The worst things in life are free
stephen clarke, 24 May 2012
Today, Andrew Bailey, a director of the Bank of England and soon-to-be chief regulator of the financial services industry described free banking as a ‘dangerous myth’.
Andrew Bailey is drawing attention to the fact that the myth of a ‘free’ current account obscures the true cost for banks in maintaining accounts with low balances and small transactions. ‘Free’ accounts lead to banks charging customers in other ways, including charges on overdrafts and perhaps selling products, such as PPI, that customers don’t want or need.
The system generates confusion; public reaction to the idea that bank accounts shouldn’t be free was, understandably perhaps, that many consumers would balk at having to pay for their current account. Many said that they thought charging for accounts was indefensible given the low interest rates and hidden charges that accompany current accounts at present, however it is precisely such hidden charges that a move away from free banking could mitigate.
Much of the coverage of Bailey’s pronouncement focused on the reactions of consumers to the immediate issues of low-interest rates, hidden fees and charges for current accounts. However, just as relevant for consumers, if less recognised, is the way in which ‘free’ banking has helped create an uncompetitive banking market.
In his evidence to the Treasury Select Committee as part of the Independent Commission on Banking, Chris Rhodes, Group Product & Marketing Director of Nationwide, estimated that a bank needs a market share of 10 per cent before they can offer free accounts without a loss. Large banks benefit from charging other banks when their customers use their ATMs or when a customer of another bank pays a merchant that banks with them. These charges, as well as the hidden ones attached to current accounts, are also important in perpetuating the myth of ‘free’ banking. The result is that free banking contributes to the lack of competition in British banking; reducing the quality of service customers receive.
Virgin money is the most recent new competitor affected by the system, its plans to charge £5 a month for its current account drew criticism and forced a partial retreat on the issue. More importantly there are silent victims; the many new institutions struggling to get off the ground in an environment where ‘free’ accounts are the norm.
‘Free’ accounts are not the only facet of the banking system that inhibits competition. A recent Civitas publication outlines the many other issues in this area including the actions of regulators, the payment systems and the rules surrounding banks. However, it is an important issue and it is encouraging that Bailey, in his position, realises this.
Until Bailey’s pronouncement the FSA showed very little interest in combatting competition issues in banking, perhaps rightly forced by public opinion and policy-makers to focus on stability in the wake of the financial crisis. However in the long-run only a truly competitive system will be stable, affordable and provide customers with good service.