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The end of ‘free’ banking

In the 1970s, the UK's Midland Bank introduced a new competitive service – free banking.

It wasn’t free of course, but it appeared that way.

The idea being that if you stayed in credit, they wouldn’t’ charge you anything.

It was a huge success.

So much so that Midland acquired many customers from Barclays, NatWest and Lloyds.

After a few months, the other banks decided they had to do something and followed Midland’s lead… just as Midland realised that it was a stupid idea and decided to cancel the whole thing due to the massive losses they were incurring from free banking.

Unfortunately, the market had all moved to the model though and none of them could now retract the offer without both losing market share and the reputational damage that goes with that.

Hence, the UK has forever since had free banking.

Until now.

Now, the regulators are saying they are going to get rid of free banking.

Oh no!

Why would the regulator do that?

Because free banking is a tax on the poor that subsidises the rich.

Free banking became the de facto standard for banking, but what it meant in reality is that all other aspects of a deposit account became expensive: loans, credit cards and particularly the unexpected or unauthorised overdraft.

There are many stories of students and the underemployed becoming overdrawn by £1 and finding charges being levied, sometimes upwards of £100, as a result.

Bear in mind that those who go overdrawn unexpectedly are often those who have the hardest time with money, and you can see why such charges became punitive on the poor.

In fact, the UK banks cross-subsidise the free part of banking with significant charges in all other areas of banking.

So why don’t they change it?

Several reasons, but the main one is that any bank that says it will charge all their customers for deposit accounts feel they are likely to lose significant numbers of customers, market share and get a large amount of negative publicity.

So why don’t all the banks agree to scrap it?

Because they would all be accused of ripping off their customers and acting in a cartel fashion.

That is why it needs a regulatory change to make it happen, according to Andrew Bailey.

Andrew, currently an executive director at the Bank of England, has spoken out on several occasions against free banking.

I say he is currently with the Bank, as the Bank takes over the responsibilities of the regulatory body, the Financial Services Authority (FSA), soon and when it does Andrew will become the head of the Prudential Regulatory Authority (PRA).

The PRA will regulate the banks and Andrew made a speech to the Westminster Business Forum this week (read the script here), making it clear that he wants to get rid of free banking.

The likelihood is that this will result in customers being charged around £180 per year for their core deposit account function.

Consumer groups don’t think this is a good idea.

For example, Richard Lloyd, executive director with Which?, says that: “it’s a complete myth that banking is free.  Customers pay more than £9 billion a year in fees and lost interest on their accounts.  The idea that if banks charged more, they would stop trying to mis-sell other financial products, is completely unfounded.”

In other words, he thinks that the banks witll levy this fee and still pay low interest on customers in credit whilst penalising those in debt.

However, the logic can be extended a little further thanks to the insights provided by Andy Haldane,  a colleague of Mr.Bailey’s, who gave a brilliant speech at the Financial Services Club this week.

The speech was given under the Chatham House Rule but there was one part that talked a little around the themes of what is free and what is not.

Let’s liken it to walking into a sweet shop and asking for a chocolate bar: “I’ll have a Mars bar please.”

The sweet shop owner says, “very good sir, and it is free.”

“What?”

“No charge sir.”

“Very good too.”

So you ask for a Twix, and that’s free too.

So you then grab a Wispa bar, a Twirl and a Dairy Milk.

All free.

Fantastic.

So you grab the Ferrero Roche, a chocolate fit for an Ambassador.

“Ah, sir, you need to pay for that one”, says the shop keeper.

“Really?” you ask, “how much?”

“£248.24 pence sir.”

In other words, on expensive chocolate subsidises all the others which are free.

The only problem with this analogy is that the poorest are not dependent on Ferrero Roche but are often dependent upon credit, loans and overdrafts.

Hence the reason why the PRA, Andrew Bailey, the Bank of England and their new powers will force the UK banks to abandon free banking and will start charging every customer for their current account.

Let’s just hope all the other charges for unauthorised overdrafts, personal loans and credit cards come down as a result.

  Flying_pigs

 

 

 

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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13 comments

  1. If I don’t use overdraft services why should I subsidise those who do? My current account has been in credit for the last ten years. I bank online. I see no reason why the administration of my account, including ATM charges, shouldn’t be covered by the interest I forgo.
    Do you?

