Monday, 19 July 2010

Banks, interest rates and the misuse of APR

An almighty outcry (at least on the BBC who want to plug their Panorama programme and Vince Cable who’d like someone to notice him) about the terrible, evil way in which banks insist on charging people high rates of interest for unauthorised overdrafts. Now this is either the result of there not being enough competition in the banking sector or because cunning and crafty bankers have a special magic that makes it impossible for customers to understand the terms of their relationship.

Now on the competition point, I rather agree. But it isn’t addressed by getting a desperate sound bite or by shouting at the banks. If you want more competition, you have to allow people to start new banks without the huge financial and regulatory barriers to entry (that are keenly supported by the evil “Big Banks” in their eagerness to protect the consumer from rapacious fly-by-night outfits). So, Vince, either do this or else shut up.

On the matter of evil bankers confusing us poor folk and thereby charging very high rates of interest (I think the official term is obscene), I see either a finely crafted straw man or else a degree of informed ignorance that only innumerate BBC journalists can achieve. Put simply, Annual Percentage Rate (APR) is a pretty lousy way of assessing the price of short term credit. And that is what we are talking about here – banks generally don’t offer rates in excess of 1,000% for general loans but for small amounts borrowed without prior clearance the fixed costs are such that very high rates are inevitable (just consider, for example, a whole floor filled with people just processing the results of our financial incompetence – and that’s just the start of it).

The banks could simply bounce your payment and, as is their right, charge you a few quid for doing this (such costs will be in the terms and conditions of your account that the bank sends you every year). But in their blessed wisdom they don’t do this but allow your water bill or whatever to pass unheeded – and then charge you a few quid for that kindness in the form of interest. It all amounts to the same cost in the end – you’re either going to borrow without permission for a few days or else the bank isn’t going to let you borrow in that way. In both cases the cost to you is the same – which would you prefer?

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