Following on from Kathryn Shepley's recent post on high-cost credit, Alex Sanger here looks at it's companion CP on overdrafts. I've written before about the slower pace of FCA policy development in the consumer credit space compared to its Supervision activity. This may be a sign the balance is just starting to shift a little.

Recently, the FCA published CP18/13 in relation to overdrafts on the back of its work on the High-cost Credit Review, which was launched in 2016. This includes elements of consultation and discussion. The FCA is consulting on changes to its rules and guidance to increase consumer awareness of how they are using overdrafts and how they work. In the discussion element of the paper, the FCA is considering further intervention on pricing structures and on measures to ensure firms take action to address repeat overdraft use.

Over the last decade, the pricing structure of arranged overdrafts has evolved, with many firms moving from interest based pricing, to fixed fees. Whist this can prove beneficial for those with higher balances, those with lower balances will end up paying significantly more than if the overdraft was provided on a percentage interest based pricing structure. Research commissioned by the FCA also indicates that consumers often do not view overdrafts as a form of debt and this is causing the regulator concern given that data has shown that overdrafts can often prove more costly than other credit facilities.

Through our experience of working with a range of high-cost credit providers, we recognise that many of the customers who end up in debt spirals, which rely on higher cost credit such as payday loans and home collected credit, are those that also have persistent overdraft debt.

As a result, it is no surprise to us that the FCA is seeking change to improve consumer engagement, customer awareness and customer outcomes in the overdraft market.

Consultation

One of the key challenges faced by consumers is the ease with which they can compare overdrafts between lenders and against other credit products. We have observed several examples of this working poorly for customers across the market, where pricing examples provided by firms are difficult to compare. Indeed, in some cases, they are difficult to compare against other overdraft facilities offered by the same firm! Therefore, we agree that there is a need to improve the key information provided to potential overdraft customers, including the provision of an online (or mobile app) calculator to assist customers in assessing the costs of overdrafts for different patterns of use. The FCA expects this increase in transparency to drive competition, and potentially to increase quality and reduce prices for customers.

The advent of Open Banking could play a significant role in the future of cost comparison analysis on overdrafts. On the assumption that customers give access to their bank account data to relevant parties, tools could be developed to base cost comparisons on actual transaction histories. This would further aid comparison and drive competition. However, due to its assessment of the harm already present in the overdraft market, the FCA has decided not to wait for such developments to materialise and is pushing ahead with its proposals for firms to make online calculators available to consumers so that they can see how much they will be charged for their overdrafts.

The FCA also highlighted the findings of the Competition and Markets Authority’s (CMA’s) 2016 retail banking market investigation, which found that whilst overdraft users are the most likely customers to benefit from switching current account provider, they are also the least likely to apply for a switch. This is one of the key reasons behind the FCA’s proposal to require larger providers of personal current accounts to provide online (or mobile app) eligibility tools to help reduce barriers for some customers when they consider switching.

In addition, the FCA is proposing to enhance the CMA’s requirements for banks and building societies to automatically enrol customers into a set of overdraft alerts. These are aimed at notifying customers by text messages or push notifications in mobile apps, so that they have an opportunity to avoid overdraft use or to reduce or avoid overdraft charges. We see this as a sensible step and one that we expect most customers to welcome.

Discussion

However, the FCA does not consider that the above proposals alone will address all of the potential harm and so it is also inviting discussion about potential intervention in how firms structure their prices. This includes a potential ban on the use of fixed fees, price capping, and measures to ensure firms take action to prevent repeat overdraft use. The FCA is showing again that it is willing to intervene and control the pricing of products in the consumer credit market, where it sees evidence of consumer harm.

The FCA expects that a move from fees to an interest rate charging structure, together with the alignment of arranged and unarranged pricing and APRs to encourage comparability, should lead to significantly lower prices for unarranged borrowing. This should provide relief for some of the most vulnerable borrowers and those that only go marginally overdrawn.

From a commercial perspective, the FCA’s research indicates that firms achieve 30% of overdraft related revenue from unarranged overdrafts. Should fees and charges fall significantly because of this or any further consultation, it prompts the question as to how firms will replace that gap in revenue. It will also be interesting to see how firms generally react to these proposals, including those that provide an overdraft facility as part a packaged bank account, which can come with a monthly fee.

The FCA also highlighted its concerns in relation to repeat use of overdrafts and the complexity of this issue. Its research highlighted that customers do not see overdrafts as debt and those that clear their balance each month (in full or in part) consider their pattern of use as low risk and short term. The reality is that these customers can become dependent on their overdrafts to the point that removing access is an ‘unworkable’ solution which, for those most at risk, could lead to a worse financial situation.

The FCA suggests that one solution would be to use a similar two-stage approach to that used to address persistent credit card use. This would require firms to identify and deal with customers showing signs of financial difficulty, encourage customers to change their behaviour and ultimately put forward proposals for repayment plans over suitable periods. The FCA also suggests alternatives including one that requires firms to reduce the charges it can apply to an overdraft over time to reduce the incentive on firms to allow repeat use.

In keeping with the intrusive approach being adopted across the consumer credit industry, firms should be under no illusions that the FCA is prepared to make significant changes to the way it requires firms to offer and administer overdraft facilities going forward.