Overdraft charges will be made simpler and fairer and “overdraft prisoners” who are persistently in the red will get more help under a radical shake-up proposed by the City regulator.
A fundamental overhaul of overdraft pricing has been suggested by the Financial Conduct Authority (FCA), including ensuring the price for each overdraft will be a simple, single interest rate – with no fixed daily or monthly charges.
It also wants to tackle the highest costs in the market by stopping firms from charging higher prices when customers slip into an unarranged overdraft – when they borrow without arranging this with their lender first.
There would be a ban on fixed fees for borrowing through an overdraft. These fees can quickly ramp up the costs for borrowers and make it hard to compare deals.
Banks will have to do more to identify overdraft prisoners who are persistently in the red and help them sooner.
The proposals, which the FCA described as the biggest intervention in the overdraft market in a generation, could be in force by early December 2019.
In some cases, unarranged overdraft fees can be more than 10 times as high as fees for payday loans.
Referring to the proposal to align the cost of an unarranged overdraft with that of an arranged overdraft, Christopher Woolard, executive director of strategy and competition at the FCA, told the Press Association: “The effect of that is if you’ve got a £100 unarranged overdraft at the moment you’re probably paying something like £5 a day for having that £100 overdraft.
“If you take these alignment proposals through, the cost of that drops to about 20p. So it’s a huge difference.”
Mr Woolard said fixed fees of, for example £2, £3 or £5 can sound like small numbers to borrowers.
He continued: “Actually, looked at as an interest rate, that’s huge.”
We expect these proposals to significantly lower overdraft charges for those paying the highest prices and that all overdraft charges would be well below the level of the payday loan daily rate cap #faircredit— Financial Conduct Authority (@TheFCA) December 18, 2018
Around 19 million people use an arranged overdraft each year and around 14 million people use an unarranged overdraft annually.
A significant chunk of the money banks make from overdrafts comes from a small proportion of customers – who are often those who can least afford to pay charges.
In 2017, firms made more than £2.4 billion from overdrafts alone, with nearly a third (30%) of this coming from unarranged overdraft fees and charges.
More than 50% of banks’ unarranged overdraft fees came from just 1.5% of customers in 2016.
Consumers in more deprived areas are 70% more likely to use an unarranged overdraft than other consumers.
The plans are part of the FCA’s high cost credit review, which has already seen it propose a price cap on the rent-to-own sector.
The FCA has stopped short of proposing a price cap for overdrafts, saying it does not believe this would fix the problems.
But it will keep firms’ overdraft pricing under review and consider a cap if it sees signs prices are becoming harmful.
We're pleased that @TheFCA has announced robust measures to ensure that consumers stuck in overdraft #debt are given more help. With an estimated 2.1 millions people spending the whole year in #overdraft, change is overwhelmingly needed and very welcome https://t.co/es65UD6gD4— StepChange (@StepChange) December 18, 2018
Andrew Bailey, chief executive of the FCA, said: “Today we are proposing to make the biggest intervention in the overdraft market for a generation.
“These changes would provide greater protection for the millions of people who use an overdraft, particularly the most vulnerable.”
Eric Leenders, managing director, personal finance at trade association UK Finance, said industry initiatives to help people manage their money include text alerts and fee-free buffers for small overdrafts.
Mr Leenders said: “Helping customers to manage their everyday finances is a priority for the banking industry and we acknowledge the FCA’s intention to make overdraft pricing simpler and easier to understand.
“The personal current account market in the UK is highly competitive with over 40 different providers offering hundreds of competitive products.”
He said UK Finance members have been working with the regulator to better identify and support customers who are repeatedly overdrawn.
The proposals were broadly welcomed by finance experts and consumer campaigners.
Martin Lewis, founder and chair of MoneySavingExpert.com, said: “Banks have reduced charges over the years, but not enough.
“Trying to calculate and compare overdrafts alone is flummoxing due to a multiplicity of charging structures – such as 20% APR, 50p a day, or 1p per day per £7 overdrawn – never mind seeing if other borrowing would be cheaper.”
He continued: “The FCA’s consultation is on the right track – though our main disappointment is it fails to impose the total cost cap.”
The StepChange Debt Charity said in the first half of this year just under half (47%) of its clients had an overdraft when they contacted the organisation.
StepChange’s head of policy Peter Tutton said of the proposals: “These should help to disrupt the toxic ‘debt spiral’ effect that overdrafts can create, trapping people in a persistent cycle of overdraft debt.”
Jenni Allen, managing director of Which? Money, said the regulator’s “strong action” will come as a massive relief for those regularly hit with “extortionate charges”.