The FCA proposes reform on charges for overdrafts

United KingdomScotland

Introduction

On 18th December 2018, the FCA announced radical proposals to reform how banks charge for overdrafts. The FCA’s Chief Executive, Andrew Bailey, said ‘we are proposing to make the biggest intervention in the overdraft market for a generation’.

The FCA reported that in 2017 firms made over £2.4 billion 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. Consequently, the FCA initiated a Consultation Paper, CP18/42 with the aim to simplify pricing of all overdrafts and end higher prices for unarranged overdrafts.

What is being proposed and how it will affect firms?

Unlike rent-to-own products and payday loans, the FCA decided not to propose a price cap for overdrafts and believes its proposals can deliver better outcomes for consumers than a price cap.

The FCA has proposed the following reforms:

  • Stop firms from charging higher prices for unarranged overdrafts compared to arranged overdrafts.
    • If a higher charge is imposed, the obligation to pay the charge is unenforceable against the customer. If the customer has paid the charge, they are entitled to reclaim it.
  • A ban on fixed fees for borrowing through an overdraft (other than fees for refusing a payment due to lack of funds (‘refused payment fees’), which firms are entitled to charge for under the Payment Services Regulations 2017).
  • Issuing new guidance to reiterate that refused payment fees should reasonably correspond to the costs of refusing payments, and explain the costs that may be included.
    • Firms cannot include the following in calculating refused payment fees: costs of refusing payments that fall outside the scope of the Payment Services Regulations; fraud detection and prevention; collection, recoveries and impairments; costs associated with advice to customers who need help to deal with their debts; bank statements; Financial Services Compensation Scheme levies; Financial Ombudsman Service general levy and / or marketing costs.
  • Ensuring the price for each overdraft will be simple, single interest with no fixed daily or monthly charges.
  • Requiring firms to advertise arranged overdraft prices in a standard way, including an Annual Percentage Rate (APR) to help customers compare them against other products.
    • Firms will be required to report their representative APR yearly to the FCA.
  • Telling banks to do more to identify overdraft customers who are showing signs of financial strain or are in financial difficulty, and to help them reduce their overdraft use.
    • Firms would be required to implement a strategy to reduce repeat use and provide this strategy to the FCA, when the rules start to apply. Firms will be required to monitor the effectiveness of their strategy and report to the FCA on the outcome of their monitoring after 6 and 12 months.

Commentary

This marks the fourth intervention the FCA has made into products it considers as having significant impacts on financially vulnerable customers. Having already intervened in the high-cost short term, rent-to-own and credit card markets, the FCA has made repeated comments that substantial areas of the consumer credit industry are not operating as effectively as they could, and are actually causing detriment to customers at this point in time.

It is clear that the FCA has concerns about the treatment of customers’ best interests in these markets, and in particular that the pricing methods used for these products are damaging these interests. Whilst a cap on interest costs is not being proposed this time, the prohibition on fixed fees and measures to increase the transparency of costs evidences that the FCA is expecting firms to place significant focus on the manner they charge customers access to credit.

We expect the FCA to begin to examine consumer credit firms’ product governance processes in more detail in the near future. Having applied significant restrictions on the commercial terms firms may implement for their products, we expect the FCA to challenge firms to evidence that they do understand the role that pricing plays in customer outcomes and that this understanding is incorporated into product design and review processes. Firms across the consumer credit industry should begin to consider the inputs into their processes to ensure that they support meeting the FCA’s expected customer outcomes.

What next?

Responses to the Consultation Paper should be sent to the FCA by 18 March 2019. Following this, the FCA plans to release their final rules in June 2019.

After this, firms will have 6 months to comply with the rules on pricing and repeat use, meaning that the rules would be in force by early December 2019.

Once the rules are made, the FCA will monitor the market and keep overdraft pricing under review.

Co-authored by Fatima Butt