Banks and building societies are snaffling £3.5 billion a year of interest from our savings by paying negligible rates on old accounts - but offering higher returns to new customers.
The figures come from a major study, Cash Savings Market Study: Interim Report, by the regulator, the Financial Conduct Authority (FCA), published in July.
It looked at the savings accounts offered by the major banks and building societies. We have nearly £700 billion saved up in them. But most accounts pay tiny rates of interest - 0.3% on average. So £1,000 would earn just £3 a year (£2.40 after basic rate tax).
And some are worse.
First Direct, the online HSBC subsidiary, pays current account holders 0.05% on savings accounts. That is just 50p a year on £1,000. By contrast it can lend that money out to other banks and earn between ten and 20 times as much.
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The loyalty penalty
The banks have a different attitude to new customers. On average they pay them 0.8% — nothing to shout about but it would bring in more than twice as much as the average low rate. On £1,000 you would earn £8 a year (£6.40 after basic rate tax). Which is still less than the £10 a bank could earn lending to other banks, and of course far less than the £219 a year HSBC would charge us to borrow £1,000.
If the banks paid all of us the average 0.8% they give to new customers then they would be paying out another £3.5 billion a year. If we all went for the best account they would end up paying twice that.
Tricks and traps
People who do try to move their money to earn a bit more have to negotiate a maze of complex rules.
The first trap is the bonus rate. These are less popular now but some accounts still have them. Halifax online ISA, for example, pays 1.5% but almost all of that is a bonus rate for the first 12 months, after which it drops to just 0.25%.
The FCA found that nearly half of the money in easy access accounts had once been on a bonus rate. Customers had been tempted in but then not moved the money out when the bonus ended. In many cases that may be because they were not told when that happens. Banks are obliged to inform only customers who have at least £500 in the account. Nearly seven out of ten accounts have less.
Even where there is no explicit bonus paid, the FCA found that banks created new accounts and then cut the interest rate paid on old accounts. Data from savingschampion.co.uk published in response to the FCA report shows that in the first seven months of 2014 there were 729 cuts in savings rates, averaging 0.38% with a maximum reduction of 1.4%.
Another trick is to slash the interest paid if customers spend their own money. For example, the best buy Britannia Select Access Saver 6 pays 1.4%. But if you have the temerity to take money out more than four times in a calendar year, the interest rate plummets to 0.1% until December 31.
Slightly better on withdrawals is the Coventry PostSave Easy Access Issue 2. It pays the same 1.4% and allows 12 withdrawals a year. But on the 13th withdrawal all interest stops for 30 days.
Read our guide to ISAs...
Some banks pay better rates to customers who also have other products – or will let only existing customers open the top-paying accounts. They do this to try to stop customers taking their money elsewhere. And, as I reported in Saga Magazine in August, some offer much better rates on the balance in a current account than on savings. The FCA found that most of us open our savings accounts with the bank where we have our current account.
It is all part of the inertia that means most of us seldom move our savings accounts. The FCA found that six out of ten of us who have a savings account have not moved it in the past three years. It also found that six out of ten easy access accounts were opened more than five years ago. There is £106 billion languishing in those accounts, earning very low rates.
Moving to another account could quadruple the interest. For example, Virgin Money will pay 1.3% or £13 (£10.40 after tax) on every £1,000 saved on its Easy Access E-Saver Issue 12 and has none of those tricks or traps.
The FCA reminded banks of the need to be clear, fair, and not misleading in the way they deal with customers. But the very low rates of interest offered are not all the banks’ fault – they come from state policy.
First, the Bank of England has kept the Bank Rate at its historic low level of 0.5% for more than five years. Although banks do not follow that rate with what they pay on savings, nor what they charge on loans, it is influential and has kept interest rates low for half a decade.
But it is a Government policy called Funding for Lending that has really shredded the return on savings.
Funding for Lending began in August 2012 and lets the banks borrow almost unlimited funds from the Bank of England at the low rate of 0.75%. Because they could borrow at that rate from the bank, they no longer needed our money and wouldn’t pay more than around 0.75% for it rates tumbled and by Christmas had fallen to half the average level before the scheme began.
This policy is scheduled to end in January, not long before the Bank Rate itself is expected to rise. Those expectations are already beginning to be factored in to slightly better rates for savings that are tied up for three or more years.
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The FCA is also clear that the solution lies partly with customers. Less than a quarter know what rate their savings earn, one in three does not check competing rates, and three out of ten do not even know if their savings earn a variable or fixed rate.
So look at the whole market using a fair comparison site such as savingschampion.co.uk, which is not influenced by commission or payments from the banks.
Whatever the regulator may do - a further report is due later this year - the solution to earning so little on our money is partly in our own hands.
All figures and rates correct at time of writing.
This article first appeared in the September 2014 edition of Saga Magazine.