Lately, I have been pondering free banking, after my post on the cost of free and the recent Facebook data scandal. I enjoy free core banking services, but who is ultimately paying for these?
How it works
In the UK, free personal current accounts are very common. Every high street and online bank offers a free current account, as well as some premium paid offerings. These free accounts offer free day to day banking. There is no charge for opening, closing or holding the account. You can deposit cash, withdraw cash, write cheques, deposit cheques, set up standing orders, direct debits and use online and mobile banking all for free. Conversely, for business banking, the proposition is altogether different, as businesses pay for core banking services.
None of these core personal services attracts fees or charges from the bank if you keep to the agreed rules. The main rule you need to keep to is to not go overdrawn without an agreement in place. This has been the service offering of personal current accounts in the UK for a long time. These services are provided for free, to anyone that keeps to the rules.
Segments of People
I know that stereotyping people and putting people in boxes is not looked upon favourably, but for the purposes of this article, I’m going to throw caution to the wind and segment society according to how people run their finances.
The financially prudent
The first segment I am classifying is the financial prudent. People who fall into this segment run their accounts according to the banks’ rules. They keep an eye on their account and balance, and always make sure they have enough money to cover their outgoings.
They are prepared for any emergency and have a fund to cover unexpected expenses. The idea of going into an unauthorised overdraft scares them, and they will never let it happen to them.
Some financially prudent people have even levelled up and evolved to invest – see my post on my evolution here. People who fall into this population benefit from free core banking services from all the banks. They are charged nothing for the banking services provided, yet the bank clearly does have a cost here in providing these services.
The financially challenged
Moving on from the financially prudent, we look at their nemesis, the financially challenged. This population of people are not in control of their money and generally are not interested in their personal finances. Some people here don’t keep a track of their accounts, and they may even go as far as to display ostrich (head in the sand) behaviour. It’s not uncommon for people here to bin statements and bank letters unopened, and to take all the money out that the cashpoint will let them.
As a result, they don’t keep to the banks’ rules and end up paying bank charges. These charges can be significant, such as a hundred pounds a month altogether. The charges have a tendency to spiral and compound. Meaning charges one month can result in a higher likelihood of charges again the next month. This population get free core banking as well but critically then pay significant bank charges. In reality, the financially challenged end up subsidising the population above. These people are the retail bank’s cash cows. They are paying for the core banking services.
The Financial in-betweeners
As with all segmentations, there are some people who don’t fit in either box. The in-betweeners are not as religiously observant as the financially prudent, yet not as uninterested as the financially challenged. Some people are lifelong in-betweeners, others pass through as they move from one population to another. Financially in-betweeners pay bank charges but are usually concerned enough to then avoid future charges.
The business model
I find it interesting to compare the UK business model to other countries. All our banks have very similar offerings, operating in an almost cartel-like approach. While we are not alone in having the option of free core banking services, the norm appears to be banks charging customers for the services they are providing, especially in the US.
The UK business model is credit risk based. If you are a low credit risk, you get free banking. If you have a higher risk, you get free core banking but pay charges. And if you are a really high risk, you will struggle to get banking services.
Is this fair?
Now moving on from the facts, I’d like to look at the ethics of this business proposition. Truth be told, there are a number of high earners in both populations, but low earners cluster in the financially challenged population. The financially challenged are in fact subsiding free banking for the financially prudent.
I stumble across these ethics clumsily, as I waver from side to side. On one hand, banks publish the rules and charges very openly, and you only get charged if you spend money that is not yours. Yet, on the other hand, we are punishing a population of people with poor financial literacy, which includes lots of low earners.
Can we liken this to budget airlines? They are notorious for having a headline price if you keep to the rules, and charging penalties if you breach them. People rant and rave about the excess charges, but at the end of the day, everyone knows they agreed to them.
And don’t start me on the subprime
As I walked through town the other day, I was approached by people hawking sub-prime credit cards. Whilst I was amused to be singled out on the assumption I was poor (#stealthwealth win), I was wondering how less financially literate people deal with it? They may be overjoyed to be offered a credit card at 45% interest rate, whereas I recoil in horror at such a high-interest rate and even the idea of borrowing on a credit card.
Best people to help
However, truth be told, I personally am not the right person to offer help. To explain why let’s consider my approach to women’s issues. I firmly believe in gender diversity, that people who have lived life as women have different lived experiences than those who have not. And therefore to get a balanced opinion, you need to hear from people with different lived experiences.
Similarly for financial issues, if we only invite the financial prudent to the room, how do we get a balanced debate? We need to involve those that have been financially challenged, to get the solutions that really helped them. Ultimately, as people we are wired differently; a financial prudent person just does something automatically that a financially challenged person needs several reminders, step by step instructions and a friendly check-in to complete.
As charges are regulated, what happens?
The UK regulators are being pressured to reduce the charges that banks can apply to consumers. Hence the banks will be losing their income from the cash cow financially challenged population. How will they make this up? I don’t for a minute assume they will provide these services as a loss leader, so what happens next?
Will we all be charged for core banking services like the Amercian model? If you are too and risky to be given an account now the bank can’t charge you to recover the costs, will we be moving more people into the unbanked population? There is a lot to think about here, and no easy solution.
Over to you
- Do you pay for core banking services?
- Do you think our model is fair?
- Should the financially challenged pay more than the prudent?