The myth of free banking and the financial inclusion conundrum
Research released today by Which? details the extent of charges on ostensibly ‘free’ current accounts. This might actually be music to the ears of the bankers – many within the banking industry would prefer to charge up-front for services like bank accounts. Either way, ordinary customers lose out.
Customers are currently being charged hefty fees in a range of circumstances. According to Which? charges for going overdrawn, without prior approval, range from £120 to £900 per year. But even customers with authorised overdrafts will be charged for being overdrawn at an APR of 19.9%, which is higher than many credit cards and personal loans.
Being overdrawn is not the only way that customers pay. Many pay large fees for withdrawing and spending money abroad. And everybody with a current account pays in ‘interest forgone’. Technically, interest is what the banks pay us for lending them our money. Interest forgone is the difference between the low interest paid on a current account – because banks say they are more expensive to run – and the interest that could be paid in another product. The Vickers Commission recommended that banks explicitly tell us about the amount of interest we are hypothetically forgoing in this way.
I first wrote about this issue on Touchstone in May, when the Bank of England’s Chief Cashier Andrew Bailey called for an end to free banking. Bailey’s argument was highly suspect: free from the burden of subsidising free current accounts, banks would no longer feel the need to sell high-priced products by deceptive means, such as Payment Protection Insurance (maybe they would be less inclined to fix LIBOR too). As Philip Inman remarked at the time, this logic – which was actually repeated by the new chairman of Barclays last month – is ‘like a pickpocket saying he was forced to steal wallets because he was denied other sources of income.’
There is a conundrum here. High charges, especially when they are hidden, are unfair and help to undermine trust in financial services. Poorer customers are more likely to suffer through high overdraft charges as they are more likely to be in arrears. The British Bankers’ Association says ‘charges can be avoided completely simply by not going overdrawn’ – but surely the whole point of a current account, in contrast to a savings account, is that it has features like overdrafts so that people can manage their money flexibly.
Making the charges up-front might be more honest, but it would mean that people who rarely or never go overdrawn end up paying more for banking. However, it would also surely cause those customers who do frequently go overdrawn to shun formal banking altogether. This would be a huge step backwards for financial inclusion, an agenda which the previous and current governments both earmarked as crucial to social and economic inclusion more generally.
And given that we all already pay for current accounts, almost by definition, in interest forgone, the rationale for up-front fees seems weak. As it happens, Which? rejects completely the idea that banks are not making any profit from current accounts, which would imply that replacing implicit costs with explicit charges would be fairer. They call for much greater competition on the high street, through measures such as more straightforward ways for customers to switch bank accounts. Only when high street banks are genuinely competing with each other on cost will we be able to see what kind of current account charges represent value for money.