Yesterday, Andrew Bailey, Executive Director at the Bank of England said that he was “like a dog with a bone” in his enthusiasm to tackle the “dangerous myth” of free in-credit banking. But in an environment where competition is driving complexity, this arguably addresses the symptoms, but not the cause of the problem.
Hidden charges: the scourge of consumer finance?
For the majority of personal current accounts, there are no monthly fees when the account is in credit. Sources of revenue for banks include charges for overdrafts, selling additional products, such as credit cards, and the net interest from loans that the deposits allow them to make.
This means that effectively, savvy consumers who manage their money carefully – by keeping their current account balances low and not using overdrafts – tend to benefit at the expense of other consumers. As set out in an SMF report last year, 49.6% of banks’ current account revenues come from the “spread” between low interest rates on positive current account balances and the interest rates charged on loans made to other consumers, and 30.9% of their revenues come from unauthorised overdraft/insufficient funds charges. So there is a substantial cross-subsidy between consumers.
Public resistance to Bailey’s approach
Andrew Bailey’s approach of getting rid of free current accounts is one way of increasing transparency and potentially removing the cross-subsidy. But a major barrier to this idea is a lack of public acceptability for other models.
In a report published last year, the SMF put two different current account models to a focus group. The first, based on the average bank account, was a free account paid for by cross-subsidies from overdraft charges and low interest rates capped at 0.47%. The second option, which raised just as much revenue for the hypothetical bank, would cost the consumer £4.45 per month but would not involve any unauthorised overdraft/insufficient funds charges and would carry competitive and varied interest rates linked to account balances.
Among respondents to the focus group, nobody was content with the concept of paying a monthly fee for an account. While two respondents did opt for the second account, both caveated their response by expressing their disagreement with a charging structure. One said: “B is the better of the two options” but “I STILL do NOT agree with paying for a current account!” The other suggested the account be improved by removing the fee.
Free bank accounts have become the norm, and norms are hard to break in consumer finance. Consumers who don’t use overdrafts and keep low balances in their current account do relatively well under the current system, and it’s unlikely that those that do use overdrafts will be clamouring for upfront monthly charges.
The worst of both worlds?
What’s more, there are no guarantees that simply getting rid of free accounts will end some of the unfair practices inherent in consumer finance. As Mike O’Connor of Consumer Focus has recently said “What must not happen is that consumers end up with the worst of both worlds: paying for accounts but still enduring unfair charges, opaque and complex products, mis-selling and poor customer service.”
Trusted financial products
The real problem in financial markets is that competition is driving complexity. It is to banks’ advantage to increase additional and hidden charges, and make products difficult to compare. Getting rid of free bank accounts may remove the cross-subsidy, but this is really only a symptom of the real, wider problem. The SMF’s report recommended a set of “trusted products”, kite-marked products that have transparent and standardised charging structures and small print. This should lead to products being easily comparable, to the benefit of consumers.
A similar idea, Simple Products, is currently being considered by the Treasury. But it is comparability and consistency of products, not necessarily just their simplicity, which is really important if competition is to work for consumers.