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Certificate
in
Financial Studies
Unit 1:
Financial Capability for the
Immediate and Short Term
Veronica Gilbert
Updated by
David Debenham
Sophie Lovegrove-Bacon
Tia Ralhan
Mark O’Neill
Author information
Veronica Gilbert BSc (Hons), MSc is an independent consultant specialising in
teaching, learning and assessment. She has worked on The London Institute of
Banking & Finance Financial Capability programme for over 10 years as author, editor
and assessment reviewer. In her role as facilitator for the qualification development
days she has had the opportunity to meet many of the teachers and tutors who
deliver the courses and to discuss what works well for different learners. She also
has over 25 years’ experience of conducting research and analysing learning needs,
then designing and implementing programmes using a mix of media including
textbooks, technology-enhanced learning and workshops.
Acknowledgements
All images © iStock except: p4 – fei stone © Bartek Cieslak at pl.wikipedia; p6 –
coin images © Trustees of the British Museum; p12 – Totnes pound note
©Totnespound.org.
All case studies are posed by models.
The publisher has made every effort to contact copyright holders, but apologises for
any inadvertent omission. Unacknowledged copyright holders are invited to contact
the publisher at the above address so that appropriate arrangements can be made
at the earliest opportunity.
Please note that where external websites are indicated, The London Institute of
Banking & Finance is not responsible for their content. Teachers should satisfy
themselves that the content remains correct and appropriate for their students before
directing them to use the sites.
Contents
Topic 1 Purposes of money
Introduction..........................................................................................................1
1.1
The development of money ..........................................................................2
1.2
Features of money........................................................................................8
1.3
Functions money must perform ..................................................................11
1.4
Considerations when using money ............................................................13
1.5
Bank account balances ..............................................................................15
1.6
Using money to meet changing needs ...................................................... 15
Key ideas in this topic ........................................................................................ 16
References ........................................................................................................ 16
Topic 2 The personal life cycle
Introduction........................................................................................................17
2.1
The life cycle ..............................................................................................18
2.2
Paying for needs, wants and aspirations .................................................... 21
2.3
Life events..................................................................................................22
2.4
Attitudes to risk and financial choices ........................................................28
2.5
External influences on the life cycle ............................................................30
Key ideas in this topic ........................................................................................35
References ..........................................................................................................35
Topic 3 Payment methods
Introduction........................................................................................................37
3.1
Cash ..........................................................................................................37
3.2
Electronic payments from current accounts ................................................40
3.3
Cheques ....................................................................................................44
3.4
Banker’s drafts ..........................................................................................46
3.5
Payment cards ............................................................................................46
3.6
Making payments when abroad ..................................................................49
3.7
Comparing methods of payment ................................................................50
Key ideas in this topic ........................................................................................52
References ..........................................................................................................52
© The London Institute of Banking & Finance 2022
v
Topic 4 Everyday banking
Introduction........................................................................................................55
4.1
Choosing a current account........................................................................55
4.2
Different types of current account ..............................................................57
4.3
Opening an account ..................................................................................62
4.4
Monitoring transactions..............................................................................63
4.5
Switching and closing accounts ..................................................................65
Key ideas in this topic ........................................................................................66
References ..........................................................................................................66
Topic 5 Savings products
Introduction........................................................................................................67
5.1
Return on savings ......................................................................................69
5.2
Impact of inflation ......................................................................................72
5.3
Taxation ....................................................................................................74
5.4
Safety ........................................................................................................77
5.5
Choosing savings products ........................................................................79
Key ideas in this topic ........................................................................................82
References ..........................................................................................................83
Topic 6 Borrowing products
Introduction........................................................................................................85
6.1
The cost of borrowing ................................................................................87
6.2
Overdrafts ..................................................................................................88
6.3
Credit cards................................................................................................92
6.4
Personal loans ..........................................................................................101
6.5
Credit history ..........................................................................................103
6.6
Choosing products ..................................................................................103
Key ideas in this topic ......................................................................................105
References ........................................................................................................105
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Topic 7 Providers
Introduction......................................................................................................107
7.1
Banks ......................................................................................................110
7.2
Building societies ....................................................................................112
7.3
Credit unions ..........................................................................................116
7.4
National Savings and Investments (NS&I) ..................................................118
7.5
The Post Office ........................................................................................119
7.6
Communication methods ........................................................................120
7.7
Choosing a provider ................................................................................122
Key ideas in this topic ......................................................................................125
References ........................................................................................................126
Topic 8 Consumer protection
Introduction......................................................................................................127
8.1
Background to consumer protection ........................................................128
8.2
Regulators................................................................................................132
8.3
Financial Ombudsman Service ..................................................................137
8.4
The Financial Services Compensation Scheme (FSCS) ................................140
8.5
Competition and Markets Authority (CMA) ................................................141
8.6
Voluntary codes of conduct ......................................................................143
Key ideas in this topic ......................................................................................144
References ........................................................................................................144
Topic 9 Budgets and forecasts
Introduction......................................................................................................147
9.1
Budgeting ................................................................................................148
9.2
Income ....................................................................................................148
9.3
Expenditure..............................................................................................150
9.4
Balance ....................................................................................................155
9.5
Monitoring incomings and outgoings ......................................................158
9.6
Cash flow forecasting ..............................................................................160
9.7
The cost of living in the UK today ............................................................162
Key ideas in this topic ......................................................................................164
References ........................................................................................................164
© The London Institute of Banking & Finance 2022
vii
Topic 10 Dealing with unexpected events
Introduction......................................................................................................165
10.1 Key features of insurance ........................................................................166
10.2 Motor insurance ......................................................................................169
10.3 Buildings and home contents insurance....................................................172
10.4 Other types of insurance ..........................................................................173
10.5 Revising budgets ......................................................................................174
10.6 Saving ......................................................................................................174
10.7 Borrowing ................................................................................................175
10.8 Benefits ....................................................................................................175
10.9 Unexpected income..................................................................................176
Key ideas in this topic ......................................................................................177
References ........................................................................................................178
Topic 11 Dealing with debt
Introduction......................................................................................................179
11.1 Affordable repayments ............................................................................181
11.2 Insolvency solutions ................................................................................186
11.3 Insolvency solutions in Scotland ..............................................................190
Key ideas in this topic ......................................................................................191
References ........................................................................................................191
Topic 12 Earnings
Introduction......................................................................................................193
12.1 National minimum wage ..........................................................................194
12.2 Maximum working hours..........................................................................195
12.3 Income tax and NI ....................................................................................196
12.4 PAYE documents ......................................................................................202
12.5 Filling in an income tax return..................................................................205
Key ideas in this topic ......................................................................................208
References ........................................................................................................208
Glossary ……...………………………………………………………………………………… 211
Index ................................................................................................................227
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© The London Institute of Banking & Finance 2022
Topic 1
Purposes of money
Learning outcomes
After studying this topic, students will be able to:
◆ define the purposes of money; and
◆ outline its key features.
Introduction
This topic explores the question, ‘What is money?’ To answer this question we will
discuss why money was invented, what purposes money serves today and some of
the many ways that people use it.
If you were to ask people what money is, many would think first of coins and notes.
These are used every day to pay for items in a wide variety of places including shops,
cafes and bus or train stations. Collectively, coins and notes are termed ‘cash’. If
people were asked where they store their money, they might mention their purses
or wallets and their bank accounts. The contents of bank accounts are held as
electronic records that the banks keep. Banks notify people about how much is in
their bank account by giving them statements of the current balance – that is, the
total in their account on the date of the statement.
Coins and notes are described as ‘money’ but most money is in the form of electronic
balances in bank accounts. People can take coins and notes out of their bank
account, for example by using their cash card at a branch. The reason to have cash
is to make a payment. Payments can take several forms, for example people may
spend it, pay it into a savings account, give it to another person as a gift or repay
money they have borrowed. People can also instruct their bank to pay some of the
contents of their bank account to someone else, for example by writing a cheque.
Payment is the common feature of what money is and its main purpose.
We can define money as ‘anything that is widely
accepted as a means of making payments’ and
specify that ‘money’ means coins, notes and the
electronic balances held in bank accounts. Being
‘widely accepted’ is an important feature of
money and we will explore it further during this
topic. For example, people in the UK can pay
using pound coins in shops because the retailers
will accept these coins.
Many people think of ‘money’ as coins and notes but it
also includes electronic balances held in bank accounts.
© The London Institute of Banking & Finance 2022
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Because the main purpose of money is to make payments, it is able to fulfil other
purposes as well. Sellers use money to set the price of goods – that is, how much
someone must pay for them. People can store their money and so save it for making
payments in the future. Money also makes it possible for people to buy items now,
even if they do not have enough money themselves to make the purchase. They can
borrow the money they need from someone else and repay the lender in the future.
As money fulfils all these purposes, people use it in different ways. For example:
◆ Jack buys snacks and magazines from a corner shop using cash on his way home
from school;
◆ Beth has given her bank instructions to pay her electricity bill by transferring
money from her bank account to the electricity company every month;
◆ Raj and Tamsin are saving for a holiday they want to take in six months’ time by
depositing money in a savings account;
◆ Mark has borrowed money from a bank to buy a moped and is repaying it over
several years in monthly instalments;
◆ Cindy goes online to compare prices for the handbag she wants to buy.
1.1 The development of money
1.1.1 Using barter to trade goods and services
Before money was created, people used a system of barter to trade goods or services.
The case study explains how bartering worked.
Bartering in early history
Consider an example from California in 1841. A farmer needs nails to be able
to mend the wooden roof of his home. This need is important to him because
winter is approaching and without the nails the roof will let the rain in and the
heat out. The farmer specialises in growing wheat and producing flour. He can
spare some flour to offer in exchange for nails. He therefore travels to the local
blacksmith.
The blacksmith makes nails. He does not grow wheat himself and therefore does
not produce his own flour. He needs flour to be able to make bread. When the
farmer arrives at the forge, the blacksmith is willing to give him nails in
exchange for flour.
Now they must decide how much flour each nail is worth. The farmer has
brought a wooden jug with him to measure out the flour. He starts by offering
the blacksmith enough flour to fill the jug once for each nail. The blacksmith
does not agree. Each nail took him an hour to make using skills he has built up
over 15 years. He asks for four jugs of flour for each nail. After discussing the
relative value of flour and nails for nearly an hour, the farmer and the blacksmith
agree on two jugs of flour per nail and exchange their goods.
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© The London Institute of Banking & Finance 2022
The barter system of exchanging goods or services has many limitations. It relies on
a ‘double coincidence of wants’, that is, the farmer must want nails and have flour
to offer and the blacksmith must want flour and have nails to offer. It relies on the
two parties agreeing a rate of exchange, that is, how much flour each nail is worth.
This could be a time-consuming process. And it relies on the farmer having surplus
flour when he needs to acquire extra nails.
1.1.2 Using items with intrinsic value as payment
The limitations of barter led people to create systems where the local community
used an item they all valued as a means of payment. People in Japan, for example,
used rice as ‘money’. Buyers and sellers would agree how much rice an item was
worth: the buyer would then give the seller the agreed quantity of rice and receive
the goods they wanted in exchange.
The use of valuable items such as cattle or grain as ‘money’ can be traced back to
around 9000 to 6000 BCE. Other items that communities have used in the past
include:
◆ cowrie shells;
◆ pigs;
◆ feathers;
◆ stones;
◆ leather;
◆ salt; and
◆ oxen;
◆ vodka.
Metals, including gold, were valued because they could be used to make weapons,
tools and jewellery. Pieces of metal began to be used as ‘money’, too.
The use of an intermediate item (such as cattle, shells or gold) that all local people
value as a form of ‘money’ allows people to sell any surplus or specialist goods they
produce for this intermediate item. Sellers can then use the item they have been paid
to buy other goods.
Using gold as payment
Fast forward to California in 1850 and another farmer is in need of nails. The
Gold Rush has arrived and prospectors are digging gold out of the ground and
finding it in rivers. Gold is valuable in its own right (it has an intrinsic value) so
local people are willing to exchange goods and services for gold. When the
farmer sells his flour to the town store he is paid in small gold nuggets. As gold
has become a measure of value that is common throughout the area, he can use
this gold to pay for a range of goods from different specialists. He is no longer
restricted to trading only with people who want flour.
The farmer goes to the blacksmith and asks what weight of gold the blacksmith
wants for the nails. After some discussion, they agree on the price. Then the
farmer and blacksmith use scales to weigh the gold and the farmer breaks a
nugget into smaller pieces to get the exact amount of gold agreed. The
blacksmith can then use this gold to pay for items he needs or wants.
© The London Institute of Banking & Finance 2022
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Looking at the list above, we can see practical drawbacks with early forms of money.
Some items are not durable – for example, cattle and pigs die, and grain can perish
if not stored correctly. Some items cannot be divided into small amounts to enable
people to make low-value purchases or to give change. For example, if a seller
wanted payment of one live pig but the purchaser did not agree the goods were
worth a whole pig there were few options available. If the purchaser did not have a
smaller pig to offer, the trade could not be made, causing problems for both parties.
Many early forms of money were not easily portable. The fei stones used as money
on the Pacific island of Yap, for instance, varied in size, but included some that were
more than 6 metres across.
Fei stones like these were
used as money until
about 1965 on the island
of Yap in the Pacific
Ocean. (© Bartek Cieslak
at pl.wikipedia)
Another problem with using an item that has value in its own right is that the value
of that item itself can vary. For example, gold was an intermediate item used as
‘money’ before the introduction of coins. It has an intrinsic value of its own because
it is rare and in demand to make items such as jewellery. However, suppose a
particular source of gold runs out or a war prevents buyers and sellers from meeting
to trade. Gold becomes scarcer and its value rises. One week, a trader might offer
an ounce of gold for two cows; a month later, they might want four cows in exchange
for their single ounce of gold. The chart on page 5 shows how the price of gold
changed over a 40-year period in the twentieth century.
1.1.3 Using items that represent value as money
An important stage in the development of money, then, was changing from an
intermediate item that had value in its own right (an intrinsic value) to an item that
represented value but had no value of its own. In China, for example, spades and
knives, which had an intrinsic value of their own, were used in barter systems. Later,
coins in the shapes of small spades and knives were used to represent a standard
value where each coin was worth roughly the same as the real spade or knife.
