Overdraft fees currently account for roughly 30 per cent of bank revenue from personal current accounts, but with the Financial Conduct Authority’s (FCA) changes to overdraft charging coming into force next April, incumbent institutions must move to protect profitability and meet customer needs.

In June, the FCA confirmed its reforms to a “dysfunctional” sector, aiming to make them simpler, fairer and easier to manage, calling it the “biggest overhaul to the overdraft market for a generation”.

In 2017, firms made over £2.4 billion from overdrafts alone, with more than half of banks’ unarranged overdraft fees coming from just 1.5 per cent of the most vulnerable of customers in 2016.

The regulator is therefore stopping banks and building societies from charging higher prices for unarranged overdrafts than for arranged overdrafts; banning fixed fees for borrowing through an overdraft; requiring overdrafts to be priced with a simple annual interest rate; and demanding more action to identify customers who are showing signs of financial strain or are in financial difficulty.

Extensive FCA research with consumers also led it to demand that the cost of borrowing is set out in pounds and pence alongside an APR and interest rate, with UK Finance agreeing to help implement this.

“Following our changes we expect the typical cost of borrowing £100 through an unarranged overdraft to drop from £5 a day to less than 20 pence a day,” said FCA chief executive Andrew Bailey.

The new rules require banks to rethink their business models and how they generate revenue. Louise Main, managing principal at consultancy Capco, suggested that if banks don’t act fast, they will lose business to the new breed of digital challengers. However, if banks seize the opportunity, not only can new revenue streams be created, but they can genuinely become more responsible product providers.

“A popular solution is introducing instalment plans which offer customers the option to split large payments out over several months, while also providing them with more transparency and control,” she stated. “Debt consolidation is also an option, enabling customers to consolidate multiple credit lines into one easy-to-manage credit pot, with one interest rate and one transparent payment per month.”

Ian McKenna, director at the Financial Technology Research Centre, pointed out that banks will have to look to make up that lost revenue elsewhere, and that could be drawn from higher fees on more wealthy customer’s accounts.

“The problem is, these customers are more able to shop around, so this could be the tipping point for people to switch from using challengers as a secondary account, to choosing the lower fees and better service as a primary account,” he commented.

“This could be the catalyst for some long-overdue innovation using Open Banking, or potential partnerships between FinTechs and other players, like financial advisers or insurers making bank account plays – they could easily cream off the incumbent’s best customers.”

Main noted that High Street brands can face challenges when implementing more innovative solutions, often due to legacy infrastructure and tighter controls. “Banks are considering faster ways to launch solutions to market, such as working with solution providers for parts of the value chain, working with delivery partners, or outsourcing to existing credit FinTechs.”

Many will aim to use Application Programming Interfaces (APIs) developed as part of Open Banking to improve apps that help more vulnerable customers with things like alerts to better deals, analytics to proactively flag when customers will run out of money before the month end, or building personal financial management functionality.

These features are already commonplace for digital-only challengers, with Monzo for instance offering a ‘share with us’ facility letting customers to communicate any challenges - such as job loss or health issues - so they can help manage repayments and get them back on track after any missed payments.

“Now is the time for banks to reflect on the most efficient business models and how they can compete with newer, potentially more innovative players,” said Main. “Traditional banks can use Open Banking as an opportunity to offer their infrastructure as a utility and partner with FinTechs to enhance offerings.”

She added: “With rising capital requirements, government directives and tightening regulation, it remains expensive and difficult for challengers to enter the traditional banking space on a solo basis.”

A Nationwide spokesperson argued that the new rules are designed to make overdrafts clearer and more transparent, so customers can easily compare pricing between providers; rather than being about curbing overdraft charges.

“So while we always look at ways to ensure our products and services are innovative and commercially sustainable, we aren’t planning anything as a direct result of the overdraft changes,” she stated, adding that the building society was the first provider to announce its response to the new rules, with the new charges coming into effect from 11 November.

Meanwhile, a spokesperson from TSB said: “Like all current account providers, we’re currently reviewing how it provides overdraft facilities to its customers – at this stage we are not in a position to give more details.”

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