There is no such thing as a free lunch in banking

Allister Heath

IT came as a bit of a shock. Britain’s new Supreme Court, which has just been spun out from the House of Lords, dealt the Office of Fair Trading a bitter blow yesterday by ruling against it in its test case against high street banks. Their Lordships ruled unanimously that deciding whether overdraft charges – which are often arbitrary – are “unfair” is beyond the scope of the OFT, which has been trying to get banks to cut these often absurdly high penalties. Over 1m customers, who were trying to force banks to repay past overdraft charges, now have very little chance of ever seeing any compensation. Yet the implications of the ruling are more complex than most simplistic analyses would have you believe. Many people were angry at the banks yesterday – but even more would have been incensed had the judges sided with the OFT because it would have meant the end of the so-called “free banking model”.

The real point of this case was whether the banks should continue to fund a sizeable chunk of their running costs indirectly – in underhand ways, such as penalty fees and higher interest rates – or whether they should be more upfront about it and charge annual fees for all of their products. The current system penalises customers who run up unauthorised overdrafts and subsidises those who don’t. As the Court put it, the charges are “part of the price paid by the customer for the banking services provided”.

As ever, I disagree with the consensus. Banks and consumer groups are both wrong. It would be much more rational for banks to charge for everything explicitly and transparently– all bank accounts and credit cards would come with an annual fee, for example, injecting comparability and hence greater competition into the market.

Meanwhile, consumers need to understand that the services they take for granted – even cheque clearing and using an ATM – are not free; they need to be paid for somehow. If the costs were to become clear, angry consumers could move to cheaper banks.

The ruling was also a breath of fresh air as it upheld, if unintentionally, the principle of the sanctity of contracts. Change is needed but it shouldn’t come from the courts and shouldn’t be retroactive. It would be mad to force banks to shell out vast sums in compensation for something that has always been legal – especially in the current climate. The ruling also exposes the government’s hypocrisy. If it really believed in greater competition, it would ask the banks it owns or controls – such as RBS – to reform themselves. To its discredit, it has done nothing at all.

There are plenty of top UK businesses that are continuing to grow profits and margins in extremely tough conditions. Because there is so much other news – from today’s Walker review to the latest economic data – they often don’t get the attention they deserve. One such firm is Compass, the catering giant – it increased revenues to £13.4bn in 2009, with profit before tax reaching £773m (up from £566m the previous year). While the firm was boosted by favourable currency moves, it compensated for a drop in sales in the UK by continuing its overseas expansion and pushing through efficiency gains. Richard Cousins, the firm’s highly capable CEO, deserves a much greater profile.