Free banking? That'll be £150 a year

coffee cup©

'FREE' banking costs consumers the equivalent of a 'cup of coffee a week', top bank executives admitted to the Treasury Select Committee this week.

When pressed, bankers said they were estimating that a cup of coffee costs £2.90 which would mean that consumers are paying out around £150 a year for their 'free' accounts.

So how are we paying out? And does free banking ever exist?

The free banking myth

It was Helen Weir, the head of Lloyds TSB's retail banking arm, who made the £150 a year claim - Lloyds has about 29% of the UK current account market - but she wasn't alone.

The retail director of the Royal Bank of Scotland, Brian Hartzer, told ministers: "Banking has never been free."

Ministers were scathing about the bankers' admission.

Labour MP Chuka Umunna said: "You are still making a profit from charging these exorbitant interest rates [on overdrafts] to people up and down the country. Can you understand why customers may be feeling ripped off by you?"

Though it may not feel like it to the bankers, Mr Umunna added, constituents in his London constituency - Streatham - would think £150 a year was "a lot of money".

How do we pay £150?

So, if not through upfront fees, how do banks manage to extract £150 a year out of customers?

Overdraft fees, as we explain here, are of course, part of the answer.

According to Weir, approximately 30% of Lloyds customers will pay overdraft fees on their accounts. That statistic comes after Lloyds rolled out changes to their overdraft charging system in June 2010.

But around 70% of customers don't go into the overdraft at all and, therefore, effectively have credit balances in the account, she said.

In addition, the banks are collecting on forgone interest.

Forgone interest is essentially the money banks are making on the accounts - by giving them our money, we allow banks to earn on it at the Bank of England base rate while we earn typically close to 0%. The forgone interest rate, then, is the difference between those two.

Weir said that, in a typical year with the base rate at 3.5%, the forgone interest on a current account would be £35.

Banks take half of that to pay for all the trappings of current accounts: bank branches, staff, cards and so on.

"Our current accounts are profitable but not excessively so," Weir said.

"We're getting a hurdle benchmark rate of return on the capital that's employed in that business. So it's not excessive on that product."

Is lack of competition to blame?

The grilling by government came against a backdrop of claims that the consumer banking sector has become unacceptably uncompetitive.

Just four banks now control 73% of the UK current account market.

However, Eric Daniels, Lloyds Banking Group's chief executive argued that lack of choice didn't necessarily lead to an uncompetitive market.

Other banking figures described the size of banks in the UK as a red herring.

However, ministers and other financial institutions pointed out that very low current account switching rates show that banks are failing to offer true choice.

The current account market has been incredibly stagnant for a while now.

According to the Office of Fair Trading, just under 6% of consumers change their current account each year.

No more interest

In July 2010, for example, RBS and Natwest accounts got rid off all the interest on their current accounts.

At the previous 0.15% interest rate here's a rough idea of how that worked out as annual interest, assuming that the account holder is also a basic rate taxpayer:

£1,000 £3,000 £7,000
£1.17 £3.15 £8.19

That's much lower than other providers appear to be offering.

Santander current accounts pay 5% interest, for example.

However, such high rates advertised alongside current accounts are often deceptive, lasting for a set period and only up to a certain amount.

The usual small print that applies to regular savings accounts, as we look at in more detail here, often also applies in this case, such as monthly deposit requirements for example.

In a statement to The Telegraph Natwest and RBS justified their decision: "Our customers consistently tell us that the credit interest rate is not the most important feature of their current account as they mainly use it for making day to day transactions and not as a home for their savings.

"They tell us the most important thing to them is quality of service."

Consumers complain that there is little choice when they compare current accounts and studies have shown that we stay with our current account for longer than our longest relationship.

In evidence submitted to the committee the Co-operative bank said that customers for its current accounts had increased by 38% year-on-year, "with a big increase in customers switching from the big four banks."

Nevertheless, the bank said, more needed to be done as low switching rates were a key barrier to competition.

It's hard not to see ever increasing fees and charges for overdrafts in the same, dim, light.

With customers so unlikely to switch, why shouldn't banks line their pockets with extra paid item fees, overdraft fees and other assorted fees for borrowing?

As a number of banks move to increase overdraft fees, changes to current accounts all round are doing nothing to enamour an already highly sceptical consumer base.

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