Staying in the black without seeing red
This means that for every ´free´ current account providing seemingly good value, there is a high cost loan or overdraft paying for it. Balancing who pays for what over a complex mix of 42m current account holders, most of whom are multi-banked (ie hold financial products with a number of providers) is unrealistic.
Free-when-in-credit banking is now under threat as banks struggle to deliver a profit from the traditional bank business model based on fee income and net interest income. The former is under increasing pressure as greater transparency, driven by regulators, has exposed charges considered to be disproportionate to the cost of providing the service. This is further accentuated by wider movements such as platforms which offer free services to users. These technologies have disrupted other industries such as retail and travel, and have sent process costs tumbling.
This, coupled with a general perception that banks are paying themselves too much and their customers and shareholders too little, has prompted even greater scrutiny. The net interest income challenge is a feature of the current economic climate, where interest rates have remained at historic lows for over 7 years. The International Monetary Fund (IMF) cites weak economic growth and an ageing population as factors prompting banks to overhaul their business models.
This change looks to be close at hand. However, the uncertainty of exactly when is a challenge to banks´ earnings forecasts. Hanging on to a dying business model is risky, though few banks have settled on a viable alternative to date. What has emerged is a growing number of fee-paying accounts where the monthly charge is -in theory- more than repaid through a combination of enhanced interest for credit balances, cashback on purchases and incentives to use self-service channels. These fee structures are more acceptable to customers as they represent an exchange of value. The customer ends up better off as a result of the deal.
The CMA banking report suggests that unauthorised overdraft fees net banks £1.2bn annually. In an environment where fees are a greater source of income than net interest, and banks´ regulatory fines have eroded most of their profit this revenue will be hard to replace. The FCA´s report on High Cost Credit called for changes in these charges, which are often borne by those least able to pay. The recent decision by Lloyds Banking Group to scrap charges on unauthorised overdraft fees pre-empted these findings. Others may now quickly follow.
Banks are businesses however, and credit has a cost, whether raised from deposits or through its own borrowing. Banks will point to Terms and Conditions which clearly indicate the agreement under which an account or overdraft is opened, and the costs of exceeding any agreed line of credit. The fact that banking is an intangible product, people rarely actually see the money they borrow, may in part explain why customers often forget the exact parameters of the agreement that they have signed up to.
This is the nub of the issue. Customers are responsible for managing their finances, and keeping themselves on the right side of their overdraft limit. The alternatives -bounced payments, adverse credit ratings, withdrawals of service and cost of reconnection- would be met with high levels of irritation by customers. In addition, the level of education available to customers through portals and advice services is better than ever before. Personal Financial Management (PFM) software enables keen customers to budget and plan their finances accurately. This being the case, could and should the banks be doing more?
The answer is yes, and some already are. Monzo and Starling Bank are good examples of PFM services already active in the UK market from new entrants. La Caixa in Spain also provides detailed analysis on customers´ spending, flagging major movements and highlighting where bill payments vary from expected or regular amounts.
For banks to be seen as helpful, they need to anticipate customers´ needs and help them to achieve their financial goals. Banks are awash with data on their customers, and if your online grocery basket can prompt you when you´ve forgotten an item from your regular shop, surely your bank could prompt you that your balance is low and you have a regular payment pending. This will become a requirement under the Competition and Markets Authority´s (CMA) Open Banking standards, due to come into force in 2018. Banks will be required to send alerts to customers about to go into the red, and provide a grace period before charging.
More fundamentally, access to data in an open banking environment, such as the standards set out under another upcoming regulation, the Payment Services Directive (PSD2), will further increase transparency and enable customers to compare costs and shop around for the best deal. Service providers will be able to pick off services and offer more competitive alternatives.
With advances in technology such as Machine Learning to tune these vast stores of data to individual customer behaviours, the future appears bright. Predictive analytics will offer ´nudges´ to customers once their data and behaviours are synchronised, though this -like it´s often discarded mobile phone variant predictive text assistant- is no substitute for good personal discipline. Banks could and have begun to place more emphasis on financial education for customers, helping them to help themselves in areas such as online security, retirement planning and regular investment.
For banks to continue to exist they need to make profits. Persisting with the traditional bank business model looks a less realistic option for banks, meaning a change is needed. The new bank business model may look to create value for the customer from the data it has on the customer´s behaviours, needs, risks and plans. This could include offering services from a partner such as a utility company that could help them save money on gas and electricity, providing a comparative quote when home or car insurance is about to expire or explaining the costs of a credit card, loan or overdraft for the same purchase. Again, PSD2 will open this up not just to other banks but to all service providers. The banks´ long-held fear of the GAFA firms (Google, Apple, Facebook, Amazon) finally offering mainstream on Financial Services looks set to become a near-term reality. Their mastery of data and ability to pinpoint customers´ needs positions them well to benefit from this change.
For the customer, the change is equally fundamental. What is the relationship a customer wants with its bank? For any relationship to be successful, the customer must have trust and feel that the bank will always act in his or her best interests. Where the customer retains a sense of fear in discussing their needs with the bank, or feels a distant relationship, the only interactions could be related to complaints. Hardly the basis for a long-term relationship.
The opportunity is clear. For banks to create sustainable income streams from loyal and engaged customers, a combination of information, education and attention to a closer relationship is the key. Forming closer partnerships between banks and third parties to act in the best interests of customers to offer improved products, services and pricing will be seen as a positive step. If customers can avoid painful charges, missed payments and higher cost of credit through a helping hand from their banks, they are likely to welcome the change. Who will make the first move?
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