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Farrer & Co | The FCA publishes proposals for new rules on overdrafts

Last month the FCA published its High-Cost Credit Review: Overdrafts consultation paper and policy statement on overdrafts (Consultation Paper). In this briefing Grania Baird and Fiona Lowrie set out the key changes being proposed by the FCA and examine the implications for overdraft providers, including private banks.

Background

Excessive use of overdrafts causes harm, and in this Consultation Paper the FCA is clear that it disproportionately affects vulnerable consumers. The FCA particularly notes that in 2016 in excess of 50% of firms’ unarranged overdraft fees came from just 1.5% of customers, with unarranged overdraft charges causing harm to more vulnerable customers. This focus on vulnerable customers is in line the FCA’s more vocal approach in relation to high cost consumer credit, for example its previous market study on credit cards.  In order to reduce the harm caused by high cost overdrafts the FCA in proposing a number of changes, the majority of which are focused on changing the pricing structures in relation to overdrafts.

Proposed changes

The overall objective of the FCA’s proposals in to achieve “simpler and fairer pricing” for consumers using overdrafts. In particular, the Consultation Papers covers the following topics which we refer to in this briefing:

Simplifying pricing and APRs

Aligning charging structure for arranged and unarranged overdrafts

Reasonable refused payment fees

Greater monitoring of overdraft use by consumers

Private banks carve out

Preparing for the new rules

Brexit

Simplifying pricing and APRs

The FCA is keen that overdraft pricing is as simple as possible to allow consumers to understand the costs associated with overdrafts and to allow them to compare costs across providers therefore facilitating switching.  As a result, the FCA intends to require firms to price overdrafts with a single interest rate, i.e.  no tiered levels of interest rates depending on the amount borrowed, although banks will be allowed to continue to offer an initial amount with no interest charge. Firms will have to provide consumers with a representative interest rate in relation to overdrafts so that consumers can more easily compare costs across overdraft providers (in a similar manner to how consumers can compare credit card costs). In order to facilitate this comparison, firms will need to provide an online or app-based tool that indicates a consumer’s eligibility for an overdraft. The FCA believes that this will reduce barriers to consumer switching. Firms will be required to give a representative APR in advertising wherever the Consumer Credit sourcebook triggers the requirement to include a representative example. In order to do this the FCA is removing the current exemption from including a representative APR for overdrafts. Firms will also need to report their representative APRs each year to the FCA and the FCA is continuing to work with industry to get agreement on a pounds and pence example that will be useful and understood by consumers.

There will also be a ban on all other fees associated with overdrafts (other than proportionate fees for refused payments). Daily fees are to be banned as the FCA found that such a pricing structure did not help consumers understand the costs associated with their overdraft.

Aligned charging structure for arranged and unarranged overdrafts

While the FCA acknowledged that consumer research indicates that consumers value unarranged overdrafts as a useful service, it does believe that repeated use of unarranged overdrafts can cause harm to individuals. In order to reduce such harm the FCA believes the prices for both arranged and unarranged overdrafts should be aligned. The FCA did not see enough evidence to indicate that firms should be allowed to charge more for unarranged overdrafts. Firms will still be allowed to set their own overdraft pricing structure  as the FCA does not believe it would be useful to set a cap in relation to such fees and therefore it may be the case that some firms increase their arranged overdraft fees to ensure that the provision of overdrafts (arranged or unarranged) does not become loss making for the firm.

Reasonable refused payment fees

As mentioned above, firms will continue to be permitted to charge refused payment fees, provided such fees “reasonably correspond to the payment service provider’s actual costs” of refusing such payments. The FCA is consulting on what costs meet this requirement. For example, the FCA believes that providing alerts and notifications in relation to a refused payment is a legitimate cost that the firm can include in its refused payment charge. However, the FCA does not believe that costs relating to fraud detection and prevention should be included in such charges.

