On 7 June 2019, the bank regulator, the FCA, announced its new rules about overdraft charges. It calls these:
the biggest shake-up to the overdraft market for a generation.
The new rules will come into effect from April 2020 – that’s a long while to wait if you are currently paying very high overdraft fees. And how much effect will they actually have?
The changes to fees – getting simpler
The new rules mean that banks:
- can’t charge more for an unarranged overdraft than an arranged one;
- can only charge a single interest rate on overdrafts; and
- can’t add a monthly or daily fee for being in your overdraft.
These are all very welcome changes.
At the moment it can be hard to work out how much your monthly overdraft fee will be. And it can be impossible to compare one bank’s charges with a different bank.
With the new simple charging, every bank will have to publish the APR on its overdraft. This will make it clear how expensive the overdraft is and also make it easy to see if another bank would be cheaper.
So no more we charge 1p a day for every £7 of overdraft you use type of nonsense. That sounds low but is actually an interest rate of more than 50%, worse than many credit cards aimed at people with poor credit.
But will the charges be any lower?
That is the 2.4 billion pound question.
£2.4billion is what the banks made in overdraft fees and charges in 2017. 70% of this came from charges on authorised overdrafts and 30% from the higher charges on unauthorised overdrafts.
The FCA hasn’t said that banks have to reduce the overdraft charges, just simplify them.
So there is nothing to stop the banks increasing authorised overdraft charges to make up for getting less on unauthorised overdrafts. And where a bank is changing from tiered charges and fixed fees to a single interest rate, some people may end up paying more and others may pay less.
Debt advice agencies had suggested that the FCA should introduce a “cap” on what banks can charge – the approach that was used for payday loans.
But the FCA has preferred to rely on simpler charges making it easier for people to compare what different banks are charging. It expects the new rules will:
Strengthen competition both between overdraft providers and between overdrafts and other forms of credit and ensure that the competitive pressure that constrains arranged overdraft pricing will also in the future constrain unarranged overdraft pricing.
Andrew Bailey, the FCA’s CEO, says:
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 a day.
I am sceptical. I don’t think that competition is good at getting banks to cut prices. People who have large overdrafts are often not in a good financial situation – they are not the customers that banks will want to compete hard to get!
And although it will be good to be able to compare overdraft charges easily, I doubt this will lead to tens of thousands of people changing banks.
There may indeed be a big drop in the charges paid by people who dip into their overdraft a small amount – getting rid of the “fixed fee” should ensure that.
But much of that £2.4 billion in fees is coming from people who are “repeat users”, spending much or all of the month in their overdrafts.
Banks have to do more to reduce “repeat overdraft use”
Having an overdraft for occasional use is a good thing, but using a large overdraft for much of the month is often a sign of financial problems.
- 14% of consumers used their overdraft every month in 2016; and
- these “repeat users” paid 69% of all arranged, unarranged and refused payment fees that year.
From December 2019, the FCA will:
[Require] banks and building societies to do more to identify customers who are showing signs of financial strain or are in financial difficulty, and develop and implement a strategy to reduce repeat overdraft use.
This will start in December 2019.
Identifying repeat users
Banks will have to identify “repeat overdraft users”. The FCA has not given a definition, except to say that it is likely that a customer who has become or remained overdrawn in every month over the preceding 12-month period should be classed as a repeat user.
Banks must decide which repeat users are in financial difficulties. The FCA gives general guidelines, including looking for:
- an upward trend in the number of days an overdraft is used in a month and the size of the borrowing;
- changes to regular credits or debits that may indicate that the customer’s general situation has got worse;
- refused payments or increased unauthorised overdraft usage.
Talking to the customers and offering options
For repeat users who the bank doesn’t think are in financial difficulty, the bank will have to send letters warning them about their overdraft usage and its costs.
Where a repeat user appears to be in financial difficulty, the bank has to try to talk to the customer about their situation. Then it should offer suitable options to reduce overdraft use over a reasonable period of time and to address financial difficulties:
- There is no definition of “a reasonable period”. Three or four years is used in assessing people with persistent credit card debt but I would expect it to be less if the overdraft amount was not large.
- The suitable options could include offering a loan at a lower rate of interest to repay the overdraft, or reducing or freezing interest and charges on the account.
- It seems likely that reducing or freezing charges would lead to an arrangement o pay marker on your credit record.
Reporting back to the FCA
Banks will have to explain to the FCA how they intend to do all this, and then monitor how well their plan is going. They will have to report to the FCA after 6 and 12 months, giving statistics such as the total number of “repeat overdraft customers” and the total size of their overdraft balances.
So the FCA will be able to see whether a bank’s plan is making a difference in practice.
So will this help you? And what are your other options?
We aren’t going to know for many months whether these new rules on charges will generally lead to lower charges. And it may depend on your exact situation whether you will end being charged much less, a bit less or even more.
If you only use your overdraft a bit, then the removal of the flat fees is likely to help you.
But if you are in your overdraft for most or all of the months, that is less clear.
Overdrafts are a very hard type of debt to get rid of. Unlike a credit card, which you can just cut up and concentrate on paying off, the fact you have credits and debits arriving can make it hard to reduce the overdraft usage by a bit each month.
For many people with a poor credit record and a large overdraft, a good way forward is to get a new basic bank account, switch to that for you main banking and just see your old bank account as a debt to be repaid. You could also ask the old bank if it can offer you a cheaper way to clear this old balance – with the new rules coming in, banks may be more prepared to do this.