Bad News For Banks And Borrowers
British banks have blown up billions in the credit crunch. However, customers are set to suffer even more for two different reasons.
Over the past year, life has become much harder for British banks. Their troubles began last spring, when investments in American subprime mortgages began to turn sour. Since then, banks across the globe have lost hundreds of billions of dollars as these risky home loans blew up. Even worse, credit problems are expanding, as bad debts leap on US credit cards and car loans.
What's more, thanks to two ongoing enquiries by financial watchdogs, British banks are under the cosh. They stand to lose further billions if these two rulings go against them:
1. Payment protection insurance (PPI)
After working in the PPI market for eleven years, I escaped and went on to become its biggest whistle-blower. Indeed, in 5½ years of writing for the Fool, I have criticised payment protection insurance on hundreds of occasions. For example, in The Greatest Rip-Off Rolls On, I warned that this accident, sickness and unemployment cover is hugely overpriced, widely mis-sold and poorly designed.
The Financial Services Authority (FSA) has fined ten different lenders for mis-selling PPI. Its most recent target was furniture retailer Land of Leather, which coughed up £210,000 earlier this month for failing to sell PPI fairly. In total, the fines levied on PPI offenders total more than £3 million. Alas, this is a drop in the ocean, as PPI providers trouser perhaps £5 billion a year from flogging this rubbish. Thus, a fine of £20 million would make only a tiny dent in a big bank's PPI profits.
Nevertheless, Britain's biggest banks nervously await the outcome of the Competition Commission's inquiry into loan insurance and other PPI. Thanks to an unfair and anti-competitive market, lenders have banked massive profits from the sale of PPI. Hence, it is highly likely that the Commission will impose sanctions against the banks when it announces its provisional findings next month.
If this ruling goes against the banks, then they stand to lose perhaps £2 billion a year from reduced PPI profits. We know that lenders have subsidised cheap personal loans by overcharging for PPI. Therefore, a ban, price cap or other selling restrictions will immediately lead to increased loan interest rates. Another option would be introduce or increase loan arrangement fees, as has already happened in the mortgage market.
As a result, personal loans rates will rise for all borrowers, whether or not they choose to buy PPI. We just can't win, can we?
2. Overdraft charges
The other big case hanging over the banks is the Office of Fair Trading's court action against unfair bank charges. Banks impose huge penalties on customers who slip into the red (go overdrawn) without prior permission. Typically, these fines amounts to £25 to £40 per offence, including rejecting a cheque, direct debit or standing order. For more information, read Reclaim Your Bank And Card Charges.
Last year, banks paid out hundreds of millions of pounds to customers who went to court in order to reclaim these unlawful charges. However, subsequent court cases are now on hold pending the outcome of the OFT's court battle against the banks. A decent outcome for consumers would be if the OFT imposed a cap on these charges, similar to the £12 guideline adopted by credit-card issuers.
As a former banker, I know that the true cost of administering unauthorised overdrafts is a few pounds per slip-up, not several tenners. Consequently, I remain confident that the OFT will win through for consumers. However, this legal battle is likely to continue into 2009 and, if the banks appeal, could run on into 2010 and beyond. So, whatever happens, we're in for a long wait.
Unfortunately, a win by the OFT might turn out to be a poisoned chalice. By my reckoning, British banks make roughly £300 million a month from these extortionate overdraft charges. Losing, say, half of this income would cost banks around £1.8 billion a year. In order to make good this loss, the banks would undoubtedly raise current account charges elsewhere. For example, introducing a £5-a-month fee on the UK's forty million current accounts would raise £2.4 billion a year.
In summary, whatever the outcome of these inquiries, there will be winners and losers. Furthermore, Britain's banks will fight tooth and nail in order to continue to make sky-high profits. Yet again, customers will end up losers in our never-ending battle against the banks!
More: Get Best Buy PPI from British Insurance | Personal Loans Are Getting Pricier | How Generous Is Your Bank Account?