  2. Sorry – “If I don’t use overdraft services why should I subsidise those who do?”
    The whole point of this article was meant to make clear that those who use overdraft services are subsidising YOU who gets free banking as a result of their punitive charges.
    Chris

  3. Respectfully, where is your evidence? How much does it cost a bank to administer the average online current account with ATM facility that is in credit over, say, a year’s worth of average-level transactions?
    Take that costs figure, add a 40% margin and tell us the result.
    Taking last year’s interest rates at, say, First Direct, how much higher would they have been for depositors if we paid the charges you estimate?
    And kindly explain again why somebody taking out a loan should be subsidised by someone who isn’t.
    Particularly given that banks are able to derive additional value via leveraging the deposits of those whose accounts are in credit?
    I find it difficult to believe that your proposal does anything except hit prudent account holders with modest sums in credit, while giving an interest windfall to those with large amounts in savings accounts and providing cheaper loans to the poor and imprudent.
    By all means make your argument for such redistribution. I merely note that in the aftermath of the credit crisis, many commentators called for a lower volume of more expensive loans to people who represented poorer credit risk. Surely you propose the reverse?

  4. Here’s a back-of-the-envelope calculation using the Which? £180 annual bank charge figure.
    To break even on a £180 annual account charge when the bank pays Band of England Base Rate interest on deposits (currently 0.5%) requires a £36,000 in credit.
    At one of Halifax’s savings rates (not current account even) of 1.6% the requirement is £11,250.
    Let’s look at it the other way. If I have £3,000 with my bank and receive 0.5% interest I’ll earn just £15 a year. The break even with charges of £180 I’d need to earn 6% on that £3,000. That’s 5.5% above base rate.
    None of these indicate a good deal for someone who wants a basic, automated service and nothing more.

  5. Talk to Andrew Bailey as he’s the one saying free banking is rubbish … and you seem to like the idea of free banking which is why you get rubbish interest rates on your savings and punitive rates on your loans.
    Start making sense,
    Chris

  6. But the very poor cannot get credit except from Wonga and similar organisations. This will not change. At present they do benefit from no charges on their current accounts.
    So the introduction of charges will only help the less poor and moderately well off who have credit histories that allow them to borrow from the banks. Even for the latter, charges will only benefit them if they borrow AND the banks reduce all other charges in compensation. Are those pigs I see flying past my window?
    Robbing the very poorest to help those better off is a lousy idea. Andrew Bailey is either a moron or a hypocrite and not fit to look after lab rats, let alone human beings.
    Nobody gets significant interest on deposit accounts so they are not actually relevant to anything or anyone.

  7. As mentioned, the notion is that free banking is bad, which it is as it results in low interest and high charges in all other aspects of banking.
    That is the focal area.
    The part where I agree with you Jeremy is that introducing monthly fees for deposit accounts is unlikely to reduce charges or increase interest in other areas, unless that is ALSO part of the regulatory change … which has been implied by Bailey.
    As I don’t know him personally, I am not sure about your final comments.
    Chris

  8. @Stabernide
    You wanted evidence?
    Barclays ‘free’ account
    £8.00 fee for each returned direct debit
    £22 fee for every seven days on an unauthorised overdraft
    £74.00 total monthly cost
    Lloyds ‘free’ account
    £5.00 fee for each returned direct debit
    £5.00 daily fee for an unauthorised overdraft
    £105.00 total monthly cost
    Natwest ‘free’ account
    £6.00 fee for each returned direct debit
    £6.00 daily fee for an unauthorised overdraft
    £126.00 total monthly cost
    There’s loads of evidence out there if you just look.
    http://www.usal.org.uk/news.asp?ID=104

  9. Chris,
    I’m in my late 30s, I don’t earn megabucks and yet I’ve never once incurred a fee for unauthorised overdrafts or returned direct debits. I don’t claim to be a paragon, but I fail to understand why I should pay for services I’ve never used.
    I presume you don’t expect to subsidise other loans,so why are you so keen to make overdrafts cheaper in particular?
    And you’ve not addressed my point re: the availability of credit to the least creditworthy and its role in generating the credit crisis in 2007.
    Surely cheap credit should *not* be so readily available to the poor? We’ve seen what happens when it is: housing bubbles built on unsustainable debt.
    The lesson from the credit crisis is that we need to reduce household indebtedness, particularly among the least creditworthy. Reducing the price of credit to the least creditworthy is madness.
    I’d be interested in your view.