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© The London Institute of Banking & Finance 2022
The changing price of gold
Figure 1.1 illustrates how the price of one ounce of gold (approximately
28 grams) varied between 1970 and 2020. The values shown are for the
highest price that year and are in GBP which stands for Great British Pounds.
The latest figures show that the price of gold has gone up in recent years.
Figure 1.1 The changing price of gold, 1970–2020
Source: World Gold Council (2021)
These coins were made of metal, often bronze or copper, but the value of the
metal was low. The coins themselves had no intrinsic value as pieces of metal.
They had representational value because local people agreed that a coin
symbolising a spade or knife had the same value as a real spade or knife. They
also had the advantage of being smaller than the real item (and therefore more
portable) and durable.
Over time, the coins were made into standard shapes that look much like round,
modern coins. Different coins came to represent different values, and the value was
written on them, just as modern coins come in different denominations such as 5p,
20p and 50p.
The word ‘money’ itself is thought to have its roots in Ancient Rome, where a mint
was located next to a temple to the goddess Juno Moneta (meaning Juno the
Protector). The coins produced at this mint from about 300 BCE onwards bore an
image of the goddess and became known as moneta, later ‘money’.
© The London Institute of Banking & Finance 2022
5
The development of coin shapes
in China
The Chinese bronze spade money
shown here dates from the period 1050
BCE to 221 BCE. In this early stage of
development each coin looks very
similar to a spade, with a hollow handle,
sloping shoulders and an arched base.
The coins weigh 27.7g and are 66mm
in length.
The shape of the coins was gradually
refined; the ones shown here are from
9–23 CE. They are still made of bronze
but are flatter, shorter and lighter than
the earlier version. Each coin weighs
14.53g and is 55mm in length. The
hole at the top of the coin makes it
easy to carry them on string or cords.
From around 621 CE the coins shown
here were issued. They are round,
25mm in diameter, made of bronze
and weigh just 4.1g each, making them
easy to carry. The Chinese words read
Kai yuan tong bao which means ‘new
beginning circulating treasure’ (or
‘coin’). The first emperor of the Tang
dynasty, Gaozu, created a new system
of coins in 621 CE which lasted over
1,200 years.
(All images © Trustees of the British Museum)
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© The London Institute of Banking & Finance 2022
1.1.4 Using paper notes as money
China developed the idea of paper banknotes around the seventh century CE.
Merchants who traded high-value goods found it impractical to carry large quantities
of copper coin. Instead they deposited the coins with a trusted person, who gave
them written receipts stating how much was stored in their name. Rather than paying
for goods with the actual coins, merchants paid by passing the receipt for the coins
to the person selling the goods, who could claim the coins in storage.
Over time, people no longer claimed the coins from storage because buyers and
sellers agreed that the banknote represented the value of the coins and would accept
the banknote as payment, knowing they could use it to make payments of their own.
1.1.5 Modern payments
Most purchases are now made using coins and banknotes or by transferring
electronic balances between bank accounts. However, barter systems still exist in
some communities, especially those where the people have little or no cash. Some
barter systems are informal, with friends and neighbours trading skills such as
gardening and cake-baking or baby-sitting. There are also bartering websites that
help put people with a ‘coincidence of wants’ in contact. More formal systems exist,
too, such as local exchange trading systems or schemes (LETS), which operate on a
system of credits without the need for cash. Another variation on the local theme is
alternative currencies. These are explored in more detail in section 1.3.
LETS
A LETS is a local network that enables people to exchange goods and services
with each other without using money. Suppose Abas is a member of his local
LETS. He advertises on the LETS website that he can give other members basic
computer training. When Abas gives Jake a three-hour computer lesson, Jake
pays him in credits via the LETS credit administration system. Sometime later,
Abas buys a flat-pack wardrobe and needs help putting it together. So he
searches the LETS website for a member who has DIY skills and finds Neville.
When Neville helps Abas with putting together the wardrobe, Abas pays him for
one hour of his time with some of the credits he earned from Jake.
LETSLINK UK (www.letslinkuk.net) describes about 300 LETS across the country
including:
◆ Brum LETS which uses a unit of credits called Hearts;
◆ Dorchester and South Dorset LETS which uses Marts;
◆ Edinburgh LETS uses a credit unit called a Reekie.
The Brum LETS website suggests that members charge a standard rate of 6
Hearts per hour and equal value is placed on the services on offer – so an hour’s
cleaning is worth the same number of Hearts as an hour checking someone’s
household budget.
© The London Institute of Banking & Finance 2022
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1.2 Features of money
In order to fulfil its purposes, money needs to have certain features; we saw some of
these when we looked at how money developed. Money must be:
◆ acceptable;
◆ durable;
◆ recognisable;
◆ portable;
◆ stable;
◆ scarce but sufficient;
◆ divisible;
◆ homogeneous.
We will explore what each of these terms means in the following sections.
1.2.1 Acceptable
People are only willing to accept money as payment for goods and services if they
are confident that others will, in turn, accept money from them as payment in later
transactions. We have seen that coins, banknotes and balances in bank accounts all
represent value rather than having an intrinsic value of their own. This means that
people have to trust that they will be accepted.
Part of the reason why people are prepared to accept money is because they have
faith that coins and banknotes are worth their face value, that is, the denomination
written on them. British banknotes have the following written on the front: ‘I promise
to pay the bearer on demand the sum of’ followed by the amount of money the
banknote represents.
This promise is signed by the Chief Cashier of the Bank of England. It is an example
of the role the Bank of England plays in maintaining people’s trust in the money they
use. Money is said to have a ‘fiduciary value’ (from the Latin fides meaning faith),
which is based on trust in the banking system.
Another aspect of faith in the monetary system is that sellers will receive the funds
transferred between bank accounts electronically. This money is transferred using a
variety of payment mechanisms such as payment cards and cheques. We will look at
the different methods of transferring these funds in detail in Topic 3.
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© The London Institute of Banking & Finance 2022
1.2.2 Recognisable
Cash must be recognisable so that people are confident they are receiving genuine
coins and banknotes – in the UK, for example, a 20p coin has seven sides, so if
someone was given a round 20p coin they would know it was not genuine. Cash must
also have security features to ensure that it is difficult to make forgeries. For example,
the Bank of England has introduced features such as raised print, metallic thread,
micro lettering, watermarks, holograms, ultraviolet features, see-through windows
and complicated designs to the notes it issues (see www.bankofengland.co.uk for
details). Some of these features, such as watermarks and metallic thread, are easy for
merchants to verify; others, such as ultraviolet features, require specialist equipment.
1.2.3 Stable
Money needs to hold its value so people can be confident that the money they accept
now will be worth the same or a similar amount in the future. Inflation, which is when
the general level of prices in an economy rise, means that the same amount of money
will buy less in the future and so its value falls in real terms. Inflation and its impact
on savings is explored in more detail in Topic 5.
1.2.4 Divisible
Coins and banknotes must be provided in a variety of denominations so that people
can use them in different combinations to make transactions of different sizes.
Having smaller denominations allows people to pay with larger amounts of cash and
to receive change. The Royal Mint website (www.royalmint.com) has details of the
coins it issues and the Bank of England website (www.bankofengland.co.uk) shows
the banknotes it currently issues. Banknotes for Scotland and Northern Ireland are
issued by a number of banks. Details can be found on the website for The Association
of Commercial Banknote Issuers (ACBI) at www.acbi.org.uk.
Payments from bank accounts are for specific amounts and do not need to be
divisible.
1.2.5 Durable
Coins and banknotes need to
be strong enough to be used
many times before they need
to be replaced by the Royal
Mint or the Bank of England.
Although UK coins are
coloured gold, silver or
bronze they are made of
metal alloys to ensure they
are durable. Coins made of
pure gold, for example, are
quite soft and damage easily.
Introduced in England and Wales in September 2016, the
durable polymer £5 note is hoped to last for five years.
Polymer £10, £20 and £50 notes followed in later years.
© The London Institute of Banking & Finance 2022
9
1.2.6 Portable
People must be able to carry the coins and banknotes they need for everyday use.
This is another reason why they are produced in different denominations and that
larger amounts are polymer-based.
The payment mechanisms used to transfer bank balances are very portable, for
example cheque books and payment cards such as debit cards. Details about how
these mechanisms work will be discussed in Topic 3.
1.2.7 Scarce but sufficient
The Bank of England manages the supply of cash in the economy so that there is
enough for people’s transaction needs. It is important to make sure that there is not
too much cash in circulation, though, because this leads to inflation and the value
of money falls. Inflation and the impact it has on people’s savings will be covered in
more detail in Topic 5.
1.2.8 Homogeneous
All coins and banknotes of a certain denomination need to be homogeneous, that
is, to look and feel the same. This helps them to be recognisable and therefore
acceptable. The designs on coins and banknotes vary but the shapes and main
features remain the same. Occasionally the Bank of England or Royal Mint changes
the size of a note or coin but they provide plenty of information about the change,
to ensure the new note or coin is recognisable. They also withdraw the earlier version
over a limited period to achieve homogeneity as quickly as possible. For example, a
new, smaller 5p coin was introduced in June 1990 and the older, larger coin was
taken out of use the following January.
10
© The London Institute of Banking & Finance 2022
1.3 Functions money must perform
We have seen that people use money to:
◆ measure value;
◆ make payments;
◆ save;
◆ borrow.
These four uses give us the following four functions that money must perform.
1.3.1 A unit of account
Money offers a standard measure of financial value, for example, for the value of
goods and services and the financial assets that a person owns. This enables people
to compare prices between goods and to see how prices or values change over time
or between countries.
It is the measure used in accounting and on bank statements to record transactions
and provide balances.
1.3.2 A means of exchange
Money enables people to make payments. We saw in section 1.2.1 that money
functioning as a means of exchange is made possible because people trust the
banking system. There is also a legal element. Certain banknotes and coins are ‘legal
tender’. This means that they must be accepted in settlement of a debt. There are
other notes and coins in circulation that are widely accepted but are not defined as
legal tender; in theory, people can refuse to accept these to pay off a debt, but it is
rare for anyone to do so.
Coins worth £1 and more are legal tender throughout the UK but the situation is
more complicated in relation to coins of smaller denominations and banknotes.
◆ Coins for amounts smaller than £1 are only legal tender for debts up to a certain
amount. For example, 20p coins are legal tender for up to £10 in a single
transaction. This is mainly because it is not practical to pay a large amount in
small coins.
◆ Bank of England banknotes are legal tender in England and Wales, but not in
Scotland or Northern Ireland.
◆ There are banks in Scotland and Northern Ireland that issue their own banknotes.
These Scottish and Northern Irish banknotes are not legal tender anywhere,
including in the countries that issue them, but they are widely accepted. The value
of the banknotes is backed by these banks holding account balances at the Bank
of England.
The money held in bank accounts is not legal tender but people accept transfers of
this money into their bank accounts because they trust in the banking system.
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Local currencies
Some communities have created their own currency to encourage people to
spend in local shops and so keep the money in the local economy. Examples
include the Lewes Pound, Brixton Pound, Stroud Pound and Cardiff Taffs.
The Totnes Pound was introduced in 2007. People bought the currency at an
issuing point in the town to spend in local shops or on locally based services.
The Totnes Pound note (© Totnespound.org)
Each Totnes Pound note met the criteria listed in section 1.2. It was:
◆ accepted as payment by local merchants;
◆ recognisable because it had a picture of a local landmark on it;
◆ stable because its value was the same as the Great British pound;
◆ divisible because it was issued in a small denomination and change could
be given in English coins;
◆ durable because it was made of strong paper;
◆ portable because it was a similar size to other banknotes;
◆ scarce because it was only issued in Totnes;
◆ homogeneous because all Totnes Pounds looked and felt the same.
After inspiring many other local currencies, the Totnes Pound was withdrawn
in 2019 because fewer people were using cash (BBC News, 2019).
Bitcoin is an electronic form of currency that is decentralised, meaning it is not
backed by a promise from a central bank such as the Bank of England. People use
bitcoin to exchange money over the internet, but because bitcoin is not regulated
the transactions are hard to trace and can be made anonymously.
1.3.3 A store of value
Money is used to store financial value for future use. For example, people save money
in bank and building society accounts and they keep small stores of cash to spend
in the future.
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1.3.4 A means of borrowing and then repaying the debt
People can borrow money to buy goods now that they cannot afford out of current
income. In effect they are delaying payment. Instead of paying the full price of the
item, the borrower pays in small amounts over a period of months or years. These
small payments are the repayments they make to the lender. During the borrowing
term, the lender cannot use the loan money for any other purpose. Borrowers therefore
compensate lenders by paying interest. The technical name for this function is that
money is acting as a standard measurement of deferred (that is, delayed) payments.
1.4 Considerations when using money
When people plan how to use their money, a key consideration is its current and
future purchasing power. The purchasing power of money is the quantity of goods
and services it can buy.
1.4.1 Purchasing power and time
A key consideration for savers is that inflation can reduce the purchasing power of
the money saved over time. For example, £100 in three years’ time will buy fewer
goods than £100 today.
Changing prices over time in the UK
Inflation has caused the price of an 800g white, unwrapped loaf of bread to rise
from 9p in 1970 to 118p in 2020, an increase of 100% in 50 years:
Increase in price of bread, 1970–2020
1970
9p
1980
33p
1990
50p
2000
52p
2010
118p
2010
118p
Source: ONS (2021a)
In 2020 the average cost of a loaf was 118p and the average wage was £560
per week (ONS, 2021a, 2021b). This means that a loaf of bread represented
0.28% of an average week’s wage in 1970 (ONS, 2010) and 0.21% of an average
weekly wage in 2020.
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The aim is therefore to find a savings interest rate that is higher than the rate of
inflation. This will enable savers to maintain or grow their purchasing power.
