Get Ready For The Banking Wars!

The Office of Fair Trading is investigating bank charges, which might reduce overdraft fees, but could put an end to free banking.

Last week, in Bad News On Overdrafts, I revealed that three banks (Lloyds TSB, NatWest and Smile) increased their overdraft interest rates from 1 September by as much as 2.5% a year.

In my view, these three banks slyly used the quarter-point (0.25%) hike in the Bank of England's base rate in August as a handy excuse to jack up the cost of borrowing for millions of current account customers. Bank profits are under pressure, thanks to rapidly rising bad debts and insolvencies, plus the near-halving of credit-card fees forced upon them by the Office of Fair Trading (OFT).

Since the OFT ruled that sky-high penalty charges for late or missing payments and exceeding your credit-card limit were unlawful, almost all major card issuers been forced to cut these fines from an average of £23 to £12 per slip-up, which is the OFT's recommended maximum fee for penalising naughty customers. This move will cost card issuers hundreds of millions of pounds a year, so some have responded by raising their interest rates for purchases and cash advances, pushing up the cost of borrowing on plastic.

Now that the OFT has cleaned up credit-card fines, it has turned its attention to the penalty charges imposed on borrowers who exceed their overdraft limits. In The Shocking Cost Of Seeing Red, I warned that these fines are incredibly excessive, ranging from £15 for exceeding your overdraft at Smile to £30 at Lloyds TSB. What's more, banks charge eye-popping fees for rejecting (or accepting!) cheques, standing orders and direct debits, ranging from £20 at Smile to an incredibly £39 a time at Halifax.

It's highly likely that the OFT will force banks to reduce these penalty charges to a level which truly reflects the amount of work involved in managing unauthorised overdrafts. My guess is that the OFT will order banks to reduce overdraft fees to a similar level to the £12 mentioned above. Naturally, thanks to what I call the "bubble under the lino" effect, squeezing fees in one area will cause bank charges to pop up elsewhere -- hence the increased overdraft interest rates announced recently.

So, is it unfair that customers with well-managed accounts are, in effect, subsidised by those who rack up hefty charges by breaking the terms and conditions of their account? My view is that customers who manage their current accounts well, don't go overdrawn and allow the banks to make money from their credit balances should not have to pay monthly fees. Then again, I would say that, because I fall into this category!

Nevertheless, as corporations, banks have one absolute legal and financial obligation: to maximise returns to their shareholders (of which I am one). Therefore, they will take the OFT's ruling on the chin, then come out fighting by boosting their charges elsewhere.

One real possibility is that we could see an end to free in-credit banking -- something which HSBC hinted at when it announced half-year profits of £7 billion six weeks ago. Of course, current-account banking isn't 'free' by any means, as banks somehow have to make a buck from their customers. Indeed, in other Westernised nations, such as on the Continent and in the US, Canada, New Zealand and Australia, banking customers pay monthly fees to have current accounts.

What's more, most UK business banking accounts charge transaction fees, covering almost all debit and credits. In addition, it's worth noting that all the Big Four banks (Barclays, HSBC, Lloyds TSB and RBS/NatWest) offer 'premium' current accounts which charge monthly fees in return for a bundle of 'free' services of dubious value.

Hence, the banks have both the infrastructure and the motivation to introduce monthly account fees on current accounts, but the big question is which major bank will break ranks by firing the first shots in the banking war? Whichever bank does go down this route, it can expect customers to depart in droves, because free banking is something we've grown accustomed to over the past fifteen years or so.

Still, my advice would be not to sit back and wait for the end of free banking before finally ditching and switching your current account. After all, it only takes a minute or two to find a bank account which pays a high rate of interest on credit balances and charges a reasonable interest rate on overdrafts!

Lastly, on a separate note, the Department of Trade and Industry (DTI) investigation into credit-card cheques has ended not with a bang but with a whimper, as I'd feared. Although its recommended changes to the Banking Code will improve the marketing of these toxic, unsolicited mailshots, by provided clearer information on interest rates and handling charges, the DTI's proposals have fallen short of the mark once again.

Frankly, the DTI seems to have been hoodwinked by the card companies. For example, it claimed that there "was no evidence that credit-card cheques were causing increased debt". So, what effect does this extra borrowing have, pray tell? Thus, in the absence of decent consumer protection, my advice remains the same as it always has: give these cruel credit-card cheques a wide berth!

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Cliff owns shares in HBOS, parent company of the Halifax, and Lloyds TSB.