Does an Overdraft Facility Influence the Customer Costs of Using a Personal Current Account?

Abstract

This study examines whether personal current accounts offering an overdraft facility cost customers less to use than accounts not offering this service. This analysis uses a UK data set of 222 personal current accounts, recorded monthly between 1995 and 2011, in combination with interest rates from 1200 instant-access deposit accounts offered contemporaneously by the same firms. Our results indicate personal current accounts offering overdraft facilities have higher deposit and payment service costs than accounts not offering this service. The finding is robust to varying service attributes. This result is inconsistent with suggestions that overdraft users have been cross-subsidising other personal current account users as widely reported in theoretical and policy literatures. It is concluded that implicit and inertia costs of personal current account use may be more influential than previously reported in the pricing of these accounts.

Key Words:

• Checking Accounts
• Personal Current Accounts
• Contingent Charges
• Implicit Costs
• Interest Rate Setting
• Overdrafts

JEL classification:

• G21

Acknowledgements

We would like to acknowledge financial assistance from Friends Provident Charitable Foundation, helpful comments provided by Rhys ap Gwilym, Robert Hudson and José Manuel Liñares-Zegarra, and research assistance from Nia Williams. The work was developed from a Friends Provident Charitable Foundation report (Ashton and Hudson 2013). All errors remain the responsibility of the authors.

Notes

1. The personal current account or checking account market is characterised by the use of different terminology internationally due to distinct laws, regulations and traditions as to how retail banking business is undertaken. As the subject of the paper is the UK, terminology from the UK is employed, employing terms widely used in this nation and employed in law, regulation and government reporting. For example, a ‘personal current account’ (PCA) is a term used to describe a bank account offering payment services, such as direct debits and credits, standing orders and other forms of payment, deposit services and, in many cases, an optional overdraft facility. The term ‘personal current account’ has long been used in nations with a UK banking heritage and refers to bank accounts similar to ‘checking accounts’, a term more widely used in North America. Other UK terms employed in this study include ‘instant-access deposit’ – this is a deposit account offered by a financial intermediary for the deposit of funds which may be accessed without prior notice being given to the bank. These accounts are also termed ‘sight deposits’ in some nations. ‘Packaged’ or ‘access fees’ are the fees payable for accessing some personal current accounts. ‘Authorised and unauthorised overdrafts’ are borrowing undertaken through the personal current account with and without prior agreement of the provider. Throughout the study, we refer to the deposit and payment services provided within a personal current account as a base good and an overdraft facility as an add-on service which is provided through an overdraft aftermarket.

2. Many other academics have also reported the presence of a distributional cross-subsidy in personal current or checking account markets. For example, Campbell et al. (2010, 11) stated ‘consumers may choose a bank account with “free” checking, underestimating the extent to which they will pay penalty fees for overdrawing their accounts in the future. Such lack of self-knowledge leads to several problems. First, naïve consumers may purchase too many bank services because they underestimate the total cost to them. Second, banks compete away the excess profits they obtain through overdraft fees by keeping base charges low on checking accounts. This implies that naïve consumers cross-subsidize sophisticated consumers who don’t overdraw their accounts’. Policy reports have also reported personal current account penalty fees are not equally shared between customers. For example, in the Australian context, overdraft costs ‘are disproportionately borne by those who can least afford to pay them, namely low income customers’ (Rich 2004, 11). Cross-subsidies have also been reported in other financial services markets. For example, Schuh, Shy, and Stavins (2010) examined the presence of cross-subsidies in US credit card markets.

3. While discussion of the wider functions of the payments system is beyond the scope of this study, reviews are provided for the UK and Nordic nations by Milne (2006) and for the USA by Gerdes (2008).

4. The data provided by Moneyfacts PLC is also used by financial and competition law regulators in the UK, including the Bank of England and the Competition Commission, in addition to providing a key source of comparison for many UK-based financial institutions and financial advisors. This data has been provided since 1989, yet has only been provided in a consistent format for personal current accounts since 1995.

5. Packaged accounts are personal current accounts which are provided on payment of a fee. It is common for these personal current accounts to offer a range of different payment services, be distributed through an assortment of channels and offer a range of additional services such as travel or identity insurance.

6. Basic bank accounts are personal current accounts developed and issued in the UK to combat financial exclusion amongst certain and often less-wealthy individuals. These accounts offer limited payment services and often do not provide access to overdraft services.

7. For example, some large North American institutions, such as Sun Bank or Citi, operate in the UK on a relatively small scale.

8. These markets are also substantial in other nations. For the USA, Parrish and Frank (2011) reported consumers paid $23.7 billion in overdraft fees in 2008, an increase of 35% since 2006 ($17.5 billion) suggesting multiple concerns arising in this market.

9. These concerns are international in scope. For example, in the USA the Consumer Financial Protection Bureau (2013, 18) reported ‘consumers from potentially vulnerable groups may shoulder a disproportionate share of NSF (non-sufficient funds) and overdraft fees and checking account costs’. The Australian Senate report on competition in retail banking (2011, paragraph 4.69) also reported contingent bank fees from overdraft use may fall disproportionately on the poor and ‘poorer customers who do pay fees subsidise their wealthier counterparts on a per transaction basis’.

10. Full details of the Lending Code are available from the Lending Standards Board (www.lendingstandardsboard.org.uk/).