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If, like us, you tend to ignore the monthly blurb sent to you by your bank (in our case NatWest), you may have missed this important note in your inbox this month:
From 30 March 2020, we're removing usage fees and increasing our interest rates.
•The £6 a month Arranged Overdraft Usage Fee will be removed
•The arranged overdraft interest will go up from 19.89% to 39.49% EAR1
•We're removing the £250 buffer, meaning the whole arranged overdraft is chargeable From 30 March 2020, our online overdraft calculator will be updated to allow you to see how much an arranged overdraft will cost going forward.
Other banks are set to do the same thing, with most lenders saying they will now charge around 40 per cent and remove interest-free thresholds entirely.
The changes are the result of the FCA’s
crackdown on a “dysfunctional” overdraft market, which has historically heavily penalised borrowers for bouncing checks or overdrawing on their accounts on unarranged terms.
To make things fairer the regulator is forcing banks to bring the usurious rates charged on unarranged overdrafts in line with arranged fees. It is also banning the use of fixed fees such as daily or monthly charges, requiring banks to advertise only annual percentage rate fees (APR) to make it easier for customers to compare and contrast deals.
The above is clearly great news for those who don’t have the credit profile to benefit from arranged overdrafts or who routinely overstep arranged borrowing arrangements. According to the FCA, seven out of 10 overdraft users are likely to benefit from the new rules.
But! As the Bank of England mulls whether or not to cut rates to boost demand, the new rules also happen to be an austerity-imposing nightmare for those who have until now responsibly used arranged limits to manage their finances or who have come to depend on these buffers for smoothing life’s unexpected earnings shocks or even as additional household spending capacity to make ends meet.
The FCA*, however, doesn’t care too much for these people. To the contrary their new rules seem devised to kill off the “just about managing” UK demographic (people who tend to be asset rich, cash poor and savings non-existent and mortgage strapped known as JAMs). This they intend to do by:
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.
So,
in the wisp of a couple of months (because that’s the official warning most people who don’t follow FCA consultations intimately will have got) we’re going from a market framework where arranged overdrafts are considered a perfectly legitimate means of financial management for millions, to one where arranged overdraft users will be equated to problem gamblers.
This is plainly nuts.
If you are one of the 2m or so UK customers stuck in permanent overdraft mode -- an overdraft more often than not freely offered to you by your bank on the back of market forces that decided the facility was proportional, if not supportive, to your credit profile -- you will only have until the end of March to find an alternative buffer to draw upon or be charged a ridiculously usurious rate for doing absolutely nothing wrong at all.
Some might argue the new rules are equivalent to an interest rate hike of 70s inflation-crisis proportions for this particular demographic segment.
Does the FCA understand the consequences of discouraging thousands of pounds worth of potential spending at a time when the BoE is looking to cut rates and Brexit aftermaths are hitting the economy hard?
Just live within your means!
Some might respond the FCA is right to transfer wealth away from the JAMs in favour of the poor on the basis the former can always sell some assets or stop living out of their means. Or they might say just get a personal loan to bridge the gap and keep it as a buffer instead.
But living within’s one means isn’t really the issue at hand. The real issue is whether society at large benefits from banks providing services to help smooth asset/liability volatility on a consumer level. We’d argue it obviously does. Not to mention an economy for which enforced husbandry is entirely inappropriate.
What’s more, it’s not just the JAMs under threat.
Overdrafts
are a lifeline to anyone who is self-employed or subject to earnings volatility as a contractor or freelancer. Think gig economy workers rather than urban stroller mums. Is hurting the precariat really a legitimate transfer of wealth from the rich to the poor?
It’s easy to preach overdraft frugality when one is the beneficiary of an employment contract, a fixed monthly salary and all sorts of emergency buffer benefits from healthcare and redundancy to holiday pay. But without the capacity to dip in and out of agreed overdrafts many sole trade professions simply wouldn’t be able to exist due to the volatility of their incomes.
Major banking institutions, on the other hand, have the capacity to draw on scale, expertise, reputation and the BoE’s borrowing window -- still charging close to its lowest nominal rate in the Old Lady’s 325-year history -- to meet interim imbalance pressures far more cost effectively than any single retail customer or trader.