  10. Staberinde
    If you cannot understand a basic concept, then the conversation is not worth continuing.
    The basic concept is this: nothing in life is free.
    You do not want to pay for something.
    You currently do not pay for it, but it is not free.
    It is subsidised by those who need credit.
    That is not viewed as fair, and so a rebalance has to occur where those who want a service pay fair value for that service.
    You are too similar to tax policy makers who think VAT should be raised on everything – especially food and housing – so that they can enjoy lower income tax rates.
    These policies benefit the rich at the expense of the poor.
    I am not a socialist, but I can equally understand why Andrew Bailey thinks that zero tax on deposit accounts (free) is not fair if the poorest are paying 50%+ tax rates to subsidise you.
    Chris

  11. Chris,
    I appreciate that nothing in life is free. My understanding is that when a deposit account is in credit the bank invests/lends that money and earns interest on it, a fraction of which it pays to the depositor in interest. If the banks didn’t make money in this fashion then of course a fee would be justified.
    So you must agree that those in credit *do* pay for their banking. What is in dispute is how much (since this is not transparent) and whether what is paid covers the actual cost of the in-credit service (ie: excluding loans such as overdrafts).
    A number of banks already segment their custom with fees for deposit accounts. First Direct, for example, charges a monthly fee unless customers deposit at least £1500 a month. Unless you can provide alternative figures, surely we should presume that these figures are a guide for the commerciality of free banking?
    It seems our discussion reduces to differing views on which services should be bundled into a standard current account. I see no reason to include loans/overdrafts, just as I see no reason to include travel insurance.
    Obviously, the more transactions and ATM withdrawals an account sees, the greater the cost to service the account. So I agree that any flat fee model (including the case where flat=zero) favours those who undertake more transactions and use ATMs more.
    The more equitable solution therefore might be PAYG banking, with charges levied on a per-transaction basis. This would be more consistent with your argument. However, I fear it might also hit the poor hardest, since the poor would tend to accrue charges on smaller amounts, creating a higher effective marginal charge rate.
    Surely the current fee model at least reflects the fact that banks require stable deposits in order to function? Per-transaction or admin fee banking would alienate customers when they are younger, undermining their affinity for banks when they are older (more valuable) depositors and driving them to put their money in alternative vehicles such as equities?
    I’d like to see an analysis of how much it costs banks to provide each service: transaction processing, ATMs, chequing (OK, not for much longer), mortgages, overdrafts, arranged loans, statementing, branch customer service (etc.) I’d also like to know the true value of deposits to banks; not just in terms of differential interest rates but also in leveraged terms.
    Only when we have these figures can we accurately judge who is subsidising whom.
    Best regards,
    Stabs

  12. I am enjoying the analysis on ‘free banking’ and would like to provide a couple of observations from my experience of working with bank charges before the introduction of ‘free’ & packaged/travel insurance & o/d inclusive accounts i.e at the time Midland introduced ‘free’ banking many years ago:
    Prices (not necessarily costs) were always accessed relative to individual account actual usage: e.g. 60p for chq debit, 70p/% on cash transactions, 17p for automated ATM/BACS, 30p per chq deposited etc. with all charges incurred irrespective of debit/credit & regardless of amounts (it’s only creditcards where amounts are applicable to the charge owing to the banks’ liabilities to the supplier- but that’s another story)
    Balances, were assessed relative to Base Rate. Many years ago, such rate was a material 10% to 15% meaning that we banks would internally calculate the value of current ac balance against the per item activity prices to assess cancelling out the applicable charges. Nowadays, the irony is that the balance is more valuable in Bank’s Balance Sheet terms as opposed to the actual Base Rate/LIBOR %, since retail funds are ‘sticky’ & can be lent 10 times over & thus ensure stability of the financial institution.
    Looking more at the concept of chrages & bank’s income, an interpretation might be that:
    – Balances: Current Acs & Deposit Balance net interest income, coupled with charges from customers cover running the bank’s infrastructure systems & branches etc.
    – Commission: The fees & commissions often looked like profits!
    – Lending: The income from lending at higher rates than offered on deposit is the ‘risk margin’ were often equated to the funds put aside to pay for the bad debts incurred.
    The other element to consider alongs side the ethos of charging is of course the market place. It is continuing practice for business accounts to be levied charges on current account activity – the basic current ac activity is a service provided by one business to another & is paid for. In a similar manner, telecommunications are billed between supplier & user – again with different markets segments enjoying different terms such as ‘free’ local calls – but woe betide you if you dial an 0870 number, or talk for longer than 59 minutes…
    Excluding the debatable ‘value’ of credit balance held on an on-demand current ac, as suggested by Chris before, banking & telecoms do have some similarities.

  13. Chris,
    Have the supporters of such charges considered the wider desire to reduce the circulation of cash in the economy and convert cash transactions to electronic payments?
    Recently banks have made huge investments (in PR at least) in contactless cards and mobile payments. The small but growing transaction volumes could easily dry up overnight if banks started to charge for providing the banks accounts that are require to send or receive such payments, while cash remained free to use.
    In the recent past banks have complained about the cost of handling cash and cheques. While charging for bank accounts might be one way to kill off cheques, it will certainly increase the use of cash.

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