By Trevor Clawson.
British banks earn a huge amount of money from current account customers who regularly, or occasionally, slip into the red. In 2017, overdraft charges amounted to a hefty £2.4bn, with 30% of that total attributable to customers who had overstepped their credit limits, thus exposing themselves to additional charges.
But things are about to change. Having reviewed the market, banking regulator, the Financial Conduct Authority (FCA) is to impose new rules to limit overdraft costs while making the charging structures more transparent.
To many of us, arranged overdrafts are a useful safety net. But when a customer is dipping into his or her overdraft regularly, the charges mount rapidly. Worse still if the same customer goes beyond an agreed credit limit and enters the realm of the unarranged overdraft, even higher charges apply.
And according to the FCA, it is the most vulnerable customers who tend to be hit by the highest charges. Last year more than 50% of unarranged overdraft charges came from just 1.5% of bank customers. Statistically, they tended to be people living in ‘deprived’ areas.
So as the regulator sees it, change is necessary.
“It is clear to us that the way banks manage and charge for overdrafts needed fundamental reform,” said FCA Chief Executive, Andrew Bailey. “We are proposing a series of radical changes to simplify the way banks charge for overdrafts and tackle high charging for unarranged overdrafts.”
An End to Fixed Charges
So what does that mean in practice? Well as things stand, banks tend to charge fixed fees for arranged overdrafts, based on the number of days in each month that a customer uses the facility and how much is borrowed. Typically the fees – which could range from a few pounds to sixty or seventy, depending on the number of days the customer is in the red – will be taken from the account the following month.
Unarranged overdrafts up the charges ante in a significant way. When a customer breaches the agreed credit limit, a bank will often continue to provide access to cash but the fixed fees can be as much as £10 a day. Alternatively, the bank might simply ‘bounce’ any cheques or direct debits and charge a fee for each of the failed transactions.
So, the FCA is saying that banks should replace daily fees with what it describes as a ‘simple’ single interest rate, which must be advertised in terms of APR (annual percentage rate). Higher fees for unarranged overdrafts are to be banned.
In addition, rather than simply sitting back and raking in a lucrative income stream, banks will be required to identify customers who are using their overdraft facilities excessively. Under the proposed new rules, these customers will be given advice on how to manage their finances more effectively.
A Mixed Response
The FCA’s proposed crackdown has drawn a mixed response from the industry. UK Finance – the trade body for the financial services industry – argued that banks were already committed to protecting vulnerable customers.
“We recognise the need to support all customers, including those in more vulnerable circumstances and banks provide eight million free to use Basic Bank Accounts as part of this commitment,” said Managing Director, Eric Leenders. “The industry also offers a range of measures to help customers better manage their money.” These included free buffers on smaller overdrafts and text alerts to warn customers that they are incurring fees.
Challenger bank, Tandem gave the proposals a much warmer welcome.
“The FCA’s crackdown on overdraft fees is long overdue,” said Product Director Matt Ford. “Not only have banks been charging high fees to people who might be struggling to stay afloat, but there is also insufficient visibility on the extent and nature of these fees.”
There are two very different perspectives here. As UK Finance sees it, Britain’s banking market is highly competitive. What’s more, the current account switching service means that it has never been easier for customers to move from one bank to another. Thus, when it comes to overdraft charges consumers can identify the best deals and essentially vote with their feet. That competitive pressure is in itself a restraining influence on bank charges.
Tandem’s Matt Ford sees it differently, arguing that without regulatory action, most banks will be reluctant to abandon a lucrative revenue stream.
“The sad truth is that overdraft fees are how banks make money from current accounts. New banks and established institutions alike rely on these charging models and it’s their customers who lose out because of opaque pricing structures. It’s important to make sure that people are at the very least made aware of the rates they will pay, so they can make informed decisions,” he said.
An End To Free Banking?
It remains to be seen what the regulator’s proposals will mean for the wider community of bank customers – including those who do not use or need overdraft facilities. As things stand, overdraft fees, to some extent, subsidise free banking for customers in credit. There is a danger that a fall in overdraft revenues will prompt banks to charge (or charge more) for current accounts.
Having announced its plans this month, the FCA is now seeking feedback from the financial services industry, so the scrapping of higher fees for unarranged overdrafts and the switch to interest rates rather than fixed charges won’t happen overnight.
However, for those who want to avoid the high costs associated with unarranged overdrafts, there are some alternatives. Among the challenger banks, Starling and M&S Bank do not offer unarranged facilities. Instead, M&S provides a £50 buffer and Starling stops payment when the agreed limit is reached. Among the bigger banks, Lloyds has scrapped both unarranged fees and monthly usage fees. Santander has removed unarranged charges, but only from its fee-paying accounts. Other banks provide a buffer for a few hours, allowing customers to get back within their credit limits without incurring charges.
So will the FCA crackdown be good for consumers? That probably depends on circumstances. Lower fees and more transparency are to be welcomed. However, if banks respond by removing ‘unarranged’ facilities, the result could be that important direct debit payments might not be honoured. This could trigger a different set of problems. But whatever the outcome, change in the overdraft market is underway.