Find out how consumers and firms manage overdrafts.
Our research looked at consumers who regularly use overdrafts and found:
- virtually no evidence of shopping around on overdraft features or charges
- little evidence of account switching
- a common belief that other providers will not take on consumers with overdraft debt
- authorised overdrafts are seen as an extension of money rather than debt, and some providers encourage this by presenting overdraft limits as ‘funds available’
- using an authorised overdraft quickly becomes a habit and limits tend to be raised (with about half of the limits unsolicited in the sample)
- over time, consumers aim to stay within an authorised overdraft limit rather than pay it off – they feel things are ‘under control’ as long as they are inside the limit
- usage is driven by general pressure on finances, with no stigma in going overdrawn.
- for more affluent consumers, an unauthorised overdraft is more likely to be a mistake and they are more likely to challenge charges
- for the less affluent, usage is more intentional, less avoidable and they are resigned to incurring charges
- there is widespread confusion and a lack of understanding about overdrafts – for example, many wrongly thought that overdrafts were simple or free and were generally confused about what happened when going into an unauthorised overdraft
You can find out our key findings from our research.
Consumers do not pressure firms to offer good value overdrafts
Consumers do not tend to shop around or switch accounts on the basis of an overdraft. They also typically do not consider alternative credit products when drawing on an overdraft, because they do not actively choose to draw on it, do not consider authorised overdrafts as debt and are often unaware of costs.
As a result, consumers aren’t very responsive to overdraft costs, so there is little pressure on banks and building societies to provide good-value overdrafts. It also means banks and building societies can earn greater revenue from overdraft users.
Some firms have argued that overdrafts effectively subsidise free-if-in credit banking. We think subsidies are more complex. As part of our ongoing market study into cash savings, for example, we have seen evidence that suggests that for some providers, a significant proportion of their instant access savings account holders also hold PCAs. This is consistent with PCAs being a gateway product for selling other products, as noted by the OFT in its 2008 market study.
These complexities show that any regulatory interventions will need to consider overall issues in the retail banking market.
Costs of overdrafts
We have seen evidence of banks charging high fees for unauthorised overdrafts.
The Office of Fair Trading (OFT) compared the cost of borrowing £100 over a month for different forms of high-cost credit in 2010. Unauthorised overdrafts were the second most expensive, with an average total cost of £37.
Authorised overdraft charges have evolved recently, with many providers moving away from interest charges to daily charges with caps on charges per month. In 2013 Which? found that authorised overdrafts were cheaper than unauthorised overdrafts, with costs of borrowing £100 over a month ranging from £0 to £30.
Still significant revenue from overdrafts
Revenues from overdrafts have fallen overall in recent years. However, they remain significant.
In 2011, 34% of revenue from personal current accounts was from overdrafts – down from 36% in 2007. This was largely driven by a reduction in unauthorised overdraft revenue from charges, down from £2.4bn in 2007 to £1.7bn in 2011. However, revenue from authorised overdraft charges increased by £0.4bn over the same period.
The recent changes to authorised overdraft charges structures, away from interest to daily charges, may be a mechanism by which providers are increasing revenue from authorised overdrafts.
How firms structure overdrafts
Our research found that:
- most providers include an overdraft as standard with a personal current account
- opt-outs from unauthorised overdrafts are typically offered, but usually for a fee
- most providers plan to move toward daily fees on unauthorised overdrafts, but charging structures still remain complex
- detailed information on overdrafts is available and actively disclosed to consumers (for example, in monthly statements and annual summaries)
- most providers offer a text alert option to consumers approaching their overdraft limit
- providers offer different grace periods for charges, but disclosure about these varies
- most providers offer a small buffer (£10 to £20) before breached authorised limits triggered charges
Overdraft providers appear to have made improvements, particularly around disclosure. We think these have been driven by regulatory pressures, such as the OFT’s and Government’s recent actions, rather than from improvements in the current account market.
For example, a number of major banks have recently lowered the level at which charges start on authorised overdrafts to very similar levels, suggesting some degree of ‘following’ behaviour in the market.
All the same, the ongoing high revenue from unauthorised overdrafts and the increase in revenue from authorised overdrafts suggest that providers can still potentially profit from consumers’ lack of understanding, confusion and limited attention.