The Bank of England website publishes the current rate of inflation
(https://www.bankofengland.co.uk). Further information can be found about
inflation at the Office for National Statistics (ONS) website (https://www.ons.gov.uk/)
and
the
GOV.UK
website’s
research
and
statistics
section
(https://www.gov.uk/search/research-and-statistics).
1.4.2 Purchasing power and other countries
The same goods can cost different prices in different countries because of factors
such as the cost of living, wage rates and taxation. These differences can have an
impact upon people when they travel or live abroad. A key consideration when
budgeting for a stay abroad is therefore to find out the relative costs of
accommodation, transport, food, drink and so on. Guide books and travel websites
provide information, and exchange rates for currencies are available in newspapers
and online.
Exchanging currency for holiday spending
Scott and Rachel are travelling to Paris, France for a holiday. Before they leave
the UK they decide to buy some foreign currency so that they have cash to buy
meals and metro (underground train) tickets as soon as they arrive in Paris.
France’s currency is the euro (€). Scott and Rachel do some research online and
discover that they can get a set menu three-course meal without wine in a café
for about €20 each, €40 in total.
They look up the exchange rate online and discover that 1 euro equals 0.85
British pounds, that is, 85p on that day. The online currency converter uses the
abbreviations ‘EUR’ for euro and ‘GBP’ for pounds. A meal for the two of them
that costs €40 is the equivalent of £33.97 at that exchange rate (40 multiplied
by 0.85 = 33.97). Scott and Rachel think this cost is slightly cheaper than they
are used to paying for a similar meal out in Manchester city centre.
Scott and Rachel know that exchange rates vary from day to day and so they
decide to exchange £100 for euros to cover two meals and some transport costs
when they first arrive in Paris. As they know that every £0.85 equals €1, they
expect to get euros to the value of 100 divided by 0.85, that is 117.64. They go
to the Post Office and convert £100 into €117.64. This is the same exchange
rate of 1 EUR equals 0.85 GBP expressed as 1 GBP equals 1.1764 EUR.
We will look at exchange rates and the cost of living in different countries in
more detail in Unit 2.
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1.5 Bank account balances
The majority of money is held as bank account balances rather than as coins and
banknotes. There are many different types of bank account designed to fulfil the
different purposes of money. For example, there are accounts targeted at savers that
offer returns on the money stored there in the form of interest. When people borrow
money via a personal loan, they have a separate loan account. For now, however, we
will focus on current accounts as people can use these to fulfil all the purposes of
money.
Current accounts are offered by a range of providers including banks, building
societies and the Post Office. People can use them to deposit money and to make
payments by withdrawing cash or issuing instructions to the provider. These
instructions can take many forms such as cheques, standing orders and payment
card transactions. We study these different payment methods in detail in Topic 3.
People monitor the value of their current account holdings using statements.
Statements list the incoming and outgoing transactions on the account and the
balance at the end of the accounting period. They can be paper-based, provided
electronically on a computer or mobile phone screen, or provided over the telephone.
People can use current accounts to store money for future use. If account holders
plan to spend the money more than one or two months in the future, however, they
would probably benefit from transferring the money into a savings account that
offers a higher rate of interest.
Borrowing is also a feature of many current accounts. Overdrafts enable people to
borrow from the provider by paying out more money than they have stored in the
account. Overdrafts are designed for short-term use – for example, a person might
need to pay a bill the week before they receive their monthly salary payment.
They overdraw their account to pay the bill and the following week the borrowing is
repaid when their salary is paid in. We will compare different methods of borrowing
in Topic 6.
1.6 Using money to meet changing needs
We have seen that people use money to make payments, save, borrow and record
value. At any one time an individual might be using money for one or more of these
purposes. Certain combinations are more likely at certain times in a person’s life.
◆ Young children receiving an allowance are likely to spend most of their money.
They may save the financial gifts they receive for higher-value items that they
want and for unspecified items in the future.
◆ Young adults who have just left home and are earning a low wage are likely to
spend most of their money on living expenses.
◆ Adults with more job experience and better wages may spend money on living
expenses and ‘fun items’, borrow money through a mortgage to buy a home and
save for the future.
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◆ Parents might borrow money to pay for items such as a family-sized car. They
may spend most of their income on living expenses and gifts for their children
and find it difficult to save.
◆ Middle-aged people are more likely to have paid off their debts and to be saving
for their old age.
◆ Retired people are more likely to be spending all of their income, which will have
fallen since their years in employment.
When people plan their finances they need to consider how much they can afford to
spend, save and borrow from their income to be able to pay for the items they want
now and in the future. The proportions of spending, saving and borrowing are likely
to vary at different stages in a person’s life. We will explore these ideas in more detail
in Topic 2.
Key ideas in this topic
◆ Definition of money.
◆ The purposes of money.
◆ Bartering and its limitations.
◆ The development of money over time.
◆ The features money needs to fulfil its purposes.
◆ The functions of money.
◆ Legal tender.
◆ The purchasing power of money.
◆ How people’s need to spend, save and borrow changes over the course of
their life.
References
BBC News (2019) Totnes pound: Currency killed by ‘cashless economy’ [online]. Available at:
https://www.bbc.co.uk/news/uk-england-devon-47471231
ONS (2010) Consumer Price Inflation Reference Tables, Table 63.
ONS (2021a) RPI: Ave price – Bread: white loaf, unwrapped, 800g [online]. Available at:
https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/czog
ONS (2021b) AWE: whole economy level (£): seasonally adjusted total pay excluding arrears
[online]. Available at:
https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours
/timeseries/kab9/emp
World Gold Council (2021) Gold prices [online]. Available at:
https://www.gold.org/goldhub/data/gold-prices
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Topic 2
The personal life cycle
Learning outcomes
After studying this topic, students will be able to:
◆ distinguish between the key stages of the personal life cycle; and
◆ analyse the effect of key influences on it.
Introduction
People at different stages of their life have different financial circumstances. They
will probably have different amounts of money coming in (collectively called
incomings or income), such as pocket money when they are a child, an allowance in
their teens, earnings or benefits when they are an adult, and a pension when they
are retired. How they use their money will vary throughout their life as well,
depending on what they spend, save, and repay on debt. When they live at home
with their parents, for example, young adults will not have financial responsibility
for paying household bills. Once they have left home, they will have to pay for rent
or a mortgage and other bills such as electricity, water and food.
A person’s life cycle starts when they are born and ends when they die. The details
of each person’s life are different. There are stages of life, based on age, that we all
travel through, however, and life events such as getting married and having children
that happen to many of us.
When planning current and future finances it is useful to consider the financial
circumstances that tend to apply to each life stage and the financial consequences
of possible life events. Young adults may want to plan to leave home, for example,
to become independent of their parents, or to move to a different town to look for
work or go to university. This may involve investigating sources of money coming in
and possible outgoings such as paying day-to-day costs, for example mobile phone
charges and saving for the future. Mature adults may
plan to start a family, to buy a car or to realise an
ambition such as travelling. Adults in late middle age
may want to plan for their old age while offering
whatever financial support they can to elderly
relatives and children.
Financial services providers such as banks, building
societies, credit unions, friendly societies and
insurance companies offer products that are designed
to enable people to pay for the life events that tend
to happen at different life stages.
The birth of a baby is a key life event that has a long-term
financial impact.
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2.1 The life cycle
Life cycles are broken down into life stages based on age. The exact age at which
someone begins school or retires, for example, will vary from person to person.
Considering typical life stages for certain life events can help people plan their
finances, not only for themselves but for others whom they support. Parents, for
example, may plan how they will pay for or contribute towards the expenses of their
children’s life events such as learning to drive, living away from home or getting
married. Table 2.1 outlines the typical life stages (there is some overlap in age ranges
at the teenager / young adult stage because a person is legally an adult from the
age of 18 but is still a teenager).
Table 2.1 A typical life cycle
Birth and infanthood
0–2 years old
Childhood (preschool)
2–5 years old
Childhood (school)
5–12 years old
Teenager
13–19 years old
Young adult
18–25 years old
Mature adult
26–40 years old
Middle age
41–54 years old
Late middle age
55–65 years old
Old age
65 onwards
Death
Possible at any age but more likely here
At each stage, people tend to have different:
◆ life events;
◆ levels of income;
◆ levels and patterns of spending;
◆ amounts of savings and attitudes towards savings;
◆ amounts of debt held and attitudes to debt;
◆ family sizes and structures;
◆ levels of education; and
◆ attitudes to risk (and to the future).
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Introducing the Martins
Dora
Four generations of the Martin family live together. Dora
is the great-grandmother, aged 68. Her son is John, aged
45, who is married to Pat, aged 43. John and Pat have
three children. The eldest is Alice aged 23, the middle
child is Kathy, aged 19, and the youngest is Pete who is
16. Alice got divorced recently and has moved back into
her parents’ home with her son Ross, aged 4.
The financial circumstances of each member of the Martin
family are very different.
Pat
John
Alice
Kathy
Pete
Ross
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Ross is 4 years old and is therefore in the childhood (preschool) life cycle stage.
He receives pocket money from his grandmother Pat every week. His mother
Alice keeps the money until he wants to spend it, usually on toys. Every birthday
Ross receives some money as gifts from relatives. Alice puts most of this money
into a savings account for Ross at the local building society.
Pete is 16 and is therefore in the teenager life stage. He receives a monthly
allowance from his mother. His parents buy all essentials for Pete such as food at
home, school meals, clothes and travel costs. They also pay for his mobile phone
charges as they feel it is vital Pete can contact them in an emergency. However,
they expect Pete to repay them for any charges over a certain amount. Pete spends
the rest of his allowance on things he wants such as fashion, meals out with
friends, music and films. He is saving for a camera he hopes to buy in the next six
months.
Kathy is 19 so she too is in the teenager stage of the life cycle. She is in her
first year of an apprenticeship with a hairdresser. She earns a monthly income
but it is not enough for her to leave home yet. Next year her salary will increase
and she wants to rent a flat with some friends. She spends most of her money
on clothes, shoes and socialising but she is able to save a small amount every
month. She plans to use her savings to pay for items she will need when she
moves.
Alice is 23 so she is in the young adult stage of the life cycle. She does not have
a job and her income is from unemployment benefit and from her mother. She
also receives some financial support for Ross from her ex-husband. She spends
most of her income on Ross. She worries what will happen to Ross if something
happens to her.
Pat is 43 years old and is therefore in the middle age stage of the life cycle. She
works part-time in a bakery and is paid monthly. She spends most of her income
on groceries and clothes for the family and allowances for Alice, Pete and Ross.
She helps Kathy by giving her as much money as possible. Pat is worried about
her old age as she is unable to save at the moment.
John is 45 and is also at the middle age stage of the life cycle. He has a full-time
job in an office and is paid monthly. He spends most of his income on household
bills and repaying a loan he took to buy a car. He also borrowed money to buy
their house using a mortgage. The mortgage repayments are a large proportion
of his monthly income. He is paying money into a pension that will pay him and
Pat an income when he retires.
John also worries about what will happen to his family when he dies. For this
reason he is paying into a life assurance policy that will give Pat enough money
on his death to pay the rest of the mortgage repayments. This means his family
will keep the house if he dies before making all the repayments himself.
Dora is 68 and is therefore in the old age stage of the life cycle. She has a small
pension and spends most of her money on her grandchildren and greatgrandchild. She has saved enough money to have the type of funeral she wants.
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2.2 Paying for needs, wants and aspirations
The case study on the Martin family highlights three reasons why people spend
money:
◆ to pay for essential items they need;
◆ to pay for optional items they want now; and
◆ to save for items they aspire to buy in the future.
The distinction between needs, wants and aspirations is an important one for
financial planning.
Needs relate to items people must have to survive, such as food, drink and a place
to live. John Martin is financially responsible for providing a home for his family so
he is willing to pay a large portion of his income to a mortgage lender to buy a house.
He is also paying into an assurance policy that will make sure his family can stay in
the house if he dies, by repaying any remaining debt on the mortgage. John is also
responsible for paying the household bills such as electricity, gas, water and for a
telephone line. John will pay for these needs before he considers buying optional
items he wants. His wife Pat pays for the main food, drink and clothing needs for the
family.
Wants are optional items that are desirable but not necessary. Pete Martin is the
person in his family who spends most of his money on things he wants, such as
going to the cinema and buying music. His parents provide his needs, such as a
home, food, drink and clothing.
Aspirations are items or experiences that people wish to have in the future. Kathy’s
aspiration is to share a flat with friends. She knows she will require money to make
this aspiration come true in the future so she is saving towards it now. Dora aspires
to a certain type of funeral in the future and has already saved enough money to pay
for it.
When planning finances, people pay for needs first. If they have spare income after
paying for these needs, they will consider paying for wants and saving towards
aspirations.
A car can be a need, but for
young people it is often an
aspiration – something they hope
to have in the future.
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2.3 Life events
Table 2.2 opposite gives examples of some typical life events in each life stage.
There are financial costs associated with many of these events. Some of these costs
are needs, such as food and somewhere to live. Other costs are wants, such as
spending on hobbies, entertainment and fashion. People may also be saving for
future events or experiences to which they aspire, such as a holiday.
In the early stages of an individual’s life the costs of needs, wants and aspirations
are met by their parents / guardians and other relatives. Children are dependants:
people who have to rely on someone else for food, warmth, security, health care,
etc. In later life stages the individual is usually responsible for meeting these costs
for themselves, although they may become dependent on their family again in old
age.
As well as the responsibility for payment, the element of choice passes from parents
/ guardians to the individual as the person moves through the life stages. Examples
from the Martin family include the following:
◆ Alice Martin pays for her son’s clothes and therefore makes the final decision
about which ones to buy.
◆ Pat Martin buys the essential clothing that her son Pete needs such as underwear,
shoes and his school uniform. Pete has an allowance and chooses which
fashionable clothes and shoes he wants to buy.
◆ When Kathy Martin moves into a rented flat she will make the decisions on dayto-day needs such as groceries that her mother makes for her now.
◆ Dora has decided what will happen to her belongings, including her money, when
she dies. She has made a will, which is a legal document that sets out a person’s
instructions for distributing their belongings (their assets) after their death. She
has left most of her money to her grandchildren and great grandchild.