That they choose to pass the benefits they reap to their customers in a bid to expand the pool of creditworthy individuals who might otherwise not make the criteria to receive loans isn’t forcing debt peonage on these individuals. It’s providing them with the opportunity to smooth earnings and consumption across lifetimes and benefit from assets when they need them rather than when they’re too old to properly take advantage of them. As long as they keep to the terms, whether they tap such overdraft facilities permanently or not is neither here nor there. Stigmatising them is madder still.
Bankers have historically understood this. They know mismatches can occur between the predictability of people’s earnings and liabilities, but that by and large when everything is smoothed out, the customer in question is more than creditworthy. It’s how and why overdrafts came to exist in the first place. To bridge customers’ liquidity shortfalls -- the exact same way banks themselves benefit from daylight overdraft facilities at their respective central banks --
which, in the BoE’s case, costs 25 basis points above bank rate, or 1 per cent as of today, from the overnight standing facility, or a higher, slightly more variable, rate from its discount window. Central banks are more than happy to argue that providing liquidity to such institutions on a near permanent basis isn’t equivalent to propping up insolvent institutions. Why then does the same not apply to individuals when banks choose to do it?
The distinction between an arranged and unarranged overdraft is also commercially meaningful for banks.
Because the former is arranged, banks can manage the risk of such liquidity drawdowns. The liability of the arranged overdraft can be offset by funding, which can be pre-planned and accessed at very low rates.
In the case of an unarranged overdraft, it’s only right and proper that a bank should for the sake of its own risk management apply rates and charges that disincentivise any behaviour that increases its exposure to unexpected liquidity provision.
By equating the two as the same thing, the risk is that banks lose the ability to forecast total exposures in this field -- since the penalty of dipping into an unarranged overdraft becomes commensurate to that of dipping into an arranged one.
There will undoubtedly be unexpected consequences of this new system for banks, and Andrew Bailey, the current chief executive of the FCA who is also the incoming governor of the BoE, should be aware of this.
So what’s really going on?
The no-sympathy reaction from the financially prudent is telling here.
From their point of view the asset-rich JAMs should just get a personal loan to bridge the gap and use that as a new buffer. “There’s nothing stopping you from keeping £1000 in your account at all times,” being the train of thought.
But this misses the point that by being forced to keep £1000 (or more, if your capacity to pay off monthly sums is greater than that) the consumer is effectively
taking a loan to fund the banks. It’s a bad deal. A really bad deal. You’re paying the bank for the privilege of not spending the cash reserve that helps them manage day-to-day imbalances.
Worse still, you’re being forced to keep that reserve in the world’s worst savings product: a current account or some other easy to tap equivalent.
It’s worth remembering a key social purpose of banking is offering liquidity support to going concerns (whether individuals or business) so as to keep them economically active while alleviating the risk and upheaval associated with self-funding all personal enterprise.
Flipping this arrangement so that customers fund banks defies the logic of the whole exercise. We might as well all transfer to bitcoin, a system which is mercilessly obsessed with avoiding debt at any cost, and in so doing adds volatility and uncertainty to the fabric of the economy, while eroding rather than encouraging trust.
Which leads us to think there may be another motivation at hand.
A new means of intraday funding
As we’ve
noted for a long time real-time payments systems (RTGS) have put a lot of pressure on banks in terms of the idle float they have to maintain to meet intraday and overnight imbalance risk. This is because even a small clog in the system risks gridlocking the payments infrastructure and toppling the system. Since holding idle float is an opportunity cost, banks have tended to tap intraday borrowing systems at the central bank to cover the risk.
But as we have learnt from repo crises and QE, this has only transferred the burden of funding day-to-day payment imbalance risk in the economy to central banks, and thus de facto to governments.
Should we be surprised that some central bankers think measures that will encourage customers to fund buffers historically funded by banks are the optimal solution? After all, the overdraft rules potentially reduce banks’ short-term liability exposures arising from overdraft borrowing. If customers are then forced to keep permanent buffers to manage their own risk that equates to a liquidity injection to boot.
The irony is, if and when the JAMs themselves go bankrupt or begin tapping unarranged overdrafts at even greater rates, the system might breakdown regardless.
*The article has been amended to reflect that the FCA and the BoE are independent bodies.
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