The overdraft market - a new era

The consultation paper implements reforms to help consumers better engage with and understand their overdrafts, obliging banks to offer:

• Digital eligibility tools enabling consumers to check if they can get a cheaper overdraft elsewhere.
• Overdraft charge calculators designed to help consumers translate interest rates into a monetary value.
• Text message or push notification alerts and changes to display overdrawn balances at cash machines designed to address unexpected overdraft use.

In 2017, the revenue generated from overdrafts reached £2.4 billion, with 30% of that coming from unarranged overdrafts. In the UK, 52 million consumers have a current account, with 14 million making use of an unarranged overdraft. While these numbers appear significant, the FCA reported that more than 50% of banks’ unarranged overdraft fees came from only 1.5% of customers in 2016. It found that people living in deprived areas were more likely to be impacted by this, with some unarranged overdraft fees costing as much as ten times the fees for payday loans.

Of the reform in this area, Andrew Bailey, Chief Executive of the FCA stated:

“The overdraft market is dysfunctional, causing significant consumer harm. Vulnerable consumers are disproportionately hit by excessive charges for unarranged overdrafts, which are often ten times as high as fees for payday loans. Consumers cannot meaningfully compare or work out the cost of borrowing as a result of and driver of poor competition.

Our radical package of remedies will make overdrafts fairer, simpler and easier to manage. We are simplifying and standardising the way banks charge for overdrafts. Following our changes we expect the typical cost of borrowing £100 through an unarranged overdraft to drop from £5 a day to less than 20 pence per day. The decisive action we are taking today will give greater protections to millions of people who use an overdraft, particularly the most vulnerable.”

The rules and measures, coming into force by 6 April 2020 will:

1. Prevent banks and building societies from charging higher prices for unarranged overdrafts than for arranged overdrafts.
2. Require banks and building societies to price overdrafts using a simple annual interest rate.
3. Ban fixed fees for borrowing through an overdraft, stopping fixed daily or monthly charges, and fees for having an overdraft facility.
4. Ensure overdraft prices are presented in a standard way, with the presentation of APR enabling consumers to compare products against one another.

While there is nearly a year before the rules come into place, there is new guidance banks and building societies must follow immediately which emphasises that refused payment fees should be fair and reasonable, with the costs imposed reflecting the amount it costs the bank or building society to refuse the payment.

Starting on 18 December 2019, banks and building societies will be required to do more to identify customers showing signs of financial difficulty or financial strain, as well as develop and implement strategies to reduce repeat overdraft use.

As well as the rules, the FCA carried out in-depth consumer analysis and found that consumers wanted the cost of borrowing to be shown in pounds and pence together with the relevant APR and interest rate. UK Finance has agreed that this will be implemented.

It is clear the rules and guidance issued by the FCA evidences their desire for greater transparency and consistency in offering overdrafts, enabling consumers to make informed decisions based on the clarity of information provided by banks and building societies. Simplifying the way overdrafts can be provided is anticipated to be fairer, simpler and easier for consumers to manage. By presenting APR in a standardised manner will give consumers the opportunity to better understand the overdrafts available to them. Similarly, presenting the cost of borrowing in pounds and pence will also educate consumers further in this area, increasing consumer choice.

14% of consumers use an overdraft every month of the year and pay 69% of all overdraft fees, and reform in this area further evidences the FCA’s desire to improve consumer outcomes and mitigate against harm, particularly for those most vulnerable who are habitual overdraft users.

While some may argue that these changes do not go far enough by avoiding the introduction of a total cost cap, the FCA believes the new regime will bring overdraft charges below the level of the current daily cap on high-cost short-term credit lenders, or so called 'payday lenders'. By ensuring consistency in messaging across banks and building societies, consumers will be equipped to make meaningful comparisons and gain a greater understanding of the price of their overdraft.

What next for firms?

There are a number of considerations banks and building societies will need to make in order to meet their obligations by the requisite deadlines. In the immediate term, banks and building societies will need to ensure any refused payment charges are fair and reasonable and mirror the costs incurred when refusing the payment. This could be achieved by adopting a consistent pricing framework that aligns with the administrative burden.

The end of 2019 also marks an important deadline, whereby firms will need to implement measures to identify customers showing signs of financial difficulty or strain. Signs of this could include: developing strategies to reduce repeat usage, targeted intervention where a consumer is reliant on their overdraft, and offering greater support to those in need.

The remaining rules, coming into force in April next year may require firms to overhaul their pricing structures. As a result, firms need to engage with their current pricing frameworks to ensure that they will comply with future rules. From this, this could involve:

• A review of documentation governing the overdraft;
• An assessment of the APR calculation applicable to the overdraft; and
• An assessment of how and when charges are applied.

The introduction of greater regulation in this area mirrors the FCA’s ongoing agenda in the consumer credit sector, with heightened consumer protection, education and transparency at its core. Whilst such changes offer enhanced consumer safeguards, it erodes the subsidisation banks and building societies have leveraged to offer free banking to consumers in credit. However, as the traditional banking relationship starts to evolve and transform, banks and building societies may need to adopt innovative methods to address any issues created by the reforms.

The FCA is also consulting on further proposals to require firms to publish overdraft fees and charges for overdrafts as part of the current account service metrics, with responses required by 7 August 2019. A link to the overdrafts policy statement can be found here.