a long time coming. British banks have stood aside from the merger frenzy that has consumed continental European rivals in the last six months. Banco Santander's merger with Banco Central Hispano in Spain has been followed by Paribas and Societe Generale joining together to try to repel Banque Nationale de Paris in France.

Meanwhile, the closest thing to consolidation in the British banking sector has been last year's acquisition of Birmingham Mid shires, a small mutual mortgage lender, by Halifax, the market leader in home loans. Will that change with the disclosure of advanced merger talks between Alliance & Leicester and Bank of Ireland?

Not necessarily is the immediate answer. Although this would be the biggest merger since Lloyds bought TSB for £5 billion sterling in 1995 (€7.54 billion), the combined group would rank only eighth in Britain by assets. Its branch network would be less than half the size of either of the divisions of Lloyds TSB Group. In mortgages, its market share of 6.4 per cent would place it fifth, way behind the price-setters such as Halifax.

Yet even among larger banks, the talks could pick away at some of the psychological barriers that have held up the process of consolidation. And mid-sized players such as Woolwich and Bradford & Bingley that would compete directly with the new group may examine their options.

There are several reasons why British banks have not rushed into mergers. First, Britain is already a highly concentrated market in comparison with France, Germany or Italy. The big four British clearing banks believe regulators would not allow them to merge with each other, because of the resulting market dominance in small business banking.

Second, Britain remains outside the single European currency. The single European banking market is still a more distant concept in London than it is in Paris or Milan. That reduces the sense of pressure that banking executives feel to protect themselves through mergers.

Third, British banks continue to make profits that - both in terms of cashflow and return on equity - make most of their European rivals green with envy. "I don't think the UK banks are totally uninterested in the consolidation going on in Europe, but the urgency for change is not there, because they are at the moment extremely profitable," says David Townshend, a Goldman Sachs analyst.

This failure to take advantage of their superior profitability, to lay the foundations of a pan-European network, has arguably been the British banks' biggest strategic shortcoming recently.

Although A & L/Bank of Ireland would combine a British bank with one in the euro zone, it is hard to see the proposed deal as being driven by any pan-European ambition. Much of the rationale comes from Bank of Ireland's existing presence in England, through Bristol & West, the building society it bought for £600 million in 1997.

The near-term outlook for British banks, meanwhile, looks better than ever. Most tightened their lending policies and raised their pricing in anticipation of a recession this year. With the economic slowdown turning out to be less severe than predicted, the result this year will be lower bad debts and higher profits.

But if the current environment is reassuringly comfortable, it may not remain so for long. Improbable as it may seem in a market as profitable as Britain, competition is fierce across large swathes of the financial services market.

Much of the impetus for change comes from new technologies. The move to telephone and Internet banking has presented the traditional banks with a heavy investment bill. Even if the high street banks invest heavily, the shortcomings of their old central computer systems make it hard for them to keep up with new entrants such as Prudential's Egg direct banking operation, or credit card specialists from the US.

The changing face of banking technology has two effects in relation to mergers. First, economies of scale, traditionally elusive in banking, are becoming more readily achievable in specific market segments.

Second, the bulk of the cost savings to be gained from a merger now come from central functions and back office processing, rather than from branch closures. This widens considerably the list of potential merger partners.

One day it may even make cross-border mergers more advantageous, though for the time being differences in banking products and taxation make it difficult to achieve these savings in a merger spanning different states. Alliance & Leicester and Bank of Ireland avoid this difficulty because of the synergies to be achieved with the Bristol & West network.

At the same time, the prospect of a prolonged period of low inflation and low interest rates has implications for British banks. This could affect their ability to maintain a wide margin between the interest rates they charge on their loans, and receive on deposits.

A large shake-out may be some way over the horizon. But Alliance & Leicester's talks with Bank of Ireland seem likely to send rival banks back to their files of potential merger partners with renewed zeal.