2.3.1 Location
Where in the world, or in a country, a person lives can influence their life events, such
as starting and ending full-time education and getting a permanent job. In Northern
Ireland, for example, compulsory schooling starts at age 4, in England, Scotland and
Wales it is 5, in Romania and India it is 6 (Eurydice, 2013; Carvalho, 2010), and in
Bulgaria, Poland and Sweden it is 7. The ages when people can leave school vary as
well: for example, in Bangladesh compulsory schooling ends at age 10 (UNESCO
Institute for Statistics, 2022). In India it is 14, in Scotland it is 16, and in England
children starting school now must be in education or training until they are 18
(GOV.UK, no date). These ages are the legal requirements for schooling. Children
may start pre-school at younger ages and continue in education after compulsory
schooling ends.
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Table 2.2 Typical life events and financial requirements
Life cycle
stage
Typical
age range
Typical events
Examples of financial
requirements
Birth and
infanthood
0–2 years
Birth
Parents or guardians pay for
everything they need.
Learns to walk
Learns to talk
Childhood
(preschool)
2–5 years
Nursery and preschool
Makes friends
Learns through playing
with toys and friends
Childhood
(school)
5–12 years
Starts school
Makes longer-term friends
Learns skills such as
reading and writing,
riding a bicycle,
swimming and other
sports, playing a musical
instrument
Teenager
13–19 years
Puberty and adolescence
Starts a part-time job
School tests and
examinations
Goes to college or sixth
form
Learns to drive
Develops closer
relationships with peers
and adults outside the
family
Relatives may save money for the
child if they have any spare
income.
May receive pocket money to
spend on wants.
Needs and some wants met by
parents.
Relatives may put money into
savings for the child’s future.
Income may include an allowance
from parents or guardians and
earnings from a part-time job.
If they leave home they will
become responsible for paying
for their needs as well as their
wants.
Likely to save for aspirations
such as driving lessons in the
future, maybe buying a car.
May leave home
Young
adult
18–25 years
Moves away from home
Goes to university or
training
Gains qualifications
Starts a full-time job
May be unemployed
When they leave home they will
become responsible for paying
for their needs as well as their
wants, eg rent, household bills,
food and travel.
They may need to take out a loan
to pay for further education or
training.
If they find a job they will have
earnings although these might be
low. If not they will receive
benefits.
May find it difficult to save.
© The London Institute of Banking & Finance 2022
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Mature
26–40 years
adult
Career promotions
Career changes
Marriage / civil
partnership
Children
Buys a car
Travels abroad
41–60 years
/ 55–65
years
They may wish to pay for a
wedding or civil partnership
celebration and honeymoon.
Couples without children may be
able to save for aspirations.
Buys property
Middle age
to late
middle age
Earnings may increase if they are
employed.
Career promotions
Career changes
Children leave home
Pays off mortgage and
other debts
Early retirement
Buying a home and / or a car
usually involves borrowing
money from financial services
providers and sometimes
relatives.
In late middle age, people may
find they have paid off their
debts and their dependants have
left home. They can save for old
age.
Career changes may involve
being made redundant and
retraining for a different role.
Early retirement may be voluntary
or because of poor health.
Old age /
retirement
65 onwards
Retirement
Part-time job
Leisure interests and
hobbies
Care home
Income may be the state pension
and any other pension
arrangements they have made
while working.
They may supplement their
income with a part-time job.
If their health is poor they may
need to pay for a care home.
Death
At any time
but most
often in old
age
In preparation for death
people:
◆ make arrangements for
their funeral
◆ make a will
24
People may buy a life assurance
policy to repay debts and pay
money to their dependants when
they die.
They may pre-pay for their
funeral.
© The London Institute of Banking & Finance 2022
The decision about when to leave full-time education will often depend on whether
or not their family can afford to send the child to school rather than to work. Rupa,
for example, lives in Bangladesh and is aged 9. Her family would like her to stay in
school but the money she can earn selling tea at the roadside is needed to buy food
for the family. She will therefore leave school next year and start full-time work. In
contrast, Steve lives in England and will stay at school until he is 18. He then wants
to do a full-time degree in sports science. This means he will reach the life event of
looking for a full-time job when he is about 21 years old, more than twice as old as
when Rupa starts working full-time.
Opportunities to work can vary from country to country and from region to region
within a country. In 2020, for example, Greece had the highest rate of unemployment
in the European Union (EU) at 16.7%, with Spain the second highest at 16.3%. By
contrast, the lowest unemployment rate in the EU was the Czech Republic at 2.8%
(Eurostat, 2021). These figures suggest that, other things being equal, people who
cannot find a job in Greece or Spain might decide to look for work in other EU
countries, such as Austria.
Figure 2.1 Annual unemployment rates in the EU, Dec 2020
Source: Eurostat (2021)
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2.3.2 Income
The amount of money people have coming in from earnings, benefits, a pension or
other sources and the financial circumstances of the family into which the person is
born influence the options they have at different life stages. Some life events may
be delayed compared with other people or previous generations.
Many young adults, for example, do not have the option of leaving their parents’
property to rent or buy their own home because their income is not large enough
and their family is unable to help them financially. However, their income may
increase by the mature adult stage so they may be able to rent or buy a home at a
later life stage. Similarly, people may delay getting married and having children
because of low incomes.
The Pattersons
Kyle Patterson was 24 when he
got engaged to Gail Jenkins,
then aged 23, so they were both
in the young adult life stage.
They were both working fulltime as nurses in a large general
hospital.
When
they
got
engaged Kyle and Gail wanted a
wedding reception with all their
friends and family, to buy a
house of their own and to have
two children, but they could not afford everything they wanted in the short term.
So they got married and had a small reception for close family and friends only.
They rented a one-bedroom flat for three years while they saved enough money
to put down the deposit needed to buy a two-bedroom flat. During this time,
they both studied for further nursing qualifications and were promoted to more
senior roles with better pay.
When Kyle was 27 and Gail was 26 (both in the mature adult life stage), they
bought their flat. The mortgage repayments were such a large proportion of
their joint income that Gail needed to work for another two years before they
could afford for her to take maternity leave. Their daughter Maggie was born
when Kyle was 29 and Gail was 28.
Kyle was promoted to senior staff nurse in the emergency department of the
hospital one year later and received a significant increase in pay. Kyle and Gail
decided to move to a three-bedroom house with a garden; they also agreed that
Gail would take a career break to care for Maggie full-time.
Four years later, they have two children: Maggie aged 5 and Bruce aged 3. Gail
(now 33) is hoping to get a part-time job at a local doctor’s surgery when Maggie
starts full-time school next year. Kyle (now 34) and Gail are planning a big party
for their tenth wedding anniversary, just like the reception they wanted but could
not afford when they got married. All the life events they hoped for when they
got engaged have happened. A key factor in why it took ten years to reach this
stage is their level of income.
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2.3.3 Health
People who suffer from long-term poor health or disabilities may have a shorter life
expectancy than others. They may need ongoing medical treatment and specialist
equipment and may be unable to work. In the UK, there is free or low-cost health
care available from the National Health Service, and people with medical conditions
may get an income and other financial assistance from the government through
various benefits. This support means that people with health issues can have the
best possible life expectancy and can participate in many of the same life events as
others.
Dave Lewis, for example, was born with cystic fibrosis 50 years ago. When he was an
infant his parents were told it was unlikely that he would live to be a teenager. When
he was a young adult he was warned that it was unlikely he would ever be able to
work or to have a family of his own. Yet with advances in medication and regular
physiotherapy Dave not only worked part-time as an accountant, he also got married,
had a child and held a private pilot’s licence. Now in the middle-age life stage he is
looking forward to becoming a grandfather soon.
2.3.4 Status
As a person moves through their life cycle, their social status changes, not just
because of their age but also because of the life events that they experience. To
illustrate this point, consider Sandra Bell, who is in the middle-age life stage. Different
people see her as a mother, a successful manager of a business, a home-owner and
a fundraiser for her local animal shelter. They see her husband Frank as a good
employee and as a family man who enjoys taking his children to support his town’s
football club.
People’s status within the life cycle can change, however. When Alice Martin got
married at the age of 18 she left her parents’ home. She rented a flat with her
husband Sam and instead of doing a paid job she looked after their son, Ross. Her
husband provided for her needs and she had a measure of independence. When Alice
and Sam got divorced, she became more dependent on her parents again and now
feels many of the same restrictions on her finances and personal choices as she did
when she was a teenager.
Another change that can affect an individual’s status in the life cycle is the early
death of a relative. When Luke Chan’s parents were killed in a car accident he became
a surrogate parent to his teenaged brothers and sisters. He was only 21 and so in
the young adult stage of life, yet he had to assume the responsibilities usually
associated with the mature adult or middle age stages. Another example is Greta
and Hans Schwartz, who were in the late middle age stage when they became
‘parents’ to their young grandchildren because their daughter died.
2.3.5 Unforeseen circumstances
A person’s status within the life cycle can be affected by all kinds of unforeseen
circumstances. These can be positive. For instance, an unexpected inheritance,
promotion at work or a lottery win could mean that aspirations such as starting a
business, travelling extensively or retraining for a new career can be fulfilled.
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Sometimes, however, the unforeseen circumstance is a negative one, such as those
experienced by Alice, Luke and the Schwarz family in the previous section. Even
an apparently positive change in financial circumstances, such as winning millions
on the lottery, may still have negative impacts. Family and friends may become
jealous of the winner’s good fortune and resentful if they feel the winner has not
given them enough of the money. Previously strong relationships can break down
and the winner can find themselves isolated. People can also feel concerned about
how best to manage large amounts of money to secure their future and the future
of their dependants.
Some unforeseen circumstances are linked to the economic situation, and again they
may be positive or negative. When the economy is growing, a person might be
offered a new and better job; in a period of low economic growth or no growth,
someone who is made redundant might struggle to find another job and have to
move back in with their parents. The impact of the economic situation on people’s
opportunities is discussed in more detail under socio-economic trends below. Other
unforeseen circumstances are accidents and the results of taking risks, which are
discussed below.
2.4 Attitudes to risk and financial choices
Attitudes to risk vary from person to person and can change over the stages of the
life cycle. Some people avoid taking risks in all aspects of their life. This is termed
being risk averse. Other people are willing to take more risk and this is termed being
risk tolerant. There are four categories of risk.
2.4.1 Physical risks
Physical risks include hazardous sports and activities such as parascending or
bungee jumping. They also include more subtle risks, such as drinking alcohol,
sunbathing or smoking, which have the potential to
cause long-term damage to health.
Some people are willing to take greater risks with
their personal safety than others. This attitude may
be linked to life stage, with younger people often
more willing to take physical risks than older
people. This is partly because of their physical
fitness but also because, often, they have no
dependants. Once people are responsible for others
they tend to reduce the risks they take and seek to
protect their dependants from the financial
consequences of the breadwinner or main caregiver being injured or killed. For instance, a person
who races motorbikes might want to carry on with
their sport once they become a parent but they
Often, people become less willing
might decide to take out insurance against injury or to participate in hazardous sports
death to protect their children’s financial interests. as they get older and their
responsibilities increase.
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2.4.2 Emotional risks
Emotional risks include trusting other people, such as friends, partners and spouses,
and so risking being hurt by that person. People may try to minimise the financial
consequences of these risks by, for instance, making pre-nuptial arrangements that
keep their finances separate when they marry.
2.4.3 Risk to reputation
An example of risk to reputation would be borrowing money and not repaying it on
time: the borrower’s behaviour affects the way they are regarded by other people.
This can have an impact on the amount of money that the person can borrow in the
future and at what cost. For example, Rachel White has missed the last three
repayments on her bank loan. Her bank shares this information with other providers
via her credit record. When Rachel applies for a credit card she is turned down
because she has a history of missed repayments.
2.4.4 Financial risk
An example of a financial risk would be putting money in an investment that might
fall in value, or gambling. An example is Tom Carpenter, who wanted to earn the
maximum rate of return on his money and was considering investing in company
shares. His mother warned him that there is more potential risk in buying shares
than in saving money in a safer option such as a building society account. This is
because when someone buys shares in a company they become a part-owner of that
company. The value of shares is mainly determined by how much profit the company
makes: their value can rise but they can also fall if the company is not profitable.
Tom decided that he was willing to take a risk because the return he might get on
his shares was much greater than the return offered by his building society. Three
years later, Tom’s shares had grown in value so he decided to keep them for a while
longer.
Now, Tom would like to sell his shares, but, unfortunately, the price has dropped
significantly. If he were to sell them now he would make no profit. So he decides to
keep them for a few more years to see if the share price rises again. Investment
products are discussed in more detail in Unit 2.
2.4.5 How attitudes to financial risk relate to the life cycle
People’s attitude to risk can be influenced by the stage they have reached in the life
cycle. In the Martin family case study, John Martin is concerned with the risk to his
family if he dies. So he is spending money now on a life assurance policy to protect
them from having to repay the mortgage themselves in the future.
Certain events are more likely to happen at certain stages. For example, older people
are more likely to suffer from poor health. This means that paying for health
insurance may be more important to people in late middle or old age than it is to
people in the young adult stage.
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The consequences of risks can also be more damaging at different stages of the life
cycle. Someone who loses all of their investment in a company when they are a young
adult, for example, has many potential years of earnings to rebuild their savings. If
the same loss happened to someone in late middle age, they would have just a few
working years left to save for old age.
Often, people want to take less financial risk as they move through the life stages.
Greater financial demands may be placed on them as they get older, such as being
responsible for dependent children and older relatives, and saving for their
retirement. Their attitude to risk influences their financial decisions – for example,
they may be less willing to borrow money because of the risk they may not be able
to repay it.
Some people, on the other hand, become more risk tolerant as they move through
the life stages. They may take the view that many of the situations that might have
presented a risk to them – for instance, illness, accident or redundancy – have not
arisen so far; or, if they have arisen, they have survived them. They may also have
financial arrangements in place that cater for most of their needs and so may be
more willing to take a risk with any money they have remaining.
