At first sight, one of the key attractions of Bank of Ireland's proposed merger with Alliance & Leicester was the presence it gave the combined entity in the British mortgage market.

The £13 billion (€16.5 billion) merger would have created the eighth largest financial institution and the fifth largest mortgage bank in Britain, allowing Bank of Ireland to build on the bridgehead it established in that market with the 1997 acquisition of Bristol & West Building Society.

Yet, on closer inspection, it was the prospect of an increased dependence on the British home loans market, along with the proposed management structure which ceded the top position to Mr Peter White of Alliance & Leicester, that turned many investors against the cross-Border alliance.

On learning that discussions on a link-up were under way, ABN Amro cut its buy rating on Bank of Ireland to hold, pointing out that the cost of diversification to the bank was "the dubious benefit of an increased exposure to the highly competitive UK mortgage market".

Effectively, investors felt that Bank of Ireland would be swapping its highly profitable domestic earnings stream for a market where the growth outlook for earnings was not as strong and competitive pressures were greater.

According to ABN Amro banking analyst, Mr Eamonn Hughes, Bank of Ireland's exposure to the booming Irish economy would fall from some 75 per cent of profits to 40 per cent, diluting its "growth story" potential. Meanwhile, exposure to the British mortgage market would rise to around 40 per cent from 21 per cent.

Further strategic expansion was also likely to come in the slower-growing Britain where most of the large mortgage banks, such as Halifax, Northern Rock and Woolwich, have been experiencing pressure on interest income from their core savings and lending operations. Composite estimates for the sector show that interest income rose by just 1.6 per cent last year while it fell in the second half.

"The UK mortgage market is a relatively slow growth market compared with Ireland," said one British banking analyst. "Volumes in the first half of 1999 are shaping up pretty well and better than we expected going into the year but it is a market facing long-term progressive margin erosion."

Falling interest rates and increased competition from both mutuals and new entrants to the market are among the factors bearing down on margins, creating an environment where companies generally are looking to merge in a bid to cut costs and diversify the products they sell to mortgage customers.

The question now is what will Bank of Ireland do with its existing British mortgage operation? Will it continue to look for a partner for Bristol & West in Britain or will it set its sights elsewhere? If it opts to grow its British mortgage business its options are limited. It will find it difficult to spend its sizeable war chest on a large acquisition in the £1 billion range as there are not that many companies of that size available, according to British analysts. But smaller acquisitions would not deliver the scale it requires.

"Their options are selling Bristol & West for a full price to someone else who can realise the cost gains or waiting for another mortgage deal to comes up," said one analyst.

However, the bank has plenty of time to consider its options. According to Mr Robert Law, banking analyst with Lehman Brothers, Bank of Ireland's domestic franchise is so strong that it has a perfectly sustainable future on its own.