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.