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Guest comment: Time for radical reform on overdrafts

The Financial Conduct Authority's executive director of strategy and competition Christopher Woolard explains why the regulator is proposing new rules on overdraft charges. Views do not necessarily reflect those of

Anyone who's ended up paying overdraft charges, however carefully they've tried to avoid it, knows that it can be a frustrating and expensive experience. Perhaps it's happened to you once or twice. But most overdraft fees are paid by a small number of people who pay a hefty price for going into the red. Stopping complicated, harmful overdraft charges requires radical reform. And that's what we want to do.

Most of us have bank accounts with an overdraft, but we don't think about how much it would actually cost to use it. When people go into the red – particularly into an unarranged overdraft – they aren't likely to compare other options for borrowing.

Going beyond your arranged overdraft limit can be a very expensive experience. Unarranged overdraft charges regularly exceed 10% a day and can be over 20% a day for some customers. We found that people living in some of the poorest areas of the country can pay around twice as much in fees and charges compared to other customers.

Perhaps most shockingly of all, 50% of banks' unarranged overdraft fees came from just 1.5% of customers in 2016. Those who use their overdraft repeatedly get hit hard – 69% of all overdraft fees come from people who go into their overdraft every month of the year.

Our proposals for fundamental change

The last time I wrote to MSE readers about overdrafts, I made it clear that we had significant doubts about whether unarranged overdrafts could continue in their current form. I said that fundamental change may be necessary. Today, we're setting out our proposals to make this fundamental change.

We're proposing a radical redesign of the way banks charge for overdrafts. They are complex and hard to understand – people can't easily compare prices between different banks, or check how much the cost compared to different forms of credit, such as credit cards. Our research shows that only one in five people can correctly pick the best overdraft deal from a set of current products. We want this to change: overdrafts should be simpler, fairer and easier to understand. And, under our proposals, we expect to see a significant reduction in unarranged overdraft charges.

Banks and building societies will have to charge a simple, single interest rate for each account – under our proposals there will be no more fixed daily or monthly fees. Crucially, unarranged overdrafts won't be more expensive than arranged overdrafts. The cost to banks of providing unarranged overdrafts is not significantly more than for arranged overdrafts, and we see no justification for them to charge higher prices as a result.

Banks will have to show the APR for arranged overdrafts in most of their advertising and we will require the industry to provide an overdraft cost calculator. We are also encouraging firms to show examples of the cost in pounds and pence.

Our new rules require banks and building societies to provide customers with better information about overdrafts. Customers will receive mobile phone alerts and see a negative balance at cash machines if they use an overdraft.

We need to treat 'overdraft prisoners' fairly

We agree with MSE that firms need to treat customers who are 'overdraft prisoners' fairly. Our proposed changes will mean that they pay lower charges for using unarranged overdrafts and get earlier help with repeat use. We're also implementing changes to give customers tools to check if they can get a cheaper overdraft elsewhere.

You may be wondering how these proposals would impact the cost of banking. There's been a lot of discussion about 'free-if-in-credit' banking and whether changing how banks charge for overdrafts will be the end to free banking. Our analysis suggests that even with these proposed changes, the free-if-in-credit model remains profitable and attractive for banks.

Overdrafts should be a buffer to help you when you most need it. But the cost should be fair and they must not trap people into paying high charges month after month.

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