This Christmas may be the last time anyone goes a bit overdrawn and is hammered by “high”, “complex” and “harmful” overdraft charges.
Because in December 2019, new rules from the FCA will force banks to stop confusing consumers by hiding their excessive fees.
Great news. But the best present of all in the FCA’s 215-page pre-Christmas report is that the advertised measure of the cost of an overdraft is to be the APR. After years of badmouthing by the lending industry, research done for the FCA found that using a single APR to describe the cost enabled customers to see which was the cheapest way to borrow. In other words, APR underpins competition. Which is why, of course, lenders hate it so much.
The FCA plans to ban daily charges (which range from 50p to £10 a day), monthly charges (£6 to £25) and allowed payment fees (don’t ask but it costs £5 to £15), and replace them all with a simple percentage charge – probably EAR and currently from 11 per cent to 67 per cent.
There will be a ban on banks charging different amounts for arranged and unarranged overdrafts, which often impose “unjustifiable charges for small amounts of borrowing”. Unarranged overdrafts can be more than 10 times the cost of a payday loan. More than half the fees for unarranged overdrafts – over £400m – comes from 1.5 per cent of customers – often those who can least afford it.
The report makes it clear overdrafts are not so much a convenience for the better off as exploitation of people who are sick, poor or disabled, with a strong correlation to deprivation indicators.
The charges are also complex and confusing. There are 22 different overdraft charges imposed by the seven biggest high street banks (including Nationwide). That makes comparisons impossible and stifles competition. Just days before the report came out, Lloyds (which includes the Halifax and Bank of Scotland brands) announced more complex rules and higher daily fees for some overdrafts. They will now have to be scrapped.
The FCA will leave banks free to charge what they want for overdrafts – as long as it is a simple interest rate charge and indicated by an APR in advertising. Newer online banks Starling and Triodos, as well as the growing branch-based Metro Bank, already just charge a percentage on an overdrawn balance.
The FCA research found, of course, that people understand charges in pounds better than those expressed as percentages. But interest rates are easier to compare – everyone knows that a charge of 60 per cent is more expensive than one of 18 per cent. The banks will also have to provide online or mobile apps to show the likely cost in pounds as well.
The arithmetic of APR is highly complex requiring an iterative calculation that defies 99 per cent of human understanding. It reflects the cost of borrowing over a year, so the APR for short-term loans can be huge.
Even after the FCA’s price cap on payday loans, the APR can be 1294 per cent. That has led to expensive lenders claiming the APR is misleading as a huge rate can in fact only mean a cost of a few pounds. But there is one important rule in finance: if your instinct says one thing and the arithmetic says another, go with the arithmetic. It’s how we got to the moon.
APR is not there to be understood but to be used as a comparison tool. If the percentage is bigger, the loan is costing you more – whatever it feels like. That is why the industry has lobbied against it for years and the banks have refused to put APRs on their overdraft charges. Now they will have to.
There will be alerts by text when an overdraft is imminent and warnings at cash machines. That will be exactly the opposite from what happens now where “available cash” normally includes any agreed overdraft encouraging people to borrow at expensive rates if they need the money. In future, they will be told clearly they are overdrawn or about to be.
Some have speculated the banks will find a way to recoup the £2.4bn a year by making other charges – what the FCA calls “waterbedding” – for example, a fee for running a current account. But doing that will be difficult. If one major bank began to charge all its customers for a current account, that could start a stampede to its rivals who did not take first-mover disadvantage. Usefully, competition law prevents them colluding to introduce a charge at the same time.
The ethical bank Triodos launched its current account last year and has managed to attract “thousands” of customers despite a £3 a month charge “towards the cost” of running its current accounts. It will not say what the breakeven charge would be. Recovering the £2.4bn lost on overdraft charges from the 73 million personal current accounts implies a fee around that level. But the per account fee would need to rise as customers who have two, three or more accounts for different purposes economised by closing some of them.
There is still another year for the banks to collect their “high”, “complex” and “harmful” overdraft charges. Consultation – and lobbying – on these plans ends on 30 March. But recent experience of the FCA is that what it consults on is what you get with just a few minor changes to show it is listening (and to fulfil the strict rules about consultations).
In June it will publish the final rules. Six months later – just in time for next Christmas – the banks will have to stop exploiting the poor, the sick, the disabled and those in a hurry, and make their overdraft charges clear, simple and competitive. And not a moment too soon.
Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programme. You can follow him on Twitter @paullewismoney