2.5 External influences on the life cycle
The length of the various stages in the life cycle, and what happens during them, is
affected by external influences including socio-economic trends. External influences
originate from outside a person and come from the external environment in which
everyone lives. To a large extent they are beyond their control and they affect many
people. An example of a key external influence for personal financial planning is the
interest rate set by the Bank of England. This rate affects the interest rate that financial
services providers pay on savings and the amount they charge for loans. For example,
an increase in the Bank rate set by the Bank of England will mean that savers receive
more income and borrowers are charged more in repayments. Conversely, if Bank
rate is low, savers will receive very low returns and borrowing becomes cheaper. This
has an impact on people’s ability to save for life events and whether or not they can
afford to borrow money. The factors that influence the Bank of England’s decision on
interest rates are beyond the scope of this topic but are discussed in Unit 3 of DipFS.
Social trends include demographic changes, that is, changes to population size and
structure through births, deaths and migration (the movement of people to live in a
different country). Social trends also include changing attitudes and habits, such as
attitudes to work, marriage and debt.
Economic trends include periods when a country is producing and selling increasing
amounts of goods and services. This is often termed an economic boom. It leads to
a greater number of jobs being available and so to lower unemployment and a higher
income per person in the country. When a country’s production falls for two or more
consecutive quarters (that is, for six months or more), the economy is described as
being in recession. Fewer jobs are available, unemployment rises and people have a
lower income per person. Employees lose their jobs and young adults find it difficult
to find a first job. The benefits system is placed under financial pressure, so some
benefits are reduced or withdrawn. A particularly poor economic situation in one
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country will encourage people to move to another in search of better job
opportunities and a higher standard of living.
Some of the consequences of these external influences are explored below.
2.5.1 Retirement life stage
Trends in life expectancy and the age structure of the country influence when people
retire and how long their retirement stage lasts.
The typical life cycle is getting longer because each generation tends to live to an
older age than the one before. This is due to factors such as better living conditions,
better nutrition and medical advances. These improvements are not spread evenly
throughout the population, however, because life expectancy is linked to lifestyle
choices (eating, exercise, alcohol consumption and smoking) and the genes a person
receives from their parents.
On average, women live longer than
men – but both men and women born
today can expect longer life spans than
those of their great-grandparents.
According to the Office for National
Statistics, a man born around 1900
lived, on average, between 50 and 60
years. A boy born in 2010, however, has
a life expectancy of around 79 years,
while a girl’s life expectancy is 83 – and
both are rising. There are now over
14,000 people aged over 100 in the UK,
whereas, in 1911, there were only 100
(ONS, 2018). It is estimated that there
will be 110,000 centenarians by the
year 2035 (ONS, 2012).
People need to work out what their financial
needs will be after they retire.
A longer life expectancy means that people retiring now are likely to be retired for
more years than in previous generations. This means they need a source of income
for longer. Most people qualify for a state pension paid by the government once they
reach state pension age. The government funds state pensions from the taxes and
National Insurance contributions made by people who are currently working. (The
details of National Insurance are explained in Topic 12.)
By 2050, it was estimated that there would not be sufficient contributions from
working people to pay state pensions to all the people who qualify, using the current
age limits. So in October 2020, the government increased the state pension age from
65 to 66 for both men and women. The age will increase to 67 by 2028 and 68
by 2046.
People who rely on the state pension for all or part of their retirement income will
need to delay their retirement life stage until they reach the new pension age that
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applies to them. Some people may have additional pension income from other
sources. Most employees, for example, are entitled to an occupational pension
provided by their employer, subject to certain rules that will be discussed in Unit 2.
The income paid by the state pension and most occupational pensions is relatively
modest compared to earnings as an employee, so many people need to work beyond
the state pension age. According to the Department for Work and Pensions, in 2016
more than one million people aged over state pension age still worked (GOV.UK,
2016). Many of these people had simply carried on doing the same job for their
existing employer. Others had become self-employed, doing either the same type of
job (such as an accountant) or changing to a different role (such as a cleaner). Most
employers cannot force staff to retire at a specific age, although some can justify
imposing a retirement age on grounds such as safety. British Airways, for example,
sets the retirement age for its pilots at 60. In situations such as this, an employee
has to retire from their job with that employer but they can still look for work
elsewhere. Some employers prefer older staff because of their experience.
Another retirement stage trend is pensioners moving to another country to live because
of a warmer climate and / or reduced living expenses (see the case study below).
2.5.2 Migration and employment opportunities
Migration refers to the movement of people between countries. Those leaving a
country are called ‘emigrants’ by the country that they have left and ‘immigrants’ by
the country in which they settle. People now move between countries much more
than they used to in order to find work. Some countries, such as the USA and
Australia, control this movement of people through immigration laws. Within the
European Union (EU), people can move to live and work in any of the member states.
As the EU has tens of member countries, there are many people who can move to
any particular country within the EU.
Migration
Elsie and Frank moved to Spain to live in the sun
in 2014 when they were in their mid-60s. They
sold their family home in Yorkshire to buy an
apartment on the Spanish coast and a small
cottage in the Dales that they rent out to visitors.
They hoped that their living costs in Spain would
be lower than in the UK and that the sun would
encourage an outdoor lifestyle that would keep
them healthier for longer.
In the same year, Alphonso and Alejandra moved from Spain to the UK to work.
Alphonso ran his own construction company in Spain until the recession in 2008
caused the demand for new homes to reduce significantly. Alejandra taught
English to Spanish secondary school students. Now Alphonso works as a
building site foreman in London and Alejandra has retrained to teach Spanish in
an English secondary school.
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2.5.3 Lifelong learning and changes in employment patterns
Access to higher levels of education and training gives people opportunities to get
better jobs and have greater career mobility. Career mobility refers to the ability to
move between jobs and also to move from one type of job to another – for example,
to begin working life as a sales adviser for an estate agent and switch to become a
nurse. Better education and training means that people are more flexible, and can
take on different roles as the jobs that are available change.
More young adults have access to higher education now than in previous
generations, as Figure 2.2 shows.
Figure 2.2 People gaining a degree in UK
000’s
350
300
250
200
150
100
50
0
1920
1930
1938
1950
1960
1970
1980
1990
2000
2010
Source: Bolton (2012). Contains Parliamentary information licensed under the Open
Parliament Licence v1.0.
The greater demand for higher education and the economic recession have meant
that tuition fees for courses have increased. Young adults need to decide whether to
continue in full-time education or start full-time work. Their decision will be
influenced by their personal goals and their academic record, as well as financial
considerations such as tuition fees and potential earnings.
Arnav Patel, for example, has decided to become a trainee at a media company rather
than go to university to do a media studies course. He argues that he will get paid
while he is being trained and he will not have to borrow money to cover the costs of
studying. His sister, Ridhi, however, argues that getting a degree will enable her to
earn more in the future and so she has decided that borrowing money to pay the
tuition fees on an art and design course is worthwhile. As a result of their decisions,
Arnav and Ridhi will start the life stage of full-time work at different ages and may
experience different career opportunities.
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Learning is not confined
to the years a person
spends at school or
university. People have
access to a wide variety of
learning opportunities,
including
on-the-job
training, apprenticeships
and
self-study.
The
culture
of
lifelong
learning is increasingly
important as the patterns
of employment change.
When Dora Martin was
born nearly 70 years ago
it was usual for people to
stay with one employer all their working life. These days, people have less job
security but they also have far greater opportunities for job flexibility, as society
does not expect them to work for one employer or in one sector for life. People can
seek retraining and learning opportunities to take advantage of new jobs, such as
those enabled by new technology. They may take several part-time jobs and / or
become self-employed.
2.5.4 Changes to the family unit
In the past, it was not unusual for several generations of one family to live in one
family home. Nowadays, members of one family generally live in several different
homes, sometimes in the same part of the country, sometimes in different parts of
the country; some family members may live abroad. This change has come about
because people are more likely to move away from home to work, more children are
able to afford to live independently from their parents, more marriages end in divorce
and more people migrate abroad, either to find work or to retire. These changes
mean that there are more ‘single-parent’ and ‘single-person’ households where one
person is responsible for meeting household costs such as rent, groceries and power.
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Key ideas in this topic
◆ Stages in a typical life cycle.
◆ Needs, wants and aspirations.
◆ Life events and their financial requirements.
◆ Personal circumstances that impact the life cycle.
◆ Attitudes to risk.
◆ Socio-economic trends.
References
Bolton, P. (2012) Education: Historical statistics [pdf] 27 November 2012. Available at:
https://researchbriefings.files.parliament.uk/documents/SN04252/SN04252.pdf
Carvalho, N. (2010) India recognises right to education for the 6 to 14 age group, doubts remain
over minority schools [online]. 4 July 2010. Available at: http://www.asianews.it/news-en/Indiarecognises-right-to-education-for-the-6-to-14-age-group,-doubts-remain-over-minority-schools18078.html
Eurostat (2021) Unemployment statistics [online]. Available at:
https://ec.europa.eu/eurostat/statistics-explained/index.php/Unemployment_statistics
Eurydice (2013) Compulsory age of starting school in European countries.
GOV.UK (no date) School leaving age [online]. Available at: https://www.gov.uk/know-when-youcan-leave-school
GOV.UK (2016) Five facts about ... older people at work [online]. Available at:
https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeet
ypes/articles/fivefactsaboutolderpeopleatwork/2016-10-01
ONS (2012) What are the Chances of Surviving to Age 100? [online]. Available at:
https://webarchive.nationalarchives.gov.uk/ukgwa/20160105221537/http://www.ons.gov.uk/on
s/rel/lifetables/historic-and-projected-mortality-data-from-the-uk-life-tables/2010-based/rptsurviving-to-100.html
ONS (2018) Estimates of the very old (including centenarians): 2002 to 2017 [online]. Available at:
https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/ageing/bul
letins/estimatesoftheveryoldincludingcentenarians/2002to2017
UNESCO Institute for Statistics (2022) Bangladesh [online]. Available at:
uis.unesco.org/en/country/bd
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Topic 3
Payment methods
Learning outcomes
After studying this topic, students will be able to:
◆ identify key features of current accounts;
◆ distinguish between different types of card payment; and
◆ critically compare different methods of transferring money.
Introduction
Topic 1 defined money as ‘anything that is widely accepted as a means of making
payments’ and specified that ‘money’ means coins, notes (that is, cash) and the
electronic balances held in bank accounts.
This topic explores the different methods of making payments by exchanging cash
or transferring electronic balances from one bank account to another. It focuses on
the relative advantages and disadvantages of each method using the criteria of:
◆ convenience for the payer;
◆ how acceptable it is to the payee (the person or organisation being paid);
◆ speed; and
◆ safety.
The need to make payments is called the ‘transaction need’, with each payment being
a separate transaction. People are likely to have several different payment options
for any one transaction. The choice they make will be determined by the payment
methods available to them and the one they perceive to be most advantageous.
3.1 Cash
People tend to use cash for everyday, low-value transactions
when they are in face-to-face situations with the sellers.
Examples include paying for:
◆ milk and a newspaper at a local shop;
◆ a short bus or train journey;
◆ coffee / tea and snacks in cafes;
◆ tickets and drinks at a cinema;
◆ DVDs and CDs in a shop.
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Although payment cards are used in more transactions than ever before, cash is still
used in just under a quarter of UK transactions (UK Finance, 2020), though this figure
continues to fall. Cash is used by people at all stages in the life cycle, from young
children buying inexpensive toys to pensioners buying fruit from a market stall.
3.1.1 Advantages of cash
The advantages of using cash for low-value transactions are that it is:
◆ convenient for the payer (as long as they have enough notes and coins with
them);
◆ readily accepted by people selling the goods or the service;
◆ instant; and
◆ low risk at low values.
Another reason people might prefer to pay by cash is to help them budget, that is to
control the amount they spend. For example, Pat Martin withdraws £100 from her
bank account in cash every week for buying everyday items that her family needs.
There are two advantages to her of doing this:
◆ When she hands cash to the seller she is more aware that she is spending
money than when she pays by card.
◆ She knows what she can afford to spend by checking how much cash she has
left for the week.
3.1.2 Disadvantages of cash
There are many situations, however, when paying by cash is a disadvantage or is
impossible, including the following examples.
◆ The transaction is not made face-to-face with the seller – people cannot pay
by cash when they buy goods or services over the internet, by mail order or by
telephone. For example, Jenny wants to buy a necklace from a craftsperson on
the Etsy online store. This seller does not have a physical store she can visit so
Jenny must complete the transaction online.
◆ The transaction must be made on the same or similar dates every month
– paying rent or utility bills (for gas, electricity and water supplies), for example.
It is possible to make these payments with cash but it would involve visiting
the landlord or rental agent (to pay rent) or a payment point (for the utility
company). Not only might it be inconvenient to do this each month, but missing
a payment or paying late might have serious consequences. People who do this
might face additional charges; if they miss payments over a long period they
might risk having their services disconnected or their tenancy not being
renewed.
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◆ Paying by cash is less convenient than
other methods – this may be because of
the location of the seller. For example,
Kathy Martin and four of her friends want
to go to the first Saturday night screening
of the latest ‘must see’ film at their local
cinema. Demand for these tickets is high.
If Kathy wants to pay by cash she either
has to visit the cinema in advance to
secure the tickets or risk there being no
tickets available on the night. Other
payment methods, such as certain types
of payment card, enable Kathy to buy the
tickets in advance over the telephone or
online. (Payment cards are discussed in
more detail later in this topic.)
Rail tickets can be bought online in
advance, using a payment card, and
collected from a ticket machine at the
station.
◆ Carrying large amounts of cash can be
risky – most people dislike carrying large
sums of cash because of the risk of losing
it or its being stolen. Payment methods
such as cheques or debit cards (discussed below) allow people to access the
money in their bank account without the risk of carrying cash. Zack, for example,
has just paid a car dealer for a secondhand car costing £6,000. Zack paid by
cheque. It will take a few days for Zack’s bank to transfer the £6,000 from his
account to the car dealer’s bank account. Once this transaction is complete, Zack
can collect his new car from the dealership.
◆ Some sellers prefer other payment methods – some sellers prefer transactions
to be made online, by payment card or by cheque. Some offer incentives to people
who use these methods: for example, energy providers often give discounts to
people who pay electronically.
