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Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

Last November the Money Programme revealed how large numbers of customers were successfully taking court action to retrieve charges made by their banks for exceeding overdraft limits and for other bank account ‘misdemeanours’.

Such charges are a major money spinner for the UK banks. Whilst it is unclear exactly how much UK banks earn from them, best estimates suggest a figure of between £2 billion and £3.5 billion a year. The consumer campaign against these charges has made the banks start to talk about the possibility of charging all customers for current accounts to compensate for the revenue stream that would be lost if these unauthorised overdraft charges are deemed unfair.

Arguably the court cases are being won by customers because the banks are not adequately defending the actions - relying only on a written defence and not turning up in court to argue their case. This tactic has resulted in judicial criticism from several County Court judges. Additionally some banks have been settling cases out of court, perhaps because the time and cost of even a limited defence in court is not viewed as being cost effective even if judgment is made in their favour.

Over the past twelve months the story has developed further, with attention focussing on action to clarify the legality of these bank charges.

In March the Office of Fair Trading (OFT) announced a formal investigation into the fairness of unauthorised overdraft charges. This followed on from the OFT’s initial review where it concluded that it shared public concern about the level and incidence of such charges. The OFT recognised, though, that applying the general principles it had set out in 2006 in respect of credit card charges - where the OFT recommended a maximum default charge of £12 - was not straightforward.

Subsequently, in April, the OFT announced details of a more wide ranging investigation into bank charges - including the examination of so-called ‘free banking’ and the implications of moving towards the charging of customers for provision of current account. This investigation sits alongside that into the fairness of unauthorised overdraft charges.

Then in May the Lloyds TSB became the first bank to successfully defend actions by customers trying to reclaim charges, with victories in the Birmingham and Lancaster County Courts. Other banks are now using these judgments to defend cases brought against them.

At the heart of the issue lies the question of whether the 1999 ‘Unfair Terms in Consumer Contract Regulations’ (UTCCRs) apply to unauthorised overdraft charges. The banks believe the rules do not apply; the OFT believes that they do. So given the lack of clarity the OFT launched proceedings in the High Court in July for a legal declaration on the applicability of the law. The other parties to the test case are the Abbey National, Barclays Bank, Clydesdale Bank, HBOS, HSBC, Lloyds TSB, the Royal Bank of Scotland and the Nationwide Building Society. Together these current account providers account for circa 90% of personal current accounts in the UK. The parties to the action are all interested in a timely and orderly resolution of this legal issue. Clearly the banks need to know where they stand on a matter which has attracted so much adverse publicity for them.

In September the OFT announced that it would consider dropping the test case if the banks unilaterally cut charges significantly. Under these circumstances it would no longer be in the interests of consumers to press on with the case. Currently, however, the OFT is still set to continue with its test case which is scheduled to be heard early in 2008.

The outcome of this case will shape the future not only for such overdraft charges but, in all likelihood, for the charging for the provision of current accounts for all customers.

Find out more

• Join the discussion - are bank charges unfair?
• Are banks ripping us off? - when a cheque bounces, we get charged. Is this fair?
• Your and your money - don't let your money be the boss of you
• Take it further - the Open University Business School offer a range of courses covering personal finance
• Personal Finance edited by George Callaghan, Ian Fribbance and Martin Higginson, published by John Wiley & Sons

About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

Subscribe to Martin Upton's posts

 

Blogging about

Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

Have you ever been at the wrong end of a penalty charge, imposed by your bank, for a letter sent about a breach of your overdraft limit or a bounced cheque? Thousands of customers have had this experience and now the mood is turning from anger to revolt about the scale of these charges.

Estimates of the UK banks’ earnings from penalty charges vary widely but The Times puts the figure at close to £5 billion per year.

Some groups are claiming that the charges are unlawful, being set at levels that breach the 1999 Unfair Terms in Consumer Contracts Regulations (UTCCRs). Mike Dailly of the Govan Law Centre, supported by Citizens Advice in Scotland, claims that banks can only recover the amount of money they have actually lost as a result of a customer doing something wrong – they cannot impose penalties or fines.

Activists have pointed to the report on credit card charges by the Office of Fair Trading (OFT) in April 2006. This recommended a maximum for default charges of £12. In examining what is a fair level, the OFT reviewed not only the UTCCRs but also the legal precedents covering damages for breaches of contract. The OFT concluded that "default fees have been set at a significantly higher level than is fair for the purposes of the UTCCRs".

"UK banks could earn £5 billion a year from penalty charges"

The Consumer Action Group, a consumer body promoting action against bank charges which has over 13,000 members, claims that the OFT’s findings on credit cards set a precedent for penalties for bank account breaches. Indeed, the OFT itself said that it expects the principles it had used to be applied to other bank charges. The Group recommends that customers take action in the small claims court to reclaim excess charges.

Martin Lewis of moneysavingexpert.com – where the bank charges discussion board has notched up 41,000 consumer postings – claims that we are seeing a consumer revolution, with thousands of customers demanding refunds.

A number of sites advising on the reclaiming of charges, going back up to the maximum of six years allowed under the 1980 Limitation Act, now exist on the internet. Many customers have already been successful in reclaiming bank charges - such as Laura Saunders of St Ives in Cornwall who successfully challenged the Yorkshire Bank over charges amounting to £922 in a County Court ‘test case’ in 2005.

Such successes to date may, though, simply be attributable to the banks’ failure to defend the actions.

