Regulatory Update: FCA overdraft reforms

Posted: 7th June 2019

Background

On the 7th June 2019, the FCA confirmed its “biggest shake-up to the overdraft market for a generation”, publishing PS 19 / 16: High-Cost Credit Review: Overdraft policy statement and CP 19 / 18: Overdraft Pricing and Competition Remedies.

The FCA has now introduced controls to fix what it calls a “dysfunctional overdraft market”, using its powers to make overdrafts “simpler, fairer, and easier to manage”. It is hoped that the rules will protect the 26 million people who utilise arranged and unarranged overdrafts each year.

The policy statement published in June follows the FCA’s long-running review of the High-Cost Credit sector. Having already implemented a price cap on rent-to-own products, it should, perhaps, come at no surprise that something of a “cap” should be introduced in the overdrafts market.

The FCA has long been concerned about the price of overdraft charges. In 2017, firms made £2.4bn from overdrafts alone. These fees also disproportionately affect a small percentage of customers, with more than 50% of unarranged overdraft fees coming from just 1.5% of customers in 2016.

From April 2020, banks and building societies won’t be allowed to charge their customers fixed fees for overdrafts or charge higher fees for unarranged overdrafts than for arranged ones. Beginning immediately, however, firms will need to ensure that refused payment fees correspond to the actual cost of refusing payment. Finally, from December this year, these firms will also have to do more to identify customers showing signs of financial difficulty and develop strategies to reduce repeat use of overdrafts.

Instead of charging customers a fixed daily or monthly fee for having less than £0 in their current account, firms will instead have to charge a simple annual interest rate for use of an overdraft. It is hoped that this will result in a fairer distribution of charges and protect vulnerable customers.

Andrew Bailey, the FCA’s Chief Executive, introduced the raft of profound changes by saying:

“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 complex and opaque charges, that are both 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 a day.

“The decisive action we are taking today will give greater protections to millions of people who use an overdraft, particularly the most vulnerable.”

There are concerns that a ban on overdraft fees could result in firms seeking to replace the profits lost by charging for current accounts. While this is far from a certainty, it is undeniable that the limiting of overdraft charges will have some knock-on effects throughout the value chain.

Eric Leenders, Managing Director, Personal Finance at UK Finance, responded to the announcements early in the same day, saying:

“The banking industry is committed to helping customers manage their money and we will be working closely with the FCA to implement these rules.

“The industry is working on a voluntary agreement to make the cost of overdraft borrowing easier to understand for consumers which will be implemented in April 2020. This will build on the range of measures already introduced by the industry, such as text alerts which have been shown to reduce overdraft charges by 25 per cent.

“Overdrafts can provide a convenient way for customers to smooth their short-term cashflow, and there is a highly competitive market in the UK with over 96 products on offer.

“We would always urge customers to speak to their bank and arrange an overdraft in advance to ensure payments are honoured.”

Next steps

The consultation on the new rules will close on the 7th August 2019, with the FCA due to publish any amendments to rules in September 2019. 

Considerations for firms

Banks, building societies and payment service providers, as well as representing trade bodies, will need to carefully read through the new publications and ensure that they are able to implement appropriate strategies, policies and procedures in place to ensure compliance with the staged introductions of individual rules.

Firms affected will also need to communicate the change in policy to all customers, paying special attention to the accessibility needs of their customers. The firm cannot simply put out a blanket statement across social media, or only by mail, for example. Staff will, of course, need to be appropriately trained to discuss overdraft arrangements with customers, and how the proposed changes may affect their banking products and access to money in the future.

Should the changes result in increased customer contact, firms will undoubtedly need human resource on the ground floor to respond quickly and effectively. It could be worth firms teeing up agreements with third-party providers ahead of time to head off any spike in complaint or enquiry volumes. 

Firms will also need to take a long, hard look at the culture and governance that underpins their firm’s overdraft offering. Banks, building societies and payment service providers need to ensure that they are effectively identifying customers in potential financial difficulty and taking action to prevent them from entering “debt spirals”.