There are several reasons why sellers prefer not to be paid in cash. When people pay
in cash the seller has the responsibility of looking after the cash until it can be
deposited in their bank account; there is a risk that the money could be lost or stolen.
Sellers who are paid in cash have to pay wages to employees to process the cash –
that is, to count it, record the amounts taken, put it into bags or bundles and take it
to the bank. Larger retailers have to employ security services to transport the cash
safely. In contrast, electronic payments move the money directly from the payer’s
account to the seller’s account without the need for processing or security.
Sellers may also be suspicious of customers who wish to pay for high-value items in
cash, suspecting that the customer obtained the cash illegally. This can be an unfair
assumption, though, as people without current accounts have no choice but to pay
in cash.
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3.2 Electronic payments from current accounts
Topic 1 explained that the majority of the money in the UK is held in bank accounts
as electronic balances. The most commonly used account for making and receiving
payments is the current account. In 2013 an Office of Fair Trading report into
personal current accounts stated that there were approximately 76 million current
accounts in the UK, with 94% of adults holding at least one (OFT, 2013). Banks,
building societies and the Post Office all offer these accounts. There are different
types of current account which are designed to be used by people with different
needs and we will look at these in more detail in Topic 4. However, most accounts
have the same key payment features.
People can give their provider instructions to transfer money electronically from their
account to another account on a specific date. Instructions can be given on paper,
online or over the telephone. Instructions given on paper or online involve the
account holder completing a form for a one-off payment or to set up regular
payments from their account. These forms are often called ‘mandates’, which is
another term for an official authorisation or instruction.
There are a number of different types of electronic payment, designed to meet
different requirements.
3.2.1 Standing orders
Standing orders are instructions to pay the same amount of money to another
account on a regular basis, such as the 5th of every month. For example, Raj and
Tamsin are saving for their holiday by transferring £50 a month from each of their
current accounts into a savings account. Instead of transferring these funds
manually, they went into their branch and completed forms to set up a monthly
standing order of £50 from each of their current accounts. Their bank will follow
these standing orders until Raj and Tamsin tell them to stop making the transactions.
Using standing orders means that these transactions happen automatically with no
further action from Raj and Tamsin.
Standing orders can be set up and cancelled by giving instructions to the current
account provider in writing, over the phone or online. They can be cancelled at any
time and cost nothing, as long as the account holder has enough money in their
current account to meet the payment.
3.2.2 Direct debits
Direct debits are another type of automatic payment that can be set up for a current
account. Standing orders are for payments of the same amount of money each time,
with the money being sent from one account to another. When people set up direct
debits, they are giving permission to their provider to pay the regular bills that an
organisation will present for payment. This means that the payments can be for
different amounts of money each time.
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John Martin, for example, has signed a direct debit mandate giving his bank
permission to pay his landline telephone company from his current account. Once a
quarter (in January, April, July and October), the telephone company asks John’s bank
to pay a specific amount. The amount varies each time, depending on how many
calls John and his family have made.
Just like standing orders, direct debits can be set up and cancelled by giving
instructions to the current account provider in writing, over the phone or online, and
they are free of charge as long as there are sufficient funds in the account to make
the payment. Unlike standing orders, direct debits are protected by a guarantee. All
providers that accept instructions by direct debit agree to refund the account holder
if an error is made with a transaction.
YOURDIRECT
DETAILS DEBIT GUARANTEE (THIS GUARANTEE SHOULD BE DETACHED AND RETAINED BY THE PAYER)
THE
The Direct Debit Guarantee
I This Guarantee is offered by all banks and building societies that accept instructions to pay Direct Debits
I If there are any changes to the amount, date or frequency of your Direct Debit the ifs School of Finance will notify you 10 working
days in advance of your account being debited or as otherwise agreed. If you request ifs School of Finance to collect a payment,
confirmation of the amount and date will be given to you at the time of the request
I If an error is made in the payment of your Direct Debit, by the ifs School of Finance or your bank or building society, you are entitled
to a full and immediate refund of the amount paid from your bank or building society
- If you receive a refund you are not entitled to, you must pay it back when ifs School of Finance asks you to
I You can cancel a Direct Debit at any time by simply contacting your bank or building society. Written confirmation may be required.
Please also notify us.
When a customer sets up a direct debit, the payments are covered by a guarantee, as shown
above.
3.2.3 Online banking
Online banking enables account holders to give instructions for account transactions
via the internet. To access online banking, an account holder must first register for
the service. For example, last year Sanjay applied for online banking with his current
account provider by completing an online form. He set up passwords and pass
numbers that he can use to prove who he is. His provider sent Sanjay a unique
customer number that he uses to sign on to the online banking service. The provider
also encouraged him to download security software that stops fraudsters spying on
his internet activity. Each time that Sanjay signs on to the online banking service, he
uses parts of his password and pass numbers to identify himself.
Online banking enables account holders to set up regular payments such as standing
orders and direct debits, as well as making one-off transfers between their own
accounts and paying organisations and individuals. For example, earlier this week,
Sanjay used online banking to transfer money from his current account to his niece
Rupalli’s current account on her 25th birthday. Rupalli lives in a different town from
Sanjay so online transfer is a quick, safe and convenient way of making sure she
receives the money on time.
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3.2.4 Faster Payments
Faster Payments is an electronic payment service offered by all UK banks and building
societies. Prior to May 2008, electronic payments were made via a payment system
called Bacs. This system could take up to three business days to transfer money
electronically. The Faster Payments Service ensures that payment arrives in the
destination bank account within two hours of the provider receiving instructions,
either online, by phone or by standing order. It is free to use the Faster Payments
Service and most online payments are sent via the service automatically.
Many providers set a maximum value that can be transferred using the Faster
Payments Service, such as £10,000 per transaction, although a few providers permit
transactions up to £100,000. According to the Faster Payments Service, in the first
quarter of 2021 there were 763 million transactions with a total value of £597 billion
(pay.uk, 2021).
Sanjay used the Faster Payments Service via online banking to pay the bills he
received from the builder, plumber and plasterer who have been working on his
home.
Figure 3.1 Growth in Faster Payments transactions, 2011–2015
Source: Payments UK (2018)
3.2.5 CHAPS
CHAPS (Clearing House Automated Payment System) is a same-day automated
payment system used for very high value payments. John Martin used CHAPS when
he was buying the family home. He needed to pay £150,000 to his solicitor’s
business account as part of the purchase price. To make this transaction, John went
to his branch and completed a form for his provider. The bank charged him £25 to
make the CHAPS payment but John felt it was worth it as the transaction was
guaranteed to be secure and guaranteed to be paid into the solicitor’s business
account that same day.
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3.2.6 Mobile banking
Mobile banking enables account holders to give payment instructions on their mobile
phone using the internet. Account holders download a mobile banking app from their
provider that includes security measures. Banking apps let account holders check
balances, pay in cheques digitally, set up direct debits and standing orders, and
transfer money between accounts.
Since April 2014, customers can also use the Faster Payments Service via their
mobile, using a service called Paym. Account holders must nominate the account to
which the Paym service will be linked, and register their mobile number with their
provider (Paym, 2018).
3.2.7 Online payment services
Online payment services, such as PayPal, enable people to pay each other without
exchanging current account details. For example, Debbie wants to use PayPal to buy
goods on eBay. She starts by setting up her PayPal account and links it to her current
account. This means that she can instruct PayPal to make payments and PayPal will
withdraw the money from her current account. PayPal enables users to link their
PayPal account to a debit card or credit card as well. When Debbie wants to pay using
PayPal she instructs PayPal to pay an individual’s or organisation’s PayPal account by
giving the recipient’s email address or mobile phone number. Using payment
services like PayPal is a very safe method of paying online because sellers never see
the buyer’s personal financial details. The company also protects users from any
unauthorised payments made from their account.
3.2.8 Advantages of electronic payments
The advantages of electronic payments are that they are fast, safe and convenient to
make. Most are free of charge as long as the account holder has enough money in
their current account to make the transaction. Automated payments can be set up
to make recurring transactions; this ensures that transfers are made and bills are
paid on time without further effort from the account holder. There are different
electronic payments to meet different customer needs.
3.2.9 Disadvantages of electronic payments
The main disadvantage of electronic payments is security. Online fraud and identity
theft mean that account holders have to be very careful to follow security procedures
and keep their passwords and pass numbers safe. They also need to check their account
statements to make sure only the transactions they authorised have been made. If they
find any suspicious transactions they should contact their provider immediately.
Another disadvantage is the risk that the account holder will make a mistake. When
an account holder uses electronic payments they often enter all the payment details
themselves. An error such as entering the decimal point in the wrong place could
mean, for instance, that an intended payment of £50.14 becomes a payment of
£5,014. There have also been reports of account holders typing in the wrong
numbers for the account into which they are trying to pay money and accidentally
paying the wrong person.
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3.3 Cheques
A cheque is a payment mechanism that enables an account holder to instruct their
provider to pay a specific amount of money to a specific person or organisation.
Providers give current account holders preprinted cheque books (unless the account
holder has a basic bank account) to complete with their payment instructions.
Cheques are often used to pay money to friends or family, or to pay bills from
tradespeople such as painters and decorators. For example, Jocasta sent a cheque
to her brother Phil at Christmas so he could choose his own presents. When Phil
received the cheque he took it to his bank and paid it into his current account. His
bank then processed the cheque by creating an image of it and claimed the funds
from Jocasta’s bank, a process known as clearing. After Phil paid the cheque into his
account the money was taken from Jocasta’s current account. By 23:59 on the next
business day Phil was able to withdraw the money from his current account to buy
himself a present.
To complete a cheque, the payer writes the name of the person or organisation they wish to pay
(Phil Johnson in this example), the amount in words and figures, and the date. They must sign
the cheque, otherwise it will not be accepted.
3.3.1 Advantages of using cheques
The advantages of cheques are that they are a secure way of paying money (they can
only be paid into an account with the same name as the person / organisation
specified on the cheque). They are also easy to carry and to use. For some small
businesses, cheques are the most common way that they receive payments.
3.3.2 Disadvantages of using cheques
Although cheque imaging has significantly sped up clearing, people or organisations
that accept cheques still cannot be certain that they will receive the money
immediately. Providers cannot honour cheques (that is, make the payment specified
on the cheque) if the person who wrote the cheque does not have enough money in
their current account to pay the transaction. In these circumstances the provider
marks the cheque ‘unpaid’ and sends it back to the person who was expecting to
receive the payment (the payee). This is known as the cheque ‘bouncing’ and is very
rare, with only around 0.5% of all cheques returned unpaid each day.
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Until 30 June 2011, providers offered a cheque guarantee card that ensured cheques
up to a specific value of £50, £100 or £250 (depending on what was written on the
plastic card) would be paid, even if the person writing the cheque did not actually
have enough money in their account to cover the transaction. Since this scheme was
withdrawn in 2011, there is no guarantee of payment, so people are only willing to
accept payment by cheque from people they trust.
Some businesses, including many large retailers, refuse to accept cheques. This is
because of the risks that cheques will be returned ‘unpaid’ and because the cost of
processing cheques is far greater than the costs of processing payment card
transactions.
3.3.3 Decline in use of cheques
The disadvantages of cheques and the advantages of alternative ways to pay mean
that the numbers of cheques written and received has been falling every year since
1990. The Cheque & Credit Clearing Company (C&CCC) reports that 11 million
cheques were written every day in 1990 and that by 2013 this number had fallen to
2 million cheques each day.
In a survey the C&CCC conducted in 2019, only 29% of the UK account holders
questioned made payments by cheque. Only 33% had received payment by cheque
(C&CCC, 2019).
Figure 3.2 Fall in use of cheques by UK consumers, 2008–2014
70%
% of respondents
60%
50%
40%
30%
20%
10%
0%
2008
2009
2010
2011
2012
2013
2014
People writing cheques
People receiving cheques
Source: Cheque & Credit Clearing Company (2014)
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Given the decline in the use of cheques, the UK Payments Council announced in 2009
that cheques would be phased out by 2018. However, many individuals and
organisations protested against this proposal; the plan was also criticised by
Parliament’s Treasury select committee. Critics argued that cheques were still a
useful and important payment method, for example for those running small
businesses, and for the many older people who do not feel comfortable using
methods such as electronic payments. In 2011 the Payments Council decided that
the use of cheques would continue for the foreseeable future (Moneyfacts, 2011).
3.4 Banker’s drafts
Banker’s drafts look similar to cheques and are processed through the clearing
system. However, they are signed by the provider rather than an individual. This
means that the payment is guaranteed. Banker’s drafts tend to be used for paying
large sums of money when a personal cheque is not appropriate. For example, Claire
is buying a new car with the money she inherited from her grandmother. The car
dealer will accept a banker’s draft for the full amount and let her drive the new car
away. If Claire wanted to pay by personal cheque, the car dealer would ask her to
wait for 10 days to ensure the money had transferred before she could take
possession of the car. Claire’s provider will charge her for issuing a banker’s draft
but she is prepared to pay this additional cost for the convenience of taking
ownership of the car immediately.
3.5 Payment cards
Plastic payment cards are another payment mechanism that enables account holders
to give their provider instructions to pay money from an account. This topic looks at
cash cards and debit cards, as these are used for paying money directly from an
account. The topic on borrowing discusses credit and store cards because these
cards make a payment from the credit card or store card companies to the seller,
which the cardholder repays at a later date.
3.5.1 Cash cards
Cash cards allow account holders to withdraw cash from their account at a branch
or using an ATM. They cannot be used to pay sellers in face-to-face situations (paying
for goods in a shop, for example), over the internet or by telephone. Providers offer
current account cash cards to people under 18 years old or those on low incomes to
enable them to access their cash easily, 24 hours a day and 7 days a week from
ATMs. For example, Pete Martin, who is 16, uses his cash card to withdraw money
every week from an ATM. He very rarely goes into his bank branch because there is
an ATM at his local shopping centre. Cash cards are also offered on some savings
accounts.
