Britain's biggest banks face payouts of more than £10bn after losing the right to charge current account holders as much as they like for unauthorised borrowing.
The High Court ruled yesterday that fees for slipping into an overdraft or bouncing a cheque are subject to standard legal rules on fairness of contracts, raising the prospect of hundreds of thousands of successful compensation claims.
High Street banks had insisted that charges on customers could be levied entirely at their own discretion, with penalties of up to £38 common for breaches of overdrafts.
The Office of Fair Trading (OFT) is now expected to press ahead with an epic legal battle to prove that the charges are unfair. If the case succeeds, then banks may be forced to compensate every customer for charges going back years, giving millions of people a windfall.
Consumer groups hailed the ruling as a "massive victory", though the banks hinted they will appeal, threatening protracted legal warfare in the Court of Appeal and the House of Lords.
In the meantime, claims for refunds worth about £711m are on hold, pending the outcome of the case. The OFT estimates that banks and building societies make £2bn to £3.75bn a year from unauthorised borrowing fees, suggesting the total reclaimable could be as much as £20bn.
One million customers won refunds before the OFT and eight financial institutions announced on 27 July last year that they would jointly bring yesterday's test case to establish whether the charges are legal.
The banks – Abbey, Barclays, Clydesdale, Halifax Bank of Scotland, HSBC, Lloyds TSB, Royal Bank of Scotland and the Nationwide Building Society – assembled one of the biggest commercial legal teams of recent times to fight the case.
Judge Andrew Smith agreed with them yesterday that the charges were service rather than "penalty" fees and that their terms and conditions were, for the most part, in "plain intelligible language".But he went on:"I reject the banks' contention that the relevant terms are exempt from assessment as to fairness under the 1999 [Unfair Terms in Consumer Contracts] Regulations.
"This does not mean that the relevant terms are necessarily to be regarded as unfair... or that they are not binding upon consumers. Those are not questions for me to decide in this judgment."
Campaigners claimed the banks should now lift the waiver and immediately start paying out to customers.
"The banks should do the right thing now: concede defeat, agree with the OFT what constitutes a fair unauthorised overdraft fee, and refund their customers as soon as possible," said Doug Taylor, of the consumer group Which?
"The Financial Services Authority [FSA] must now drop its waiver so the thousands of cases pending can be processed. Every second this remains unresolved is costing consumers £111 in overdraft charges."
Martin Lewis, of MoneySavingExpert.com said: "Thisis a massive victory for the bank charge campaign because the primary line of attack has been that bank charges are unfair under unfair terms legislation.
"Banks currently charge £35 for what is an automated letter printed off the computer. What does it really cost? Some generous people say £4, I say about £2."
The British Bankers' Association said the judgment was "complex" and the banks were considering its implications, adding that further court hearings were required.
"As previously agreed with the Financial Ombudsman Service and the FSA, customer complaints relating to unauthorised overdraft charges will currently remain on hold," it added.
Under the law, bank customers can bring legal claims for bank charges dating back six years in England and Wales and five years in Scotland. Annual results for the major lenders show they have so far paid out more than £559m in refunds but the total is higher because Abbey and the Nationwide kept their refunds secret.
"In one sense this is a good result," said David Kuo, of the personal finance website fool.co.uk. "But the banks will try and appeal and prolong the agony for consumers. I do hope they see sense – they have lost this one and will certainly lose the next one."