Avoiding High Overdraft Rates – Taking Advantage of Alternatives! A Study by the Centre for European Economic Research and the Institute for Financial Services on Behalf of the Federal Ministry of Food, Agriculture and Consumer Protection
ResearchSome 80 per cent of German households have an overdraft credit. According to experts of consumer protection organisations, the interest rates on overdraft credits are too high. A study presented in Berlin on July 19, 2012, discusses the pros and cons of different legal regulation systems aiming at limiting overdraft rates and preventing misuse. The study conducted by the Institute for Financial Services (Institut für Finanzdienstleistungen e.V., iff) and the Centre for European Economic Research (ZEW) has been funded by the Federal Ministry of Food, Agriculture and Consumer Protection (BMELV) through resources of the Federal Office for Agriculture and Food (BLE).
Study on Overdraft Rates/Instalment Credits – Key Findings
According to the study by ZEW and iff, the level of overdraft rates is determined by different aspects. Many banks offer accounts free of maintenance fees for customers, which might encourage institutes to charge higher overdraft rates in order to compensate for their own account management costs. Further components are refinancing costs, risk costs, equity capital costs, option costs for flexibility, administration costs (unit costs), as well as the individual bank margin. In general, clients are not differentiated through the level of overdraft rates but by the credit limit admitted.
Only at first sight would the reduction of overdraft rates be the right approach when it comes to the struggle against over-indebtedness of private households. According to the study, a number of private households are developing a tendency towards excessive utilisation of overdraft lines. High overdraft rates and a comparatively easy access to overdraft credits strengthen this tendency. Unemployed persons, for example, use overdraft credits more frequently than jobholders, and the same holds true for single parents, couples with children, and freelancers. The budgets of these groups are subject to stronger variations which cannot be compensated for through a partners’ income or, on the long term, through an instalment credit. It is interesting that persons with a higher degree of general knowledge on financial issues make use of overdraft credits less frequently.
These findings already show an important starting point for practical changes: the authors of the study suggest improving customers’ knowledge about the consequences of going into debt. As a matter of fact, it is only the banks that are able to provide more detailed information on the budgetary burden than before. It is also important for banks to identify their clients’ possible problems much earlier and to offer personal consultations dealing with the financial situation of their clients. Consultations could, for example, result in a refinancing scheme that is applied long before a household has fully exploited its budgetary margin.
According to the study, another important aspect is alternative options, which have to be discussed before an overdraft contract is being signed. An overdraft credit is neither designed nor intended for long-term financing. If clients are planning long-term commitments, an instalment credit should be concluded, which normally is cheaper for borrowers, because securities can be used to reduce the interest rate. Instalment credits can be cleared gradually, whereas overdraft credits lack the disciplining effect of frequent redemptions.
The introduction of maximum limits for interest rates would beyond doubt lead to an improvement of the financial situation of borrowers. According to the study, however, it has to be considered that such a maximum limit would also lead to a situation where only financially solid households would be given an overdraft credit. Households denied an overdraft credit could look for alternatives which would be more expensive in most cases. This could lead to an expansion of credit card debts in Germany, or to an increasing importance of the instant credit market. This, however, would not improve the debt situation of private households.
A more extensive and obligatory counselling by banks, as well as alternatives to overdraft credits could improve the situation of financially stricken households, according to a central finding of the study. The main reason is that there would be obstacles to using overdraft credits, as opposed to the current generous use of overdraft credits.
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