Cash cards are branded as Visa or MasterCard. These two payment systems operate
computer networks that enable payments to be taken from cardholders’ accounts.
We will discuss how these payment systems work in more detail in Topic 6.
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3.5.2 Debit cards
Debit cards allow account holders to access cash from their accounts and also to pay
for goods in stores, over the internet, by telephone and by post. They work like
electronic cheques because the payment is taken directly from the account. Unlike
cheques, however, the payment is made immediately.
Debit cards are branded as Visa Debit or MasterCard Maestro or Solo. Sellers
advertise which brands of debit card they accept by displaying the brand logos at till
points and on websites. Figure 3.3 shows the transaction process.
Figure 3.3 Paying by debit card via chip and PIN
Customer inserts card
into card reader
Device reads computer
chip on card
Device instructs card
holder to enter PIN
Card reader checks PIN
entered against PIN recorded
on card’s computer chip
PIN entered matches
data on chip
PIN entered does not
match data on chip
Card reader requests
authorisation from Visa
or MasterCard
Card reader prompts
customer to re-enter PIN,
up to 3 times
Authorisation received.
Transaction complete
After third incorrect attempt,
transaction declined
Authorisation means that the seller is guaranteed to receive the payment. Sellers
therefore encourage customers to pay by debit card, even though the seller has to
pay their bank a small fee for accepting debit cards.
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Many of the larger supermarkets offer a cashback service of up to £50 (or £100 in
some stores) for debit cards. For example, Ian is at a till in his local supermarket. He
realises that he is low on cash so when he pays for his shopping he asks for £30 cash
back. The transaction made on his debit card is for the cost of his shopping plus the
£30 cash back. As the transaction is fully authorised, the supermarket is guaranteed
to receive the full payment. The supermarket cashier gives Ian £30 in cash from the
till. Using cashback means Ian does not need to go to the ATM for cash.
3.5.3 Pre-payment cards (eg Oyster card)
Pre-paid cards are like electronic purses. Cardholders load the card with money and
then use it to pay for goods or services. For example, Petra lives and works in
London. She has a pre-paid card called an Oyster card for payment for journeys on
the London bus or Tube system. To top up her Oyster card she taps the Oyster card
reader at the ticket machine and decides how much money to load onto it. She inserts
cash or her debit card into the payment machine and the money is added to her
Oyster card. Each time Petra travels by bus or Tube she touches her Oyster card to a
card reader and the cost of the travel is deducted from her card. The Oyster card
works out the cheapest rate to charge for whatever journey Petra takes. When the
balance gets low she repeats the process of loading money onto her Oyster card, or
she can set up an auto top-up, so that the balance is topped up when it falls below
a certain amount.
3.5.4 Contactless cards
Some debit or pre-paid cards can also be used for contactless payments of up to a
specified limit per transaction. This service allows cardholders to make transactions
by holding their card near a reader, rather than by inserting it into a device and
entering a PIN. The advantage of contactless technology is that transactions can be
made very quickly. Occasionally the system will request a PIN as a security check to
reduce fraud. Both Visa and MasterCard offer a contactless service on their cards and
there are over 100 million contactless cards in the UK.
Contactless cards were introduced as an alternative to cash. By 2017, billions of pounds
were being spent each month using contactless technology (Andreasyan, 2017).
Smartphones can also be used to make contactless payments. For example, Apple
Pay uses mobile technology that allows
customers with an enabled iPhone to
make contactless payments, in place of
credit and debit cards. Smartwatches
can also be set up to make contactless
payments, such as through Apple Pay
or Google Pay.
A contactless card is simply passed in front
of a card reader in order to make a payment.
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3.6 Making payments when abroad
When people travel to different countries they can pay using:
◆ cash in the local currency;
◆ a debit card;
◆ a pre-paid travel card;
◆ travellers’ cheques.
3.6.1 Using debit cards
Debit cards can be used in stores, hotels, restaurants, etc, that display the logo of
the card company, such as Visa or MasterCard. The transactions will be made in the
local currency and the provider will use an exchange rate to translate this amount
into pounds. Cardholders may be charged a fee for using their debit cards abroad.
Debit cards can also be used in ATMs to withdraw cash in the local currency.
3.6.2 Pre-paid travel cards
These are plastic payment cards that can be loaded with money and then used to
make payments in other countries, wherever sellers accept the brand (Visa or
MasterCard). They can also be used to withdraw cash at ATMs. Travelex and Caxton
FX are two of the main providers of this type of card.
Pre-paid travel cards operate like an electronic purse and can be topped up with
additional money. People can choose which currency to load onto their travel card
and are not restricted to paying in this currency because the currency can be
converted to the local currency at the point of sale. Travel cards are quick and easy
to use. They are also a safe way of carrying money when travelling. If the card is lost
or stolen the card can be blocked and the remaining balance refunded.
3.6.3 Travellers’ cheques
These are pre-printed cheques for set amounts of currency, such as 50, 100 or 500
US dollars. They can be used to pay in shops and hotels, for example, and can be
exchanged at banks for local currency. When someone buys travellers’ cheques they
must sign each one. When they want to pay using a traveller’s cheque they counter
sign the cheque. Sellers can make sure the two signatures match before accepting
the cheque.
Travellers’ cheques are easy to use, accepted by a wide range of sellers and safe. If
they are lost or stolen, the issuing company (such as American Express) will replace
them.
People usually need to show photographic identification when buying travellers’
cheques. This is to guard against money laundering, as criminals could buy travellers’
cheques with stolen banknotes that can be traced through their serial numbers, then
exchange the travellers’ cheques for banknotes with different serial numbers.
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3.7 Comparing methods of payment
The choice of payment method usually depends on:
◆ how convenient the payer finds different methods;
◆ which methods the seller accepts;
◆ how quickly the transaction can be completed; and
◆ how safe the method is perceived to be.
The Cheque & Credit Clearing Company survey conducted in 2014 asked what people
considered the most convenient method of making various transactions, as
alternatives to using cheques. Responses are shown in Figure 3.4.
Figure 3.4 Most convenient methods of making transactions (excluding cheques)
Source: Cheque & Credit Clearing Company (2014)
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The Martins: comparing payment methods
It is Sunday afternoon and Pat Martin has just driven Kathy and Pete to the local
shopping mall. Her first transaction of the day is to buy a parking ticket for
£3.50. She has two options:
◆ pay cash; or
◆ use her mobile phone to pay by debit card.
Pat decides to pay cash as she has the right coins in her purse and it is the
quicker option. Also, Pat is not comfortable using her mobile phone to make a
debit card transaction because she thinks there is a risk someone will steal her
card details.
The family have drinks and snacks in a coffee shop. Pat is buying and has three
options of how to pay:
◆ cash;
◆ debit card; or
◆ cheque.
The bill is £16.80 and she has more than £50 of cash in her purse. She wants to
save the cash for helping her children with their shopping. She could pay by
cheque as the coffee shop accepts them but she thinks it will take too long –
there is a queue of people waiting to pay. So she decides to use her debit card.
It is quick and she knows she has enough money in her current account to cover
the purchase.
Kathy checks her ‘pay as you go’ mobile phone and decides to pay £10 to topup her talk time. She has three options of how to pay:
◆ she can go into a shop run by her network and pay by cash or debit card;
◆ she can go online and use her debit card; or
◆ she can dial the top-up service from her mobile phone and use her debit card.
As Kathy wants to be able to call friends during the afternoon, she decides to
top up immediately using her mobile phone and debit card.
Pete wants to check that his allowance has been paid into his account. He uses
his cash card at an ATM to print out a mini-statement. The statement shows that
£60 was transferred into his current account from Pat’s account on Friday. Pat
has set up a standing order to pay Pete his allowance every month so it happens
automatically. This is much easier for her than paying in cash as she does not
need to remember to withdraw the money herself. She also thinks it is safer for
Pete not to carry £60 as he may lose it. While Pete is at the ATM he withdraws
£10 in cash so he can buy snacks in the following week.
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Back at home, Dora wants to make a donation to the NSPCC. She decides to
write a cheque rather than making an online donation on the charity’s website
using her debit card. Dora feels more comfortable with writing cheques than
using the internet although many of her friends use online banking regularly.
John has just signed on to his online bank. He checks that his balance is enough
to cover all the direct debits that will be made during the rest of the month. He
decides that he needs to transfer £200 from his savings account to his current
account. He could go to his branch and complete instruction forms; however, it
is much more convenient to select the ‘transfer money’ option online. It takes
just a few minutes to select the instructions he needs and to type in how much
he wants to transfer. The payment is made immediately.
Key ideas in this topic
◆ Different payment methods.
◆ Advantages and disadvantages of each payment method.
◆ When each is most suitable, depending on:
− convenience;
− which methods the seller accepts;
− how quick the transaction is; and
− how safe the method is.
References
Andreasyan, T. (2017) One in four UK card payments now contactless [online]. Available at:
https://www.fintechfutures.com/2017/01/one-in-four-uk-card-payments-now-contactless/
Cheque & Credit Clearing Company (2014) Cheques Market Research: Consumer Use of Cheques.
Cheque & Credit Clearing Company (2019) Cheques: Annual Tracking Market Research 2019 [pdf].
Available at:
https://newseventsinsights.wearepay.uk/media/fqnjbjr2/annual_tracking_market_research_2019.pdf
Moneyfacts (2011) Cheque U-turn hailed as victory for ‘common sense’ 13 July 2011.
Office of Fair Trading (2013) Review of the personal current account market [online] Available at:
https://webarchive.nationalarchives.gov.uk/20140402182200/http://www.oft.gov.uk/shared_oft/re
ports/financial_products/OFT1005rev
Paym (2018) Paym [online]. Available at: https://paym.co.uk/#
Payments UK (2018) Free industry statistics.
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pay.uk (2021) Summary of key payment statistics for Q1 2021 [pdf]. Available at:
https://newseventsinsights.wearepay.uk/data-and-insights/payment-statistics-overview/
UK Finance (2020) UK payment markets summary 2020 [pdf]. Available at:
https://www.ukfinance.org.uk/system/files/UK-Payment-Markets-Report-2020-SUMMARY.pdf
© The London Institute of Banking & Finance 2022
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Topic 4
Everyday banking
Learning outcomes
After studying this topic, students will be able to:
◆ identify the key features of different types of current account; and
◆ begin to evaluate lifelong financial planning by understanding that people’s
everyday banking needs change as they pass through the various life stages.
Introduction
As we saw in Topic 3, current accounts
enable people to use a range of payment
methods. For example, people use current
accounts to make and receive payments by
electronic transfer, standing order and
cheque. Payments out of an account are
recorded on bank statements as debits,
while payments into an account are called
credits. These include direct credits, which
are used by organisations to make
electronic payments of salaries, pensions,
state benefits and tax credits into current
accounts.
People also use current accounts to
store money, and some providers offer
interest on balances. People can borrow Current accounts have different features, such
from their current account, too, using as text alerts to warn the account holder when
an overdraft facility, which we discuss in their balance falls to a certain level.
more detail in Topic 6.
4.1 Choosing a current account
Most adults use a current account for their everyday banking needs, such as receiving
payments, storing money for short periods of time, making payments and accessing
cash. There are current accounts designed for people aged 11 and over and others
that are only available once people are 18 because they include the facility to apply
for overdrafts. Young people often use a savings account for everyday banking
because their main requirements are to store money and withdraw cash.
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Choosing a suitable current
account 1
Cheryl is 15 years old and needs an
account to store the money she earns
from babysitting, her allowance from
her parents and occasional financial
gifts from relatives. She wants to be
able to withdraw cash easily, pay for
goods in shops and for her money to
earn interest until she needs it. Cheryl
decides on a current account
designed for young people aged 11–
18 that pays interest of 0.10% AER on credit balances. It offers her a debit card
to withdraw cash in branch and at ATMs and to pay for goods in shops (provided
she has sufficient funds in her account). It also offers online and mobile banking
with text alerts if her account balance is low.
Cheryl’s brother Jason is 14. He prefers to pay for everything in cash and to
earn a higher rate of interest on his money so he uses a savings account for
everyday banking. Jason’s savings account is designed for people from birth up
to the age of 15. It pays an interest rate of 1% AER, offers a cash card for savers
aged 7 and over and unlimited withdrawals.
When people choose a current account they look for an account that matches their
everyday banking needs – for example, to be able to make automated payments such
as direct debits and to bank online. Some current accounts are free to use as long as
the account is in credit; for others, people have to pay a fee because extra services
are available with the account.
Current accounts are available from banks and building societies. They are also
available from retailers such as Marks and Spencer, which offers packaged accounts
operated by M&S Bank, a wholly owned subsidiary of HSBC. This means that M&S
bank branches are open whenever the stores are open, including on bank holidays.
Tesco also offers current accounts through its wholly owned subsidiary, Tesco Bank.
All current accounts offer regular statements online or on paper to enable people to
monitor their transactions. Other facilities vary from account to account. Paper
statements are increasingly unpopular, with many customers preferring online or
mobile statements and choosing to go ‘paperless’.
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4.2 Different types of current account
There are a number of different types of current account including:
◆ standard current accounts, offering a full range of payment methods including
debit card and cheque book;
◆ packaged accounts, which charge a fee for including additional services with the
account, such as travel insurance and car breakdown cover;
◆ basic bank accounts, which offer a debit card and/or cash card but no overdraft
or cheque book;
◆ student accounts, often with an interest-free overdraft;
◆ youth accounts (for people under 18 years old); and
◆ premium accounts (for wealthy customers).
Figure 4.1 Types of current account, 2011
2% 1%
1%
Standard – 67%
3%
Packaged – 17%
9%
Basic – 9%
Student – 3%
17%
67%
Youth – 2%
Premium – 1%
Other – 1%
Source: Office of Fair Trading (2013). Contains public sector information licensed
under the Open Government Licence v1.0.
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4.2.1 Basic bank accounts
A basic current account suits people who wish to avoid borrowing, such as those living
on benefits or low incomes or people who have not held a current account before. This
type of account usually offers a debit card or a cash card but not an overdraft or a
cheque book, thereby limiting the possibilities of getting into debt. Most basic current
accounts can be operated free of charge; however, people with a history of fraud or
who are bankrupt may need to pay a set-up charge and / or a monthly service charge.
