You know those days when you just don't want to answer the phone?

The crash of 1987 may have wiped a fifth off the value of London shares in the space of a week and shaken the financial system to its foundations, but one thing that remained naltered was the market’s belief in its own ultimate invincibility.

Within two years of Black Monday Deutsche Bank had scooped up merchant bank Morgan Grenfell for nearly #1bn. This was followed by a stampede of foreign buyers descending on such venerable institutions as Warburg, Kleinwort Benson and Barings. Meanwhile, top domestic players NatWest and Barclays were busily throwing millions at their investment banking arms NatWest Markets and BZW while the sores of large equity exposures were still festering.

“For those that survived the crash it is probably safe to say the damage some suffered over time contributed to their selling out to foreign buyers,” says Matthew Czepliewicz, banking analyst at Salomon Brothers. “It drove home the point that these are increasingly volatile markets and even if they weathered the storm, the equity base of a Warburg and its business mix perhaps wasn’t going to be a guarantee of consistent performance in the longer term.” Enter Swiss Bank Corp, whose London broker Savory Milln was far too small to satisfy its ambitions, especially when confronted with arch-rival UBS’s successful build-up of its own Phillips & Drew.

“Despite the crash the appetite for buying London investment banks has in no way been diminished,” says Martin Cross, analyst at UBS. “There is no evidence of any fears of a repeat of the 1987 crash. It did not have any lasting effects on strategy.” For instance, Schroders, the largest of the remaining independent investment banks, has roughly doubled the size of its fund management business since the crash.

The two big UK players took different approaches to coping with the crash and this had a big impact on their relative positions today: BZW continued to provide prices and deal for its clients. County, as NatWest’s merchant banking business was then known, virtually stopped answering the telephone and got its head below the parapet. “BZW made a lot of friends in those days,” says Hugh Pye, analyst at Robert Fleming. “If you are dealing for your customers in a crash they will not leave you.” The result is that NatWest Markets has been plagued by woes from the outset, lacking strategic direction, competent leadership and the tight controls that could have avoided the recent interest rate options book debacle.

However, when other banks were hoovering up every broker in sight, Lloyds Bank deliberately turned its back on Big Bang. Sir Brian Pitman, then the bank’s chief executive, said it was madness for clearers to buy investment banks. His simple rationale was that in a good year the staff want all the profits, while in a bad year the staff want all the profits. It should be noted that of all the bank chief executives around at the time of Big Bang, Pitman was the only one left 10 years later.

“There were far too many players in investment banking in 1986 and we felt that the ability to achieve an acceptable return on capital and fulfil our objective of maximising shareholder value in that business was nil,” says Kent Atkinson, Lloyds TSB’s finance director.

Pitman must be relishing a taste of sweet irony after his takeover of TSB Group in 1995. TSB was, after all, a classic example of what troubled times held in store for a bank without investment banking experience.

TSB was a stodgy yet profitable institution with a huge customer base made up largely of little old ladies sending in a few pounds a week to save up for their funerals and who never missed a payment. Shortly before the crash TSB could not resist the pull of Big Bang: it went public and squandered nearly #800m of its flotation proceeds to acquire Hill Samuel merchant bank. Then the bottom fell out of the market and some five years later TSB was forced to ring-fence #1.8bn of Hill Samuel’s bad debts.

Two years after that TSB fell into the arms of Lloyds – which promptly dismembered Hill Samuel and merged the rest into its own operations.

“Lloyds was right and if there were another crash today shareholders would be putting some tough questions to the banks,” says analyst Peter Thorne at Paribas. “They would want to know why Lloyds TSB is earning more than 30% on its capital while NatWest Markets and BZW lag behind with ROEs of 8% to 10%. A bear market would certainly show up the weaknesses of the investment banks.”

Salomon Brothers’ Czepliewicz says that a 10-year stock return of what were then the big four clearers would show Lloyds to be the best performer by far. “Lloyds was also the first to focus seriously and consistently on cost-cutting,” he says. “Investment banking and cost-cutting are about as inconsistent as you can get.”

So after almost three years of a bull market, what if the unthinkable were to happen today? Where would the big losses hit? “The banks lost money in 1987 on their market-making operations,” says Fleming’s Pye.

“They were left holding stock they couldn’t offload. Today there is a lot more proprietary trading and that is where there could be huge losses.

All it would take is a massive drop in confidence and for some nervous institutions to start dumping big sell programmes.”

It would not be so much a question of survival, since even the 1987 crash did not produce any bankruptcies. It is really a question of how long a bank is willing to cope with severely reduced returns. “Most would be willing to tolerate poor returns for a number of years to be perceived to be among the super-league survivors,” says Salomon Brothers’ Czepliewicz.

One exception might be NatWest Markets.

Another crash, with severe aftershocks indicating rising rates over a two-year-or-so period, could finally provide the catalyst for NatWest to unload its investment banking arm to the highest bidder. BZW too, for that matter. Barclays’ chief executive Martin Taylor is very return driven, and would not be likely to turn down the right price.

Jules Stewart is a freelance journalist.