UK: The FCA's Verdict On Free-If-In-Credit Banking And Its Consequences For Vulnerable Consumers

Our previous blog on the FCA's Strategic Review of Retail Banking Business Models (the Strategic Review), analysed the review's focus on the free-if-in-credit ("FIIC") banking model, the impact that this model had on vulnerable consumers, and the potential for FIIC banking to create what the FCA might see as unacceptable cross-subsidies between vulnerable consumers and other consumer groups. Our overall conclusion was that the FCA was unlikely to ban FIIC banking, but would instead focus on the cost of overdrafts and likely look to introduce some form of price cap for unarranged (and possibly arranged) overdrafts.

The FCA has now published an update to its Strategic Review, as well as a Consultation Paper outlining its potential interventions on overdrafts as part of its High Cost Credit Review (HCCR), which we have written about in more detail in another blog. This blog revisits our initial analysis and expectations in the light of these latest FCA publications. Overall, as we predicted:

• the FCA has not found that the FIIC model leads to unacceptable cross-subsidies at the expense of vulnerable consumers; and accordingly
• has not sought to ban FIIC banking; but has instead
• targeted overdraft charges through its consultation proposals to consider introducing a ban on fixed fees, and to end the distinction between arranged and unarranged overdraft pricing.

Nevertheless, whilst contrary to our expectations, the FCA has not definitively decided to introduce a price cap on overdrafts, and has said that it is still "modelling" this option; that is, it is still holding it in reserve as what it characterises as a "backstop", with it yet to outline the circumstances which might lead to its full adoption.

The FCA's distributional analysis of FIIC banking

The Strategic Review's scoping paper outlined a number of concerns the FCA had about the FIIC banking model, including "whether vulnerable PCA [personal current account] consumers are particularly profitable for banks" and whether "this could indicate distributional issues, for example if vulnerable consumers pay (significantly) more than others." The FCA was also concerned that the FIIC model could mean that vulnerable consumers could be cross-subsiding other groups of consumers through overdraft fees and charges, which they would be more likely to pay.

Our initial blog drew upon the analysis in the CMA's original review of the retail banking market to argue that some of these distributional concerns were likely to be misplaced. We concluded that "the CMA's evidence suggested that the premise that FIIC banking results in poorer, potentially vulnerable consumers cross subsidising wealthier ones, is too simplistic, and that it is actually wealthier consumers, with higher credit balances, who generate most of banks PCA revenues and so are likely to cross-subsidise other consumer groups."

Having explored this issue in the Strategic Review update, the FCA has reached a similar conclusion, noting that "the consumers who generate the most contribution for banks on their PCAs are not any one specific group in terms of vulnerability" and that this is "due to the importance of the funding benefit banks receive on deposits."

The FCA's update notes that the vast majority of PCA consumers are profitable for banks, and that around 10% of PCA consumers generate between a third and a half of all PCA revenues. Of these 10% of most profitable consumers, similar amounts of revenue come from overdraft charges and the funding benefit from deposits. The FCA also found that around 10% of PCA consumers were loss making for banks, and that these loss making consumers were largely those with bad overdraft debts which the bank had written off. These 10% of loss making consumers will be cross-subsidised by others, but given that heavy overdraft users also fall into the most profitable group of consumers, any cross-subsidies between different consumer groups is likely to be small, and not at the expense of vulnerable consumers. The overall picture painted by the FCA is thus distributionally complex, with no particular group of consumers receiving a cross-subsidy from another.

The FCA also carried out a distributional analysis which looked at the link between PCA revenues and levels of household deprivation. The FCA found that "consumers living in less deprived areas (who are less likely to be vulnerable) generate higher amounts of contribution on average", with "the highest levels of funding benefit generated from consumers living in the least deprived areas."

Overall then, the FCA's analysis of the distributional impact of FIIC banking reaches similar conclusions to those we thought likely in our original blog. This is encapsulated by the FCA's citation of the CMA's original review, which it notes "looked at the distribution of revenues across PCA customers and did not find strong evidence that banks are cross-subsiding across customers or that poorer customers may be paying more for PCAs."

The FCA's overdraft interventions

Our first blog on the FCA's Retail Banking Review thought that unless the FCA found evidence to contradict the CMA's previous findings, it would not seek to ban or unpick the FIIC model. Instead we thought the FCA was "more likely to crack down on unarranged overdrafts, which would tackle-directly a source of high costs often faced by vulnerable consumers and address the FCA's concern that some vulnerable consumers may "pay (significantly) more than others.""

Although the FCA did not find any cross-subsidies which adversely affected vulnerable consumers, it did find that unarranged overdraft charges were more heavily concentrated on vulnerable consumers, and that "consumers living in more deprived areas (who are more likely to be vulnerable) incur higher UOD [unarranged overdraft] charges on average."

These conclusions have led the FCA towards the actions we said were likely in our first blog. Namely a series of overdraft related interventions as part of its HCCR, including a potential ban on fixed fees, and considering whether to end the distinction between arranged and unarranged overdraft pricing. The Consultation Paper also confirms that the FCA is "modelling the potential role of an absolute price cap to act as a backstop" for both arranged and unarranged overdrafts, which our first blog said was one of the interventions we thought the FCA was likely to propose.

Implications for firms

As we thought likely, the FCA has not found that the FIIC model leads to unacceptable cross-subsidies at the expense of vulnerable consumers. As a result, it has not sought to ban FIIC banking, but has instead targeted overdraft charges. While an absolute price cap is apparently only a backstop measure at this stage, firms should take note of the FCA's concerns about the high level unarranged overdraft charges falling on vulnerable consumers and its willingness to consider price caps in other high cost credit markets, most notably the rent-to-own and high cost short term credit sectors.

As the final parts of the Strategic Review are yet to be published, firms will also want to consider how the reviews focus on other topics, including branch closures, the operational and capital costs of retail banking, and technological change, may feed into the FCA's wider work on retail banking, including its mortgage market study and work on the cash savings market, or potentially lead to the FCA starting new pieces of work if it finds significant problems in other areas.

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