So are the customers who incur these charges at the wrong end of a banking ‘rip-off’? Not so say the banks. They disagree with the OFT’s legal reasoning on credit card charges and they, along with the British Bankers’ Association, reject the notion that the same principles apply to other bank charges. Notification of contract terms is supplied to customers and the banks claim that charging for breaches of the contract terms is lawful.

And as regards the scale of the charges – the banks say it represents the appropriate economic costing for the action being taken. So says Ian Mullen, Chief Executive of the British Bankers association (BBA), who claims that the process of dealing with customers who have breached overdraft limits involves manual intervention – and is not just computer processed – with the result that the charges levied reflect the costs actually incurred by the banks.

Additionally banks would argue that, elsewhere, they do not charge customers for the economic costs associated with their bank accounts. For example, close to 95% of ATM transactions are still free - in contrast to the United States where around 40% are charged. In many parts of Europe customers pay an annual fee of as much as €50 for the provision of a bank account .

So what does the future hold for these bank penalty charges?

Currently the OFT is investigating whether it should now impose a cap on unauthorised overdraft charges. Some banks, perhaps in reaction, are now considering re-introducing charges to customers for providing bank accounts as this would help to claw back the lost earnings if overdraft charges were to be capped.

In November 2006 First Direct, the online banking arm of HSBC, announced that it is planning to introduce a £10 monthly charge for all customers who neither place a minimum of £1,500 of earnings into their account each month nor hold a minimum average balance in the account of £1,500.

So the outcry about overdraft charges could end up triggering the end of free current account banking in this country.

Further reading

• Are penalty charges bank robbery? – The Money Programme investigates penalty charges
• Calling companies to account – big business has a reputation for abusing its power, so how can we call companies to account?
• New Fees signal an end to free banking in The Times on 15th November 2006
• Calculating fair default charges in credit card contracts: A statement of the OFT’s position, OFT842 April 2006
• Nationwide warns MPs of threat to free cash machine network – Nationwide press release 10th February 2005
• Personal Finance edited by George Callaghan, Ian Fribbance and Martin Higginson, published by John Wiley & Sons
• The Consumer Action Group
• Govan Legal Centre bank charges campaign
• Martin Lewis's Moneysavingexpert website

About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

Subscribe to Martin Upton's posts

 

Blogging about

Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

Markets such as the airline industry, where there are a few large players, are known as oligopolies. In such markets, the limited number of players mean there’s an opportunity – and temptation – for firms to formally or informally agree to increase the prices of the services they provide, operating what is known as a cartel. Game theory can help us understand this behaviour, and the choices made.

The Prisoner’s Dilemma is a classic game devised in the late 1940s by John Nash (the subject of the movie A Beautiful Mind) to teach the conflict between group and individual rationality. Consider a crime drama where two partners are arrested. Both are being separately interrogated by a clever inspector who offers them this deal:

• If one implicates the other, he may get parole while the other will get 20 years in jail
• If neither implicates the other, both will get two years in jail
• If both implicate each other, both will get ten years in jail

Given the consequences of the different choices, and to minimise their individual punishment, both partners choose to implicate the other and end up getting ten years in jail.

Prisoner’s Dilemma is applicable to many walks of life. Consider sports. Imagine a contest with two players. Each player’s in a dilemma about whether to take a performance-enhancing drug. Rationally, each player may think like this:

• If I don’t take it and the other one takes it, this increases my chances of losing
• If I take it and the other one doesn’t take it, this increases my chances of winning
• If both of us take it, then at least I’m not disadvantaged

Thinking like this each player ends up taking the drug!

There's an incentive to any player in the game to blow the whistle

However, cartels aren’t a recent phenomenon. Adam Smith, the father of modern economics, warned of such possibilities over three hundred years ago in Wealth of Nations, when he wrote,

"people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices".

Fearing this, many countries have created regulators to curb anti-competitive behaviour. But would Smith have approved of regulatory interventions to prevent anti-competitive practices in a free market? The answer would appear to be no, as he went on to say,

"it is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice".

Now, let’s get back to the recent story about airlines. It is alleged that British Airways (BA) and Virgin conspired to increase the prices of passenger tickets, by making almost parallel increases in fuel surcharges over the last few years. Virgin reported this to the Office of Fair Trading (OFT), a government agency in charge of curbing anti-competitive practices.

Let’s look at this case from the perspective of game theory. The Enterprise Act 2000 provides that any party involved in cartels can become an informer to the OFT and cooperate with the investigating agency for possible ‘immunity from prosecution’. This provides an incentive to any player in the game to blow the whistle on another player.

Whether Virgin and BA cooperated and earned huge profits, or not, won’t be known until the full report of the ongoing enquiry is published. But, by becoming an informer before BA could do so, Virgin has increased its chances of going scot free by playing the game smartly. It appears it's one more smart move from Richard Branson and co!

Further reading

• Play the Prisoner's Dilemma with Open2 – an interactive version of the philosophical experiment
• Money Programme: The great plane robbery
• Calling companies to account – explore the tactics used to keep companies in line
• An Enquiry into the Nature and Causes of Wealth of Nations by Adam Smith
• Game Theory .net
• Setting the trap in the Economist
• Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life by Avinash Dixit and Barry Nalebuff
• The Cartel Offence from the OFT (PDF document)

About the author

Devendra Kodwani is Lecturer in Finance at the OU Business School. His research interests include the economic regulation of utilities and he has written several papers on privatisation and regulation.

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