Greater monitoring of overdraft use by consumers

The FCA also wants to see much greater monitoring of the use of overdrafts and wants firms to develop a strategy to reduce repeat use. Firms will be required to develop their strategy before the implementation of the new rules (December 2019) and the FCA wants to be provided with copies of these strategies at that point.

Firms will then need to monitor their strategies and their effectiveness and the FCA is expecting reports from firms on the outcome of their monitoring after 6 months and again after 12 months.  The intention of this monitoring requirement is to “promote earlier intervention” by firms in relation to consumers who use overdrafts on a frequent basis  in order to reduce the use and the harm associated with the use of overdrafts in this manner.

The FCA is not proposing to require the reduction or removal of overdraft facilities for consumers in difficulties as it acknowledges that this risks harm to vulnerable customers as well. By allowing the firms to develop their own strategy, in line with the guidance in the consultation paper the FCA believes it is addressing the harm created by the repeat use of overdrafts by consumers in an appropriate way and in a manner consistent with the remedies which followed from its Credit Card Market Survey.  

Firms should be aware that as the FCA intends to require reports on firms’ strategy and the outcomes of their monitoring, the FCA requirements in this area could easily develop over time.

Private bank carve out

Private banks are to a large extent carved out of the remedies proposed in the Consultation Paper, which defines a private bank as “a bank or building society or an operationally distinct brand of such a firm over half of whose personal current account (PCA) customers are eligible individuals” which in short means individuals who hold in excess of £250,000 in readily realisable assets (e.g. money on deposit or transferable securities).

The FCA does not believe that customers of private banks are likely to suffer the same harm relating to overdrafts as the rest of the consumer population and as a result private banks will not be obliged to comply with vast majority of the FCA’s new rules. For example, private banks will not be obliged to provide an online calculator tool to assist consumers in understanding the cost of an overdraft.  However, private banks will be subject to rules requiring greater clarity in relation to overdraft facilities at the account opening stage (or if not previously provided at the point a consumer enters into an overdraft with a private bank).

Private banks will also  be subject to the FCA requirement on refused payment fees to be reasonable and proportionate.

Preparing for the changes

Most firms will already be working to ensure that they can meet the FCA’s requirements and we set out below key areas that clients need to consider.

Commercial implications -  many firms will already have carefully analysed their PCA population and should be able to finalise their work regarding how the FCA mandated simplification of their overdraft charging structures will affect their fees and interest rates from a commercial perspective.  

Client documentation - including account opening documents and terms and conditions, will need to be reviewed as a result of these proposed rules to ensure that they are able to comply with the incoming rules from a contractual point of view and should carefully consider whether any changes need to be made.  Account opening documentation will need to be reviewed for clarity and to ensure it is consistent with the guidance set out in the Consultation Paper.

Communication with consumers – while any changes to the firm’s charging structure will be due to regulatory changes, firms should be considering how best to convey any necessary changes to their consumers in an appropriate and clear manner.

Monitoring strategy – firms should also be considering their strategy for monitoring consumer use of overdrafts in order to reduce persistent use of overdrafts and considering whether any changes are required to a firm’s monitoring strategy in order to meet the FCA requirements as set out in the Consultation Paper.

Technology – the FCA has acknowledged the usefulness of online tools, for example the requirement to provide an online or app tool to allow customers to understand their eligibility for overdrafts and the requirement to provide an overdraft calculator so that consumers can understand how much an overdraft will cost them. In terms of the monitoring strategy required of firms by the proposed rules, technology can be helpful in carrying out monitoring tasks and helping firms analyse the outcomes of their monitoring strategy.

Brexit

The FCA notes that it has developed the policy set out in the Consultation Paper in the context of the existing regulatory framework and it acknowledges that there may be some regulatory implications following the UK’s exit from the European Union, including for example the issues regarding EU firms exercising their passport rights. However, the FCA is of the view that any amendment required by the Brexit process will be minor and it will not therefore need to re-consult on such changes.

If you require further information about anything covered in this briefing note, please contact Grania Baird, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, February 2019

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