The great overdraft con
Banks are charging extortionate levels of fees and interest on nearly £10 billion worth of overdrafts in a bid to claw back lost profits. Moneywise can reveal that the industry is still cashing in around £2.5 billion a year from overdrafts, despite consumer and regulator attempts to challenge unfair charges and reform the market.
In recent months, typical authorised overdraft rates levied by the major high street banks have soared to an all-time high of around 19%, despite interest rates having remained at an historic low of 0.5% for more than 20 consecutive months.
During this period, more than a quarter of current accounts have seen an increase in authorised overdraft rates, according to Moneyfacts, the financial data provider. And in July, a report by wealth manager SG Hambros found that average unauthorised overdraft rates amounted to a staggering 167% a year once additional charges had been taken into consideration.
The shocking truth is that, these days, entering into unauthorised overdraft territory can be more expensive than taking out a payday loan with a typical APR of several hundred per cent.
Defending the trend, Lesley McLeod, spokesperson for the British Bankers' Association, which represents over 200 banks, says:
"After the credit crunch, the pricing of risk has increased, so the cost of lending has increased. And overdraft facilities, whether they're drawn down on or not, now have to be covered under the Capital Requirements Directive.
"However, around 85% of current account holders don't pay any unauthorised overdraft charges at all."
This is, in effect, an admission that the cost of the banking crisis - caused largely by banks' own reckless lending and speculative investment in complex financial instruments that not even they understood - is now being passed on to consumers, just as the government's proposed £2.5 billion bank levy is likely to be.
In a vicious pincer movement, the banks are increasing the cost of overdrafts with one hand, while reducing interest on in-credit balances with the other.
Over half of all current accounts now no longer to pay interest on balances - including NatWest and RBS - and more than a quarter pay 0.1% or less. So with inflation currently running at around 3%, customers who keep their current accounts in credit are effectively losing money.
In 2008 the Office of Fair Trading (OFT) found that a third of bank revenue from personal current accounts came from unauthorised overdrafts, which were - in its own words - "difficult to understand, not transparent, and not subject to effective customer control".
Over a million disgruntled customers had complained about what they considered to be unfair bank charges.
The OFT agreed to take a test case to court under the Unfair Terms in Consumer Contracts Regulations. The Supreme Court finally ruled in November 2009 that the fairness of these charges couldn't be challenged on the basis of the test case. Its decision took the wind out of the campaign's sails and appeared to let the banks off the hook.
Meanwhile, the Financial Ombudsman Service (FOS) reported that the number of complaints it received about current accounts nearly doubled in the 2009/2010 financial year - up 85% on the previous year. Many of these concerned financial hardship and the way bank charges made difficult situations worse - for example, when automatic direct debit payments pushed people into the red.
The FOS also dealt with a backlog of 15,000 complaints about unauthorised overdrafts.
While the OFT says it won't take further legal action, it does acknowledge that banks could be "far more transparent" in their overdraft charging structures and that it's "very difficult" for consumers to compare accounts on a like-for-like basis.
This is a partly a result of consumers failing to shop around, which in turn means competition between the banks is not as effective as it should be.
Since the Supreme Court ruling, the OFT has been working behind the scenes, encouraging banks to improve the clarity of the information they provide. Most banks, for example, now publish 'charging scenarios' on their websites. Even so, these scenarios often still hide the true cumulative effect of charges and interest, and can be almost impossible to understand.
Take HSBC's 'overdrafts and charges' webpage. One scenario states: "A payment from your account takes you into an informal overdraft, and you make nine more payments from the account while you are overdrawn or over your limit. Charge: £125."
This is confusing enough - but the footnotes then acknowledge that "an additional charge of £25 could be levied if a formal overdraft had been agreed within the last six months".
So your total charge in this case would actually be the bank's monthly maximum of £150.
What's more, under HSBC's new charging structure, which takes effect from December, customers who are refused an 'informal' overdraft and don't have sufficient funds in their accounts to cover outgoing payments will be charged an eye-watering £25 per payment request over £25 that has to be returned.
So if you pay your bills by direct debit - gas, electricity, water, and home insurance, say - you could be clobbered with fees of more than £100, plus debit interest, each time you go 'informally' overdrawn.
Note the change of language here. HSBC now calls breaching your 'formal' overdraft limit a de facto application for an 'informal' overdraft. This smacks of banks attempting to re-brand unauthorised overdrafts to defuse recent bad publicity.
Similarly, Barclays has introduced the concept of a 'personal reserve' - a borrowing buffer zone of up to £2,500 that still allows payments from your account to be honoured even if you've inadvertently breached your agreed overdraft limit by as little as £1.
This means you incur a 'reserve usage fee' of £22 that gives you the right to use this reserve for five working days. If you're still beyond your overdraft limit after that, you incur another £22. But if you exceed your overdraft limit and you haven't applied for a reserve, then all your standing orders, direct debits and cheques will be returned unpaid at £8 a pop - up to a maximum of £40 in charges each day.
Other banks call this facility an 'overdraft buffer'. It may not attract interest but you still have to pay a fee for it. So, in effect, the unauthorised overdraft has simply been re-branded.
The OFT is currently adopting a softly-softly approach with the banks, encouraging them to get their house in order by 2012, and threatening them that otherwise it may still recommend that the government introduces a change in the legislation. In the meantime, it has persuaded some banks to offer customers the chance to 'opt out' of unauthorised overdrafts altogether.
However, it remains unclear how this will prevent banks penalising customers without sufficient funds in their accounts when direct debits and standing orders are failed or refused.
…and in the here and now
If you want a decent interest-free overdraft now, you tend to have to pay a daily or monthly fee for it. For example, Barclays Premier Account holders may receive an interest-free overdraft of up to £1,000, but they have to pay £25 a month.
Halifax and Bank of Scotland, meanwhile, don't charge interest on overdrafts but do charge 'usage fees' of £1 a day for overdrafts up to £2,500, and £2 a day for overdrafts over £2,500.
So does all this mean the days of fee-free banking are coming to an end? The BBA's McLeod says: "The 'free while you're in credit model' isn't in jeopardy at all. But if people take money which isn't theirs and for which they haven't arranged a borrowing facility, they must expect to pay for it. Consumers have an obligation to shop around for the product that's right for them."
However, until switching is made easier, charging transparency improved and competition boosted, it seems that the cost of the banks' own financial mismanagement will continue to fall on the shoulders of their customers.
If you think you've been treated unfairly by your bank or building society, first complain to the bank itself. If it doesn't address your complaint to your satisfaction, you can seek advice from your local Citizens Advice Bureau (citizensadvice.org.uk) or complain to the Financial Ombudsman Scheme (fos.org.uk).
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
If you’ve have a complaint about a financial service product you have bought but the company you bought it from refuses to resolve your problem after eight weeks, the Ombudsman can help. The Ombudsman will investigate and resolve the matter. The Ombudsman is independent and its service is free to consumers. The Ombudsman may find in the company’s favour but consumers don’t have accept its decision and are always free to go to court instead. But if they do accept an Ombudsman’s decision, it is binding both on them and on the business.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.