Financially Challenged vs Financially Prudent
Money

Why do the financially challenged pay for our free banking?

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

Financially Prudent InvestThe 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

Financially challenged are cash cowsMoving 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?

19 comments on “Why do the financially challenged pay for our free banking?

  1. The poor and financially challenged always pay higher interest and fees due to higher credit risk, but is that ethical? I struggle with these questions because I worked hard to be in a good financial position. I believe people have the ability to improve there financial literacy and socioeconomic standard through hard work but many choose not to. No easy answer. Good post, Thanks.

  2. Something similar happens with some banks in the US. However it’s important to remember banks also make money off your deposits. They loan them to others. So even the well to do are paying their way to some extent.

  3. This is a really hard one for me to answer. As much as I love my free bank accounts, you’re right that the cost is passed along to those less able to bear the burden. I like the idea of not being allowed to overdraft at all, and to just be declined if there’s no money in the bank, but it also feels like I’m probably missing something there.

    1. Yeah, it’s really difficult. And given banks charge for declined payments, that itself causes the overdrafts. Not to mention most card payments can’t be declined.

  4. I was really surprised when I came to the UK in terms of banking. When I finally managed to get a bank account (because you need a job to get a bank account, but you need a bank account to get a job), I did not understand why my basic account had the opportunity to go into overdraft, with the associated fees. Wasn’t it just a debit card? Also, being naive Norwegians, we did not realise how much more predatory banks in the UK were.

    When Mr. E. first arrived to study, there was a bank office on campus!!! They convinced him that since he was, in fact, an international student, he should get the international student account. Which charges £5 per month! Contrast that to my regular basic account with a different bank where I paid… nothing (as long as I keep it above zero, as mentioned). And now that we have been back in Norway for almost a year, Mr. E. is Still fighting with them to close the account. We have to make sure the black hole of an account never goes below zero from the monthly fee, or they will certainly refuse to close the account whenever they see fit to look at it.

    In Norway, your basic banking services are free of charge. Several years ago, banks used to charge fees for things like withdrawing cash from an ATM not their own, but now I think the fees are mainly overseas and transaction costs. With my debit card, I cannot go into overdraft. If there is not enough money to pay for something, I will get declined in the shop. It’s embarrassing, sure, but it does seem better than preying on financially illiterate teenagers who might not have gotten so far the rabbit hole as to get a credit card yet.

    1. That’s a really interesting perspective Kristine – I agree they certainly come across as predatory in lots of cases. Students are one of their target markets, where they offer freebie after freebie to reel you in.

  5. I think its actually more complex than that. So actual Basic bank accounts exist in the UK and they work as Kristine describes, no fees, no overdrafts..
    They are a government mandated thing to counter banking exclusion. Although there are apparently 8 million of these accounts most banks are not going to give you one unless you explicitly ask for them and even then you might need to fail their credit checks in order to get one.*

    There is no way (in net) I’m going to pay a bank for banking, once you put money in a bank its legally theirs, why would I pay for that ? . If fees come in I’ll be straight over to a Basic account and forgo the cinema tickets, high interest regular savings and so on.

    * https://www.moneysavingexpert.com/banking/basic-bank-accounts

    1. Hi Nathan, thanks for visiting and commenting. I agree, like most things in life, it’s actually a bit more nuanced and complex. Basic banks accounts are available, usually with reduced debit card services which does not make them attractive.

      That’s interesting that you expect banks to provide a service for free – how do you propose these are paid for?

      1. Tricky isn’t it? Who pays for cash ? If we are to be encouraged away from cash, then you need ‘free’ universal access to the currency otherwise you don’t have an economy.

        If the banks can’t provide it by utilising the money on deposit and fees on business transactions then the state will have to, like a modern giro bank.

        I really don’t like the idea of a tax on participation in the economy levied by a private institution.

        1. Yes, that is the question Nathan – we need currency with universal access and divisibility etc so that the country works.

          And getting into banks vs government providing it is an interesting question – as the govt pay for cash I presume, but cashless transactions are paid for under a different method.

  6. Interesting post, with, as you and others have said, no easy answer.

    I’m now one of the ‘Financially Prudent’ but for many years, I was one of the ‘Financially Challenged’. Within a week of getting paid, I would be into my overdraft, which was arranged but which I regularly went over and of course I was charged for the ‘privilege’.

    Why not just arrange a larger overdraft? Because I knew that I would still end up going over this bigger overdraft, which would put me in an even worse financial position. As well as being charged for the overdraft, I also got charged for declined payments and missed/late credit card payments – I was truly a nice little cash cow for the banks!

    Since it took years of extreme budgeting and commitment to dig myself out of debt, I feel like I’ve paid all the bank charges I ever want to pay, that I’ve ‘earned’ my free banking, so I for one would not be happy if I were to suddenly have to pay for what is now provided for free.

    1. Weenie, I definitely think you have earned all the free banking after paying those charges of ages. You are exactly the sort of person who can help turn people around, it’s an inspiring story there.

  7. I worked with the financially challenged for many years and really struggled with their way of viewing and dealing with their money. Many of the people I worked with had doorstep ‘accounts’ as they couldn’t access any form of overdraft and often had their wages/benefits swallowed by unauthorised overdrafts. If they had a bank account at all that is! At least we now have basic bank accounts and local credit unions.

    A few years ago a colleagues’ husband lost his job when the company became insolvent. He was out of work for 3 weeks and missing wage packets totalled 7 weeks. A year later my colleague remarked on their financial situation and I was STUNNED to find out they had amassed over £4000 in charges due to these 7 weeks. They both worked full time, had free childcare via grandparents but did have a mortgage. I took it for granted that given the industry she was in and customer based she worked with she would have a better understanding and ability to not get herself in that deep.

    I felt guilty as in hindsight if she had talked about the impact of those missing 7 weeks, she didn’t have to get that far into debt, there are things she could have done. But I guess they buried their heads in the sand and carried on spending as before. With no emergency fund even if on a credit card then you are are the mercy of the banks

  8. As I am firmly in the financially prudent category (I used to be a bank manager), my core banking services are all given to me at no cost. However, I just learned that my grown daughter, who has been struggling with unemployment, is paying $10/month for her bank account every time it dips below a certain balance. I plan to help her with this when she starts her new job in a week or two (having a direct deposit generally means there is no low balance fee), and I realize $10/month isn’t much compared to the overdraft fees one can rack up, but the idea that the least equipped among us are the ones paying for banking is a troubling concept. Yes, if you break the rules, you pay the price. But if you are on the low end of the income scale, sometimes there is no good choice.

    1. Hi Gary, thanks for sharing your experiences. That’s shocking to hear your daughter’s experience, it is indeed a bit troubling how the charging structures are decided.

    1. I agree generally, yet this is more nuanced making it not a clear cut rich vs poor situation. Lots of poor people are awesome with their money, and lots of rich people are pants.

What do you think?