People may choose to operate basic current accounts using cash cards or pre-paid
cards. Pre-paid cards can be loaded with funds from the account and then used to make
purchases anywhere that the card brand is accepted. Most basic current accounts offer
direct debits and standing orders to pay bills. Providers will not make these payments,
however, if the account does not have sufficient funds to pay the transaction. This type
of account would suit Alice Martin, who is currently unemployed.
Basic bank accounts were introduced in 2004 as part of the government’s plans for
financial inclusion – that is, ensuring that people have access to banking services.
The government agreed a ‘shared goal’ with the main high street banks to halve the
number of people without bank accounts by 2009. Research quoted in the HM
Treasury report, ‘Realising banking inclusion: The achievements and challenges’
(Ellison et al, 2010) identified that people without a bank account are disadvantaged
in a number of ways. One of the key problems is that they cannot pay by direct debit.
As a result, they are unable to take advantage of any services that require regular
electronic payments, such as mobile phone contracts or internet access. They pay
higher energy costs because they use pre-paid meters rather than direct debits:
energy companies often offer discounts to people who pay by direct debit. They also
cannot make payments over the telephone or online.
In 2004 approximately 2.7 million people in the UK did not have a bank account. By
2010 1.1 million of these people had opened a bank account, with 7 in 10 of them
opening a Post Office Card Account. The Post Office’s contract with the Department
for Work and Pensions will cease in November 2022, however, which means these
individuals will need to change accounts.
According to the Office of Fair Trading’s 2013 report into current accounts, in 2011
9% of active accounts in the UK were basic bank accounts. An active account is one
that has had a transaction within the last three months.
Figures from 2016 show an increasing number of basic bank accounts on offer across
36 banks (Defaqto, 2016).
4.2.2 Youth accounts
Youth current accounts are available for people aged under 18 years old. These
current accounts do not offer overdraft facilities because people need to be aged 18
or over to enter into a contract to borrow money. Youth current accounts offer a
range of services, depending on the account and the age range of the intended
account holders. For example, cash cards, debits cards, standing orders and direct
debits, a cheque book, online banking, mobile banking and text alerts are often
available on accounts for people in the 16–19 age group, while accounts for those
aged 11–15 often offer cash cards or debit cards.
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The Office of Fair Trading (OFT) 2013 report on current accounts identified that just
2% are youth accounts. This is probably because many young people use savings
accounts to manage their money instead of current accounts. People often get their
first current account when they start work and their employer wants to pay them
electronically.
4.2.3 Standard current accounts
Standard current accounts offer the full range of current account facilities, such as
receiving payments, a cash card or debit card, direct debits, standing orders,
overdraft, cheque book, online banking, mobile banking and text alerts. Standard
current accounts are usually free of charge unless the account holder uses the
overdraft facility or requests services that incur a charge, such as another copy of
their statement.
Standard current accounts suit most people who wish to pay bills by direct debit,
manage their money using a variety of communication channels and borrow money
for short periods of time. Text alerts can be particularly useful to tell account holders
when their balance is low so they can avoid going overdrawn. According to the Office
of Fair Trading’s 2013 report, 67% of the current accounts used in the UK are
standard accounts.
4.2.4 Student and graduate accounts
These accounts are variations on the standard current account tailored to the needs
of students in higher education and recent graduates. The key features are a lowinterest or no-interest overdraft facility and incentives such as discounts on contents
or travel insurance policies. Providers wish to attract students to their current
accounts as some will be high earners in the future. Student accounts make up
3% of the current accounts used in the UK, according to the Office of Fair Trading’s
2013 report. This is
probably because
student
current
accounts are only
available to people
who are studying.
Once their course
ends, graduates will
switch to other types
of current account.
Once students graduate,
they need to switch to a
graduate or standard
current account.
© The London Institute of Banking & Finance 2022
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4.2.5 Interest paid when in credit
Some current accounts may pay interest on credit balances. An example is the
FlexDirect account from Nationwide Building Society, which pays interest at 2% AER
fixed for a year on £1,500, before dropping to 0.25% in the second year (Nationwide,
no date).
There are usually conditions attached to these current accounts, such as paying in a
minimum monthly amount, keeping the account in credit, or banking online or by
telephone. Interest is paid on balances between certain minimum and maximum
amounts. There may also be fees for holding the account.
People who usually have a budget surplus may find these accounts suit their needs.
Caution is required, however, as going overdrawn on these accounts can incur
charges that are greater than the interest or reward paid. Further, some accounts
require a minimum balance to be maintained, such as £1,000, and people may find
that their surplus can earn higher AERs in savings accounts that have fewer
withdrawal restrictions.
4.2.6 Joint accounts
Joint current accounts are held by two or more people. Most types of current account
can be held in joint names. Joint accounts suit people who share finances, such as
married couples and those in civil partnerships, and people sharing a rented home.
John and Pat Martin, for example, might wish to consider opening a joint account to
pay for household bills.
A joint account is probably not suitable for people who have different priorities or
attitudes to managing money. If they wish to pool some incomings in a joint account
to pay for joint outgoings, account holders may wish to draw up clear rules for how
the account will be operated and who will be responsible for managing it. The
provider will need to know who can withdraw funds from a joint current account,
and if a signature is required from more than one of the account holders to make a
withdrawal. If joint accounts become overdrawn then all account holders are
responsible for repaying the full amount. In some circumstances providers can take
money from one person’s account to repay the overdraft on a joint account that bears
their name.
4.2.7 Packaged accounts
Packaged current accounts offer account holders extra benefits for a monthly fee.
Benefits may include mobile phone and travel insurance, car breakdown cover,
discounts in stores and subscriptions for media services. The account fee can vary
from £2 to £20 or more per month, and the benefits vary from account to account.
According to the Office of Fair Trading’s 2013 report, 17% of UK current accounts
are packaged accounts.
People may find packaged accounts suitable if the costs of the benefits they will use
are greater than the annual account fee. For example, Tabita is considering a
packaged account that provides mobile phone cover, travel insurance and car
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breakdown cover; it has a monthly fee of £20, meaning that she would pay £240 per
year. Her house contents insurance includes mobile phone cover, so she does not
need that benefit. She rarely travels so does not need the travel insurance that is
included. This means that the only benefit she would use would be the car breakdown
cover and she can buy that for far less than £240 per year. Tabita decides against
the packaged current account. Her friend Philippe has different personal financial
circumstances. He has family in France and regularly takes his wife and children to
visit them. He would use the European car breakdown cover and family travel
insurance offered by the packaged account. The account fee is cheaper than if he
bought these two insurances separately, so the packaged account represents good
value for money for him.
4.2.8 Premier accounts
Premier accounts are designed for wealthy customers and offer a range of additional
services, such as a personal banker to help account holders manage their finances
and banking products. Account holders have to have a certain level of income and /
or funds to save or invest to be eligible for premier accounts – for example, earnings
of £75,000 or more. According to the OFT report, only 1% of UK current accounts
are premier accounts.
Choosing a suitable current account 2
Fred lost his job last year and has been unemployed ever since. He closed his
standard bank account and opened a basic account instead to help him manage
his low income. The advantage of the basic account is that he is unlikely to get
into debt because his provider will generally not pay transactions unless he has
enough money in his account. Fred chose an account with a popular high street
bank as he is prepared to move anywhere in the country to get a new job and
there should be branches in or near most locations.
Fred’s sister Tina has been married to Brian for two years.
They each have a current account in their own name and
they have a joint account for their rent. Tina chose a
standard current account with her building society. Her
employer pays her salary into this account by direct credit
and Tina then pays £300 per month into the joint account
by standing order. She also pays for some of the household
expenses from her current account. For example, she has
set up direct debits to pay for the gas and electricity bills.
Tina does most of her banking online.
Brian chose a packaged current account from a bank for his sole account. He
also receives his salary by direct credit and pays £300 per month into the joint
account by standing order. He also pays bills by direct debit. The reason why
Brian chose a packaged account was that the discounts on car breakdown cover
and home insurance were larger than the account’s annual fee. Brian also finds
the mobile banking service useful for checking his account.
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4.3 Opening an account
Before anyone can open any new account, including a current account, they must
supply the provider with proof of their identity and address. This requirement is
designed to prevent money laundering and is set out in the Money Laundering
Regulations 2007. Money laundering is the term used to describe the ways in which
criminals can use accounts to hide the source of their funds (for example, drugdealing) and to make payments in support of their activities (for example, terrorist
activities). Providers who do not follow the legal requirements face heavy fines. For
example the Financial Conduct Authority (FCA) has previously fined a private bank
£4.2 million for failing to take reasonable care to establish and maintain effective
anti-money-laundering controls over a period of more than three years (FCA, 2013).
Providers need separate proof of identity and address so one document cannot be
used to prove both. When people show providers their documents in branch, the
documents must be originals rather than copies or print-outs from internet sites.
Photographic identification documents such as passports and UK drivers’ licences
must be current – the provider will not accept them if they have expired. If people
apply for an account online, they may be asked to send documents by post, show
them to the local branch or upload
copies online. Posted documents can
sometimes be photocopies, especially if
they are signed by a professional such as
a lawyer, accountant or doctor to confirm
that they are true copies of the originals,
and that the person signing has seen the
originals. Applicants need to check with
their provider which documents are
accepted as it can vary from provider to
provider and account to account.
According to the former British Bankers’ Association (BBA) the following are often
accepted by providers as proof of identity or a UK address:
◆ gas, electricity, water or phone bill that is less than three months old;
◆ council tax bill issued within the current financial year;
◆ driving licence issued in the UK (photo card and full paper counterpart with
current address);
◆ current passport;
◆ employer’s ID card if the employer is known to the provider;
◆ pension or other social security book;
◆ medical card;
◆ HMRC documentation;
◆ insurance certificate issued in the last 12 months; or
◆ mail order statement that is less than three months old (BBA Enterprises, 2009).
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People who are on benefits, who are young or who do not pay bills can find it difficult
to prove their identity and address because often they do not have the types of
document required. In these cases, providers will accept other documents: for
example, people on benefits might use an entitlement letter issued by the
Department for Work and Pensions (DWP), HM Revenue and Customs (HMRC) or a
local authority, or an identity confirmation letter issued by DWP or a local authority.
Young people may be able to use birth or adoption certificates as proof of identity;
they would also need a confirmation letter from their school / college / university /
care institution or their employer, stating their name, address and details of their
educational or employment status. This letter needs to have been issued in the last
12 months. Students may be able to use their UCAS letter. For some accounts
designed for very young children, the parents’ or guardians’ identification and
address details are taken instead.
Providers can refuse an application to open an account. This may happen if the
provider thinks that the applicant would not be a profitable customer. Providers can
also suggest that people open a different type of account. For example, George
applied to open a standard current account. The provider checked George’s history
and discovered that he had had problems repaying money he owed. The provider
suggested that George open a basic current account but said that it would review
his account in six months’ time.
4.4 Monitoring transactions
It is important that people check their current accounts to ensure they have sufficient
money to pay transactions that are due, that they are keeping to their budget and
that mistakes have not been made. People can use statements that are provided
online, on paper and via ATMs to monitor their transactions. Statements are usually
provided once a month for current accounts, unless very few transactions are made,
in which case they may be provided less frequently.
Statements often use abbreviations to describe transactions, and each provider can
devise its own. For example, money paid in by electronic transfer may be referred to
as a DC (direct credit), Bacs transfer (Bacs is the central payment system used to
process several different types of electronic payment, especially direct credits) or
BGC (bank giro credit). Direct debits may appear as DDR, DD or BD. Providers usually
explain the codes on the statement and / or on their website or current account
literature.
Cheques will usually appear as the number of the cheque. It is therefore very
important that people write the details of the payee on their cheque books so they
know where the money has been paid.
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Checking a current account statement
Here is one of Tina’s statements.
Date
Details
Payments
– debits
03 Feb Balance from previous statement
Receipts
– credits
Balance
1,500.25
1,567.43
67.18
04 Feb DCR Kite and Raglan plc
06 Feb SO Joint account
300.00
1,267.43
06 Feb Cheque 203108
25.00
1,242.43
07 Feb Cash Wdl ATM, Old Town
100.00
1,142.43
07 Feb DCD Supermarket, Old Town
125.98
1,016.45
10 Feb DCD Always Petrol, Old Town
32.98
983.47
12 Feb Cheque 203109
13.50
969.97
13 Feb Cheque 203110
102.78
867.19
14 Feb Cash Wdl ATM, Old Town
150.00
717.19
14 Feb DCD Supermarket, Old Town
67.14
650.05
18 Feb DD Gas Company
26.00
624.05
18 Feb DD Electric Company
71.67
552.38
20 Feb DD Local charity
3.00
549.38
21 Feb Cash Wdl ATM, Old Town
100.00
449.38
24 Feb DD Mobile phone
41.10
408.28
25 Feb OP Credit Card
107.53
300.75
25 Feb DD Water Company
28.90
271.85
21 Feb Cash Wdl ATM, Old Town
100.00
171.85
28 Feb DD Landline and broadband
35.00
136.85
28 Feb DCD Supermarket, Old Town
72.39
64.46
28 Feb XF to Savings
50.00
14.46
DCD = Debit card, DCR = Direct credit, DD = Direct debit, SO = Standing order, OP = Online
payment, Wdl = Withdrawal, XF = Transfer
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When Tina receives her statement she checks each
entry to make sure it is what she expects. From her
cheque book she can tell that cheque:
◆ 203108 was sent to her brother Fred to help
him pay for groceries;
◆ 203109 was her share of the bill in a café when
she went out with friends; and
◆ 203110 was paid to a plumber who repaired a
leak from her hot water pipe and serviced the
boiler.
From her ATM receipts, Tina can check that each cash withdrawal is correct. She
has not paid any fees for withdrawing cash using her debit card because she
always uses ATM machines that belong to the LINK network. These machines
are free for customers of her building society. She withdrew more cash than
usual on Valentine’s Day because she wanted to buy a present for Brian.
Tