"Fee Banking", Not "Free Banking": The Shameful Overdraft Saga Continues

Readers will recall that UK retail banks are self-regulated when it comes to overdrafts. They lost control of deposits, savings and payments in 2009, but kept control of lending (bizarrely, given the over-extension of credit in the lead up to the crash). They continued to battle savagely against the OFT's attempt to assess the 'fairness' of their overdraft charges for many years before finally offering to charge a bit less in late 2009. By 2013, however, the banks felt the heat was off, and were congratulating themselves on having found "no breaches" of their own Lending Code. Yet in 2014, the FCA found that "overdraft prices were high, complex, confusing and poorly understood". Now a new report reveals:

"Not only are unarranged overdrafts expensive, but in many cases they cost significantly more than [payday] loans. Many consumers are also unaware either that they have used an unarranged overdraft or of the cost implications even if they do."

The FCA's latest analysis suggests there are about 42m current accounts, about 27% of which are in arranged overdraft for 1 to 12 months (staying within a pre-set credit limit) while 10% operate as unarranged overdrafts for 1 to 12 months (no right to be overdrawn at all or in breach of the credit limit). The FCA's analysis "shows that a quarter of people that used unarranged overdrafts used them in four or more months during 2016. Nearly 10% of unarranged overdraft consumers used them for 10 or more months."

The banks' Lending Code does not require a creditworthiness assessment, yet the FCA found that "overdraft users typically have lower credit scores than consumers with current accounts... [and] consumers using unarranged overdrafts have noticeably lower credit scores than the overall population of current account and overdraft users." The FCA adds that it is "concerned that consumers who repeatedly using unarranged overdrafts are being given access to a service that seems unsuitable for them, and which may be contributing to potential financial distress."

This sounds like a clarion call to the claims management industry 

to switch from seeking refunds of PPI premiums

to seeking refunds of unagreed overdraft charges.

No doubt the banks will continue to resist interference with their dastardly overdraft arrangements, claiming that it would mean the end of "free-banking" (which industry insiders refer to as "fee banking" because banks rely on fees arising from the mismatch between actual customer needs and poorly aligned/understood products).

Banks claim that overdrafts are a feature of current accounts, so the FCA should wait to see how the recent attack on those by the competition regulator pans out before taking further action.

But, as the figures show, not all current accounts come with an overdraft, although my sense is that overdrafts are actually a side-effect of shortcomings in banks' legacy technology - the systems can't maintain real time balances, so the bank has no way of knowing the actual account balance or whether an overdraft limit will be breached when each transaction comes through. But that's the banks' problem.  Overdrafts do constitute a form of "credit", whether they are "arranged"  or "unarranged" and the fact they are still self-regulated as 'lending' speaks volumes (current accounts are regulated as "payment accounts" under the Payment Services Regulations).

Lloyds has already lost its nerve, however, and moved to a new charging structure that the FCA says "does not allow a consumer to use unarranged facilities and does not charge a daily fee if they do."

The banks certainly have plenty of cause for alarm. 

In 2014, the FCA took over regulation of the comparatively tiny 'payday lending' market - 1.6m customers borrowing £3bn at its peak in 2013 - and imposed rules that reduced volumes by 42%. But in this case, the FCA is sounding the death knell of unarranged overdrafts entirely:

"Based on the evidence we have to date, we believe there is a case to consider fundamental reform of unarranged overdrafts and consider whether they should have a place in any modern banking market."

2013: Levelling The Financial Playing Field

Six years of financial crisis have finally produced some of the legal changes that will expose the cosy world of regulated financial services to innovation and competition. But there is plenty more to do.

During 2013 we've seen consumer credit move to the FCA, the regulation of peer-to-peer lending, and the FCA's proposed rules for how the 'crowd' can lend and invest. And this week the Banking Reform Act implemented the recommendations of the Independent Commission on Banking and key recommendations of the Parliamentary Commission on Banking Standards.

Some may see these changes as a magnificent display in closing the stable door. But I prefer to see it as an opening of the floodgates. 

After all, the European Commission is consulting on its own approach to regulating online financial marketplaces; and the US states are competing with the Securities Exchange Commission on the regulation of crowd-investing.

So 2014 will see a lot of focus on enabling the growth of alternative financial services, at the same time as the banks become even more preoccupied with solving their own problems at their customers expense.

That bodes well for a market that grew 91% in 2013.

But, like I said, there's still a lot of work to do.

 

Failure Is Key To The Success Of Equity CrowdInvesting

An odd article on page 20 of today's FT suggests that the failure of some ventures to raise money somehow puts 'crowdfunding' in doubt, while page 4 cites Nesta research to show that this alternative finance market is growing rapidly. 

What's going on?

Well, traditional financiers have been forced to take crowdfunding seriously now that the FCA is consulting on specific rules to govern certain types (peer-to-peer lending and crowdinvesting in equities and debt securities). Some see this as an opportunity, and want to help these alternative marketplaces grow, while others perceive a threat that must be contained.

Those who feel threatened typically overplay the benefits of 'traditional' investment models, and mistake the strengths of the crowd-based models for weaknesses. 

For instance, venture capitalists often claim that theirs is 'smart money' compared to equity-based crowdinvesting. In fact, one is quoted in today's FT article as saying that VC investment brings "partners, skills and support that will nurture the business through growth over the medium to long term." This is rubbish. Venture capitalists spend most of their time looking for deals, not managing the businesses in which they have invested - and most of those businesses will fail anyway. They are not looking to build a portfolio of steady performers, they are hoping a few stars from their stable will return 20 to 30 times their investment. Board meetings are infrequent events at which VCs study the numbers. The occasional insightful comment may emerge, but these pale to insignificance compared to the 360 degree, 24/7 feedback any business experiences in today's social media world. Ironically, most of the time is actually taken up by management explaining the business to the VC directors - and quite properly so. But any responsible director can fullfil this role, and a business that can raise VC money or other funding is equally likely to attract directors with real subject matter expertise (and/or genuine independence) in any event. VCs don't have a monopoly on introducing good directors.

Related to this is the issue of discretion. Few people may be aware a business is seeking VC investment, but nor could they be expected to care since they are excluded from the process. So the search for venture capital generates zero interest among potential customers or other supporters of the business. Nor is the venture process likely to be very efficient, let alone successful. Start-ups and early stage companies typically approach many VC firms in the hope of getting a commitment from 2 or 3. It's a gruelling 3 to 6 month process involving lengthy, repetitive due diligence sessions that come as a huge distraction from the day-to-day management of the business.

Crowdinvesting, on the other hand, enables the business to engage in a single process that tests the appetite of both investors and customers. Flaws may be visible to the world, but this transparency provides consumer and investor protection while giving the business a chance to adapt on both fronts at an early stage. This may not guarantee long term success any more than traditional venture funding does, but it helps everyone avoid wasting a whole lot of time and money.

It's a process that venture capitalists might grow to like.

We Need Let The Crowd into Financial Services

What a difference a year makes. At an industry event yesterday none other than Nicola Horlick, a well-known fund manager, confirmed her faith in crowdfunding as way of people putting money directly into the lifeblood of the economy, at a time when bank finance for small businesses is limited. Her own film finance vehicle raised £150,000 by issuing shares within weeks of an initial discussion with Seedrs CEO, Jeff Lynn, about how the crowd might help. A year ago, she wouldn't have given it a moment's thought. 

Of course, Nicola was referring to equity crowd-investing, which is the latest type of crowdfunding to burst into life. People have been donating to each other's projects via online marketplaces for nearly a decade and lending to each other online since 2005. Even the UK government is lending along side savers on peer-to-peer lending platforms. 

But these 'direct finance' marketplaces are no longer simply challenging a dozy bunch of retail banks. The addition of crowd-investing in shares and bonds is a direct assault on the sophisticated world of venture capital, private equity and boutique investment banking. 

Silicon Roundabout has launched a rocket attack on Mayfair.

This trend has raised a few bushy eyebrows down at Canary Wharf, where the paint is still wet on the signage at the hastily re-named Financial Services Conduct Authority. Not everyone at the FCA is excited by the prospect of just anyone being able to put a tenner into a business run by Nicola Horlick. In fact, the 'hawks' down there seem to believe that ordinary folk should content themselves with a low interest savings account, a lottery ticket and a flutter on the nags between visits to the nearest pub. If you can't afford to lose a grand, say the hawks, then you've hit the economic buffers. The banks can enjoy the use of your savings for free, while the government enjoys the betting taxes and the excise on your beer and cigarettes.

And we wonder why the poor get poorer.

You might also wonder, as I did yesterday, how 'the government' might explain to the same person who is banned from buying a share in the local bakery why he is still be free to blow £10 on a drug-fuelled quadruped at a racetrack, or donate it to a band that might go triple platinum and never have to share a penny of the upside with those who backed them.

But that's where you're reminded that the government never puts itself in the citizen's shoes; and there's really no such thing as 'the government' anyway. Just individual civil servants at separate desks in separate buildings, each looking at his or her own policy patch and waiting to be told what to do. Collaboration is not a creature common to Whitehall. In that world, no one at, say, the Treasury snatches up the phone to share a bold new vision for driving economic growth from the bottom-up with the folks over at Culture Media and Sport, or Business Innovation and Skills or Communities and Local Government. 

Or do they...?

At least those in Parliament, bless them, did collaborate in response to the ongoing financial shambles. Julia Groves of the UK Crowd Funding Association quoted some choice words on alternative finance from the report of the Parliamentary Commission on Banking Standards, and I've set out the full quote below (as I have previously). Julia also put it very nicely in her own words: "Wealth is not a skillset." We need to let the crowd into financial services, and we need to keep the 'crowd' in crowdfunding. Let's hope this time the following message permeates all the way to the remaining hawks at Canary Wharf.

"57. Peer-to-peer and crowdfunding platforms have the potential to improve the UK retail banking market as both a source of competition to mainstream banks as well as an alternative to them. Furthermore, it could bring important consumer benefits by increasing the range of asset classes to which consumers have access. This access should not be restricted to high net worth individuals but, subject to consumer protections, should be available to all. The emergence of such firms could increase competition and choice for lenders, borrowers, consumers and investors. (Paragraph 350)

58. Alternative providers such as peer-to-peer lenders are soon to come under FCA regulation, as could crowdfunding platforms. The industry has asked for such regulation and believes that it will increase confidence and trust in their products and services. The FCA has little expertise in this area and the FSA's track record towards unorthodox business models was a cause for concern. Regulation of alternative providers must be appropriate and proportionate and must not create regulatory barriers to entry or growth. The industry recognises that regulation can be of benefit to it, arguing for consumer protection based on transparency. This is a lower threshold than many other parts of the industry and should be accompanied by a clear statement of the risks to consumers and their responsibilities. (Paragraph 356)

59. The Commission recommends that the Treasury examine the tax arrangements and incentives in place for peer-to-peer lenders and crowdfunding firms compared with their competitors. A level playing field between mainstream banks and investment firms and alternative providers is required. (Paragraph 359)."

Less From the Pulpit, More From the Pew

The Church of England's terrible muddle over pay day lending shows that it's out of touch with the details in the payday lending market. Just as we've seen in other markets, pontificating from the top down is no substitute from working on problems from the customer's standpoint. So, a little less output from the pulpit's point of view and more from the pew's would be no bad thing.

As mentioned previously, the challenge for borrowers who need or want to borrow short term is finding a combination of speed, convenience and affordability. In March, the OFT's own research revealed that 90% of online customers found the it "quick and convenient" to get a short term loan and 81% said such loans make it easier to manage when money is tight. Customers expressed their satisfaction in terms of decision speed (36%), convenience (35%) and customer service 27%). The majority of payday customers (72%) only borrow for a month. So, the critical issues seem to be how to ensure the other 28% are better able to understand the risks of rolling over short term loans, and how to avoid it; as well as cutting the overall costs for those who use short term financing. 

The root causes of these problems do not lie in the cost of payday loans. Short term borrowers are often working amongst the contractual fine print of late fees, cancellation notices and so on. Allocating money to debts 'just in time' is a high risk occupation. One slip can make life hell in a non-financial sense - maybe the kids won't have school shoes, there will be no heating or the landlord will finally lose patience. Credit cards, debit cards and cheques are useless from this sort of timing perspective, because they don't tell you how much you have left to spend at the time you use them. There can also be an accounting lag between when you pay and when the transaction lands on your account, so you can find yourself 'surprised' by a payment you thought had been accounted for days or even weeks previously. And the amount of interest and other charges is only known when it appears on a monthly statement. We hear a lot of noise about APRs, but not so much about the timing problems or the scale of fees payable when you get on the wrong side of bank products - these are far more relevant to short term borrowers, and why many remain 'unbanked' by choice.

In these circumstances, rather than playing money-lender, it would be better if the Church could foster the development of an application or other means of presenting to a borrower the most affordable short term finance option, based on the analysis of the borrower's own transaction data from existing creditors (including cancellation rights and late fees), and the costs of different finance products (including charges for missing a payment). This really only requires a commitment on the part of all the typical creditors and financial services providers to make their product and pricing data available in machine-readable format, which the government has been pushing them to do as part of the voluntary 'Midata' programme. That data can then be analysed and the results made available either online or physically, via mobile phone, computer or print-out. 

No doubt the Devil is in the detail underlying such a service. But surely the Church isn't bothered by that?

Labour Is Still Pushing Financial Capitalism

When Gordon Brown (remember him?) repeatedly proclaimed the "end of boom and bust" he was declaring his belief - along with that of his fellow group-thinkers - that capitalism had found a way to become sustainable. But his support for unbridled growth in everything from investment banking to the Private Finance Initiative eventually revealed he was hooked on financial capitalism, rather than the 'real' capitalism of employment and productivity. Look at how ISAs, for example, have become a drain on the 'real economy'.

Ed Milliband has been trying to repair Labour's image with some lipstick apologies here and there, but old habits die hard.

Recently, the party released "An Enterprising Nation", a report by its Small Business Taskforce. To be fair, there are some good insights into the problems faced by small business, as you would expect from the membership of the taskforce. But, surprisingly, the report contains no proposals for short term solutions, or even medium term solutions. One suspects that either the collective intelligence had already fed all those ideas into the government, or the left wing political establishment doesn't grasp the need to foster an environment in which new businesses can start and thrive today.

Academic as they may be, perhaps the worst of Labour's long term ideas is that of a US-style Small Business Administration. It's an idea I first heard from them in November 2011. And as I pointed out then, the SBA programme had already gained a somewhat unhealthy reputation through David Einhorn's book "Fooling Some of the People All of the Time." Heavy application of the Labour lipstick has now branded this idea the "Spark Umbrella" (a nod to the many local German savings banks, or sparkassen, to which this programme actually bears no resemblance).

Basically, the idea is to saddle the UK with 20 lending vehicles, or "Sparks", funded with £10m of public money (naturally) and £90m drawn, no doubt, from the traditional City suspects. Each Spark would fund its lending to local businesses by selling the loans to the "Spark Umbrella" which would in turn finance the loan purchases by issuing bonds to investors eager to package those bonds into  another set of bonds to sell to... anyone stupid game enough to buy them.

Sound familiar? 

The only way not to end up carrying the can for this, would be to emigrate.

But the UK already has an artificial, publicly subsidised channel for small business lending that limits innovation and competition in the retail financial markets. It's run by the UK's major banks. So we don't need another publicly guaranteed channel to crowd-out sustainable private alternatives. 

I mean, who would start a local lending business knowing that the government was about to launch a publicly funded competitor?

The government should foster an environment in which the private sector can generate alternative finance options, not simply create markets that are ultimately underwritten by the taxpayer.

The fundamental flaw in the Spark Umbrella is its reliance on securitisation (or vertical credit intermediation) to try to overcome the riskier nature of small business lending. That model is hugely expensive in terms of issuing and underwriting bonds that are prone to being mis-priced, particularly in riskier markets, as we have seen. It also creates huge scope for moral hazhard, and traditional financial institutions, intermediaries and speculators are likely to be the only potential winners - as Einhorn's book reveals. There is certainly no guarantee that the loans to small businesses will be competitive with other potential alternatives.

Anyone pointing to the US for solutions also has to understand that, like Germany, it enjoys a much more varied set of small business funding options than the UK, as Breedon reported. So it's possible that the SBA won't have crowded-out US private finance businesses in the way that Spark Umbrella would in our bank-dominated market. 

It's also worth noting that Spark Umbrella is purely debt focused, whereas only 3% of UK small businesses finance themselves by issuing shares.  

Of course, we already have a rapidly growing set of alternative financial services platforms that are beginning to solve the problems that the Spark Umbrella will not. Peer-to-peer lending and crowd-investing provide finance to borrowers and entrepreneurs in small amounts directly from many people at competitive rates from the outset, using both debt and equity finance. There is no need to create new markets for these platforms to grow. However, the government has been dragging its heels on the removal of regulatory barriers and perverse incentives, and that does represent an opportunity for opposition parties. 

True, the government has directed some of the Business Finance Partnership funds through peer-to-peer finance platforms. But that funding goes directly into the businesses who borrow - not through countless intermediaries in the financial markets. Labour needs to recognise the difference.

Horizontal vs vertical credit intermediation from Simon Deane-Johns

'Bank' of Dave Goes P2P

I've hugely enjoyed the documentary series tracing Dave Fishwick's valiant efforts to start a small community 'bank' in Burnley high street. 

I say 'bank' because, while it made for good television to say so, Dave didn't necessarily mean "bank" in regulatory terms. His goal was to enable local people to lend to other local people and businesses without profiting unduly. He rightly thought that's what banks are supposed to do, so he was determined to call himself a 'bank' to make the point. And his good-humoured, optimistic crusade has certainly rammed the point home.

While Dave also didn't necessarily set out to launch a peer-to-peer lending marketplace, his path to launch was eerily familiar to those who have done so. The FSA wouldn't speak to us either, prior to the launch of Zopa in March 2005, but was all too keen to discuss the detail afterwards. Fortunately we'd done our homework and didn't have to stop taking money. At least that made for good TV in Dave's case.

Since 2005 a dozen other management teams have also threaded their way through the regulatory maze to directly link savers and borrowers, or investors and entrepreneurs, via online 'P2P' lending or crowd-investing markeplaces. And it's good to see that Dave's journey has led him to adopt the peer-to-peer model on the high street. He may be facing the bricks-and-mortar problems that the online models solve, but at least he's shown there is very real demand for innovation amongst people who still manage their finances by walking around. And the benefits to the 200 local borrowers who are paying a net 5% to local savers are undeniable.

Unfortunately, there are still unnecessary difficulties in structuring these businesses, regardless of whether they facilitate loans or investments in shares or debt. The sources of that uncertainty were summarised here in January 2012, here in February 2012, here in June 2012 and here in July 2012. Industry CEOs and others met policy and regulatory officials to discuss these difficulties at a summit in December 2012, and again last month (as summarised here). The salient points were also explained again in my submission to the Parliamentary Commission on Banking Standards.

However, while it's clear there is plenty of shared frustration and many officials have been supportive in discussions, there is worryingly little sign of actual regulatory change.

We need a lot more war stories like Dave's.

My Legal Alter Ego Has Been At It Again

Image from Parliament.uk

This time he's made a submission 

To the Banking Standards Commission.

He's a poet and he didn't know it.

Evidence From Non-bankers On Banking Standards

Here's what some of the non-banks have to say about banking standards (from 17:52).

Credit Where It's Due

The long overdue move to regulate consumer credit the same way as other financial services has finally been announced.

I've been advising businesses on both sides of the strange divide between the Consumer Credit Act and the Financial Services and Markets Act regimes for the past decade, and I still find the dichotomy as maddening as when I first laid eyes on it.

Gold-plating the Consumer Credit Directive hasn't helped improve the cost and complexity, and transparency is not improved by obliging a provider to register under both the CCA and FSMA regimes for products that are part of the same sales process. Or by allowing banking groups to present themselves as "authorised and regulated by the Financial Services Authority", while in fact sheltering their consumer lending activities under an obscure self-regulatory regime. It defies belief that the banks' consumer lending processes should operate any better than those that have earned them big fines in recent months.

But perhaps the most interesting point, in these troubled financial times, is that the government department that's presided over the CCA regime estimates that we'll save a net £120m annually by repealing it.


Image from Midnight Poutine.