The Financial Conduct Authority (FCA) has confirmed it is introducing reforms to fix a dysfunctional overdraft market. These changes will make overdrafts simpler, fairer, and easier to manage and will protect the millions of consumers that use overdrafts, particularly more vulnerable consumers. The changes represent the biggest overhaul to the overdraft market for a generation.

In 2017, firms made over £2.4bn from overdrafts alone, with around 30% from unarranged overdrafts. More than 50% of banks’ unarranged overdraft fees came from just 1.5% of customers in 2016.  People living in deprived areas are more likely to be impacted by these fees. In some cases, unarranged overdraft fees can be more than ten times as high as fees for payday loans.

Today the FCA has announced that it is:

  • stopping banks and building societies from charging higher prices for unarranged overdrafts than for arranged overdrafts;
  • banning fixed fees for borrowing through an overdraft – calling an end to fixed daily or monthly charges, and fees for having an overdraft facility;
  • requiring banks and building societies to price overdrafts by a simple annual interest rate;
  • requiring banks and building societies to advertise arranged overdraft prices with an APR to help customers compare them against other products;
  • issuing new guidance to reiterate that refused payment fees should reasonably correspond to the costs of refusing payments; and
  • requiring banks and building societies to do more to identify customers who are showing signs of financial strain or are in financial difficulty, and develop and implement a strategy to reduce repeat overdraft use.

Extensive FCA research with consumers showed that they also wanted to see the cost of borrowing set out in pounds and pence alongside an APR and interest rate; UK Finance have agreed to implement this alongside the FCA’s remedies.

Andrew Bailey, Chief Executive of the Financial Conduct Authority said “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.”

The new rules will be in force by 6th April 2020, apart from the guidance on refused payment fees, which will take effect immediately, and the repeat use remedies which will come into force on 18th December 2019. The repeat use remedies will take effect alongside the changes the FCA announced in December 2018 to make overdrafts easier to manage:

  • digital eligibility tools that allow customers to check if they can get a cheaper overdraft with another provider
  • overdraft charge calculators that help customers translate interest rates into pounds and pence
  • text message or push notification alerts and changes to display overdrawn balances at cash machines to address unexpected overdraft use

Responding to the reforms to the overdraft market, Eric Leenders, Managing Director, Personal Finance at UK Finance said “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.”

Peter Tutton, Head of Policy at StepChange Debt Charity, said “The FCA is absolutely right to point to the harm that getting stuck in expensive repeated overdrafts can cause. Our own research shows that around half our clients have accumulated overdraft debt at the point they turn to us. So while it’s disappointing that the rules prohibiting harmful unauthorised overdraft charges will take a bit longer, we are delighted that the FCA is turning the page on a long standing cause of hardship for struggling households.”

“The challenge now is to make sure the steps to help customers get out of expensive overdraft debt work in practice.”

“In the credit card market, the effectiveness of the remedies required by the FCA is not yet proven in practice. In the overdrafts market we would therefore like the regulator to be more pro-active and fleet of foot in identifying and refining the specific, practical steps banks should be taking to help customers escape the overdraft trap more quickly, and to break the cycle of repeat use of overdrafts.”

Joanna Elson OBE, chief executive of the Money Advice Trust, said: “The FCA is right to introduce stronger protections for consumers in relation to overdrafts. These measures, including banning fixed charges and higher pricing of unarranged overdrafts, are a welcome step in the right direction and should help reduce costs for people who use this form of borrowing.”

“From what we see at National Debtline, we know that repeated overdraft use is often a sign of financial difficulty. It is right that banks are required to do more to identify and support these customers – getting the right support and advice as early as possible can stop financial problems escalating further.”

“It is now crucial that the FCA monitors these changes closely to help ensure that they do bring costs down. If this is not the case, the regulator needs to act swiftly to introduce a price cap.”

Michael McKee, Financial Services Partner, at global law firm DLA Piper said “The regulator needs to decide what its objectives for consumers are: either to encourage them to be more hands-on or be the backstop. While the policy rationale for this change is based upon economic and competition philosophies, and pressure from consumers to limit the penalties of unplanned overdrafts, it disincentivises sensible money management by bank customers. Therefore, we could see more customers entering into more short-term debt – which is not what the FCA intends.”

Sajedah Karim, UK FS Partner, EY said “Today’s announcement confirms banks will have to fundamentally reassess their pricing structures and considerably increase clarity on the cost of overdrafts.  This will cost the banking industry.  The FCA’s figures show it expects a 96% fall in the charges applied to typical unauthorised borrowing of £100 (from £5 to less than 20p).  This will clearly impact the £2.4bn in revenue that banks receive from arranged and unarranged overdraft fees and charges.   Lowering rates whilst continuing to make existing current account propositions viable will be a difficult balancing act for banks. Notably, the FCA makes no new comment on the future of free banking.”

“Most banks have made changes or have started planning for these changes.  Moving the implementation date from December to April 2020 will be a welcome window in which firms can refine their overall propositions.

“The regulator has been clear about the approach it wishes to take for some time: overall lower costs, better transparency to promote choice, engagement with repeat usage customers, who rely on overdrafts over the long-term and less reliance on revenue from the most vulnerable. The changes are in line with expectations and, as well as delivering a ‘radical package of remedies’, they provide a clear signal on the FCA’s stance on vulnerable customers.”

“Requirements on firms to monitor progress and provide additional information on pricing changes are a further ramp up in expectations. This adds to the operational impact and will need to be carefully managed across the industry to ensure the remedies have the intended results.”