The Financial Conduct Authority is investigating how providers set and monitor overdraft limits, as well as their governance and strategies, after it claimed that Britons are paying "too much".
Only a week after the regulator took over responsibility for 50,000 consumer credit firms, the FCA said that the overdrafts still aren't providing good value, with many consumers confused about the costs.
"Just about everybody who banks can have access to some sort of overdraft facility – whether they've signed up for it or not," said Christopher Woolard, director of policy, risk and research, at the FCA.
"The sheer size of this market is huge and with overdrafts bolted on to over 30 million UK current accounts, we want to make sure it is working well for consumers."
According to FCA data, the overdraft industry is worth £8bn (€9.7bn, $13.4bn).
The watchdog looked at both arranged overdrafts, those that come as part of a current account package, and unarranged overdrafts, where firms allow customers to go beyond their overdraft limit.
It says that Britons who use an arranged overdraft fall into the habit of using it on a regular basis and, in tandem, "give little thought to the actual cost of interest or fees."
"As consumers tend not to consider overdrafts when deciding on a current account and don't switch on the basis of overdrafts, there is little pressure on banks to provide good value overdrafts," it added in its report.
The FCA said that added that, as part of the next steps for its investigation, it will also consider making some voluntary measures mandatory in autumn 2014.
"The FCA will also work alongside the Competition and Markets Authority to make sure any actions complement (and do not duplicate) its current work updating the OFT's 2013 review of the current account market," it added.
"A number of banks have claimed that overdrafts subsidise 'free' current accounts, but we think the situation is more complicated than this. There is evidence that personal current accounts help banks to sell a range of more profitable products. One aspect of this is cash savings, which the FCA is currently exploring through a market study."
Why Britons Are Paying Too Much
- Many people don't realise how much overdrafts can cost and are confused by unarranged overdrafts
- Consumers often don't see arranged overdrafts as borrowing and quickly become accustomed to using them, sometimes viewing them as an extension of their income. The presentation of this as 'available funds' reinforces this
- Repayments are often driven by income coming in rather than as scheduled payments to clear an outstanding balance
- There may be incentives for firms to raise revenue by increasing overdraft limits, these extensions are often perceived by customers as their bank 'trusting' them.