How do the FCA’s reforms to overdraft charges measure up?
By Adam Butler, Senior Public Policy Advocate
Radical changes to the rules governing overdrafts will help people in financial difficulty — is there a catch?
Exorbitant overdraft charges that hit people in financial difficulty have been the subject of calls for change for at least two decades. Campaigners made progress in reducing one-off ‘failed payment’ fees but high unauthorised overdraft fees remained.
With its strong remit to ensure customers are treated fairly, the Financial Conduct Authority (FCA) has finally set out a plan to clamp down on unauthorised overdraft charges [PDF].
The substance of the changes the FCA proposes to require banks to make from December 2019 is relatively simple.
- If banks allow customers to borrow in excess of their overdraft limit, they can charge no more than the standard ‘authorised’ overdraft rate.
- Banks will be required to charge for overdrafts using a single interest rate expressed in APR rather than through the complex fee structures that are common at present.
- Banks must in future identify repeat overdraft users in financial difficulty and support them to safely wind down overdraft debt.
There are significant upsides to this package, the most important of which is that banning unauthorised overdraft fees will dramatically reduce costs for people in difficulty.
To put the impact of the changes in perspective, unauthorised overdraft fees can currently cost more than the interest charge on a payday loan.
Following the new rules, the FCA expects unauthorised fees to be ‘significantly below’ the interest rate cap on payday loans.
Flaws but not deal breakers
The success of the measures depends on exactly how banks implement the new rules, and there are a few caveats worth noting.
The FCA hasn’t specified that banks can’t offer different customers different overdraft interest rates. This means banks may introduce ‘risk-based’ pricing where customers are offered different rates based on their circumstances.
This is common among other credit products like credit cards but is largely new territory for overdrafts.
The FCA expects firms to recoup income lost due to the end of unauthorised overdraft fees by increasing their authorised overdraft fees across the board modestly.
Most light overdraft users will pay a little more, while people in a lot of difficulty who regularly exceed their overdraft limit will pay a lot less.
However, if banks introduce higher rates for more frequent users, over time fees may again become concentrated on more vulnerable people.
In a worst-case scenario, unauthorised fees could be re-introduced through a backdoor.
Risk-based pricing could also undermine competition between current account providers, because instead of being able to see a single overdraft interest rate, people will have to get a personal quote to find out what they’ll be charged.
This will make it less likely that competition between account providers will drive down overdraft charges.
Banks are also being asked to identify repeat overdraft users who are in difficulty and offer them support.
This is important: it makes a big difference to people in difficulty when firms reach out at an early stage to offer them a safe way out of difficulty.
This might mean budgeting help, a gradual reduction in an overdraft, or forbearance. The weakness of the FCA’s proposals is that it hasn’t provided a precise definition of repeat overdraft use.
This is with reason: patterns of overdraft use are complex and it would be difficult to find a single useful definition of repeat use. However, the FCA may have got the balance wrong and given banks too much discretion.
The result could be that people in difficulty are only identified as in need of support at a late stage when repeat use is obvious and financial problems are advanced. That would be little different to the present situation.
Nevertheless, the FCA’s intervention is undoubtedly positive news. We’ve called on them to monitor the impact of the new rules carefully.
The FCA has stated that it’ll keep the case for a cap on overdraft fees under review. Evidence that high charges remain concentrated on vulnerable customers would be compelling evidence a cap is needed.
They should also respond to learning from implementation of the repeat use rules quickly, to ensure firms intervene early and effectively when people get into difficulty.
An awkward question
The stark figures uncovered through the FCA’s investigation of overdraft lending beg an awkward question.
Using current account data, they found that half of overdraft fees are concentrated on just 1.5% of customers, and that this group tends to be more vulnerable, with lower incomes and a greater likelihood of illness and disability.
It also found that even when firms have been aware customers are in difficulty, they have often not offered effective help.
If the evidence is so stark that some banks weren’t treating their customers fairly and meeting regulatory requirements to support people in financial difficulty, why is no redress scheme planned?
Moving on as if nothing was amiss smacks of sweeping a significant failure of firm culture under the carpet.
You can read our full response to the FCA’s call for evidence on overdraft charges on our website.
