The FCA yesterday confirmed proposals to radically overhaul how banks charge for overdrafts. This is a seminal change and comes after years of seemingly endless investigations into the sector by a range of regulatory authorities. For many, the reforms seem to be common sense but a lot of work lies ahead, with significant risks for both the regulator and firms.
Below my colleague Oliver Morgans provides a brief summary of the changes, together with some thoughts about the implications for the regulator, and for the major banks.
The change confirmed today is big news. £2.4 billion per annum is currently made from overdraft charging, 30% of which is from unarranged overdrafts. That revenue source will no longer be allowed in the new world and banks will have to consider hard how to re-structure their pricing. This poses significant costs and risks. But in many ways the risks are no less for the regulator, since the proposals appear less interventionist than the FCA has introduced for similar markets in recent years, notably the payday and now rent-to-own price caps.
For overdrafts, it is clear that the FCA has gone for a more pro-competitive route, building on existing proposals for greater transparency and comparability. Yet, when fees have been historically up to 10 times those of payday loans, with half of those charges coming from the poorest or most vulnerable 1.5%, it cannot be argued the harm is any less.
For many consumer groups, it is far from clear that an intervention premised on competition will work for those most harmed by borrowing. Experience suggests it is doubtful how far consumers, especially those struggling the most, will bring competitive pressure to bear.
Behavioural economics' literature identifies common issues for users of high cost credit. Customers tend to focus on speed and ease of access to relieve their underlying financial issues, rather than on the short term cost of that borrowing. There is also extensive empirical literature that those who suffer most from unarranged overdrafts shop around and switch the least. As such, it is far from clear that any of the proposed efforts to increase transparency will enhance competition, or reduce the harm of unaffordable borrowing for existing users of unarranged overdrafts.
With that in mind, some, such as the Shadow Chancellor, have called for a price cap on overdrafts. If the FCA’s reforms do not work out, it may find itself with some hard questions to answer.
So why did the FCA decide upon this less intrusive route? Here are the four main reasons in my view:
1. While the payday and rent-to-own are small markets, extremely focused on sub-prime customers, the overdraft market is enormous and serves a far wider population. The FCA simply does not have the evidence to justify a broad intervention like a price cap that may limit the operation of parts of the market where customers are enjoying the convenience of the existing arrangement.
2. The proposed solution aligns the overdraft market to the wider credit pricing norms, where a daily charge and an advertised APR are how prices are structured. The FCA believes the re-pricing being forced on banks will deliver lower prices without the need for a cap. This meets their regulatory obligation to achieve their objectives in the most competition-friendly way.
3. The FCA can use other tools in its armoury to address on-going poor treatment of vulnerable customers, or where firms fail to address customers using short term facilities to meet longer term borrowing needs (including failing to prevent unaffordable borrowing).
4. There is a range of work currently underway in the retail banking, payments and technology spaces, which aims to improve transparency and foster competition. In particular, the work on Open Banking is very much targeted at helping consumers increase value from banking and the credit market through the secure sharing of personal information. This is a quickly moving market and a cap would cut across much of that work.
Challenges for the banks
For the banks, these changes pose a number of quandaries – most specifically, how are they going to recoup the revenue that they used to earn from unarranged charges, around £720m annually? Ultimately, their answer(s) will determine the success of the policy. Without any pricing cap, the most obvious response from banks will be to raise the daily APR cost on existing arranged overdrafts to compensate for the lost revenue. The size and scale of the price rise needed to compensate for lost revenue is far from clear and there will be winners and losers amongst customers, depending on their borrowing behaviour.
In particular, those with large arranged overdrafts may lose out from any changes in the APR daily rate and a decrease in fixed charges. Small borrowers may gain. One factor limiting price increases will be customer reactions. Lloyds Banking Group has already experienced public challenge when it re-allocated costs in a similar way, voluntarily (in 2017), on the basis of 1p per £7 overdraft, equivalent to an APR of 52%. Firms may be mindful of the possibility of negative publicity when determining their pricing model.
Another possible reaction by banks is to extend charging for current accounts beyond the existing range of packaged accounts. As with the wider packaged account market, pricing changes may have to be accompanied by the inclusion of a wider selection of goods. Firms should be mindful of the FCA’s recent findings on packaged accounts, around ensuring comparability and clarity about eligibility for any complementary products, most notably insurance. How banks do this may vary, and will depend on their strategy, target customers, and views on how competitive dynamics will evolve in the sector.
Complicating matters further, the announcement comes during a time of significant change in the retail banking model of many banks, with branching closing, new fintech firms challenging incumbents, and broader risks around Brexit. So for banks, there is a lot to consider.
If the result is an end to the free in-credit model, it may be no bad thing. The fairness of the existing model that re-distributes charges - from richer and the organised to the poor and dis-organised - has long been the subject of concern. As long ago as 2012, Andrew Bailey, now the CEO of the FCA, identified the model as a “dangerous myth” since it provided incentives to banks to hide their charges. Arguably, any changes should more fairly allocate costs to usage, create greater transparency and possibly greater competition. However, the current account market has long been immune to efforts to enhance competition and it is far from certain this time will be different.
The proposals are due to come into effect in April 2020 and there is a lot for the banks to consider in the run up to that deadline. Prior to the introduction Grant Thornton can help firms with considering any re-pricing strategies, from a range of perspectives.
For more information do not hesitate to contact me. [Oliver.L.Morgans@uk.gt.com]
In 2017, firms made over £2.4bn from overdrafts alone, with around 30% from unarranged overdrafts. More than 50% of banks’ unarranged overdraft fees came from just 1.5% of customers in 2016. People living in deprived areas are more likely to be impacted by these fees. In some cases, unarranged overdraft fees can be more than ten times as high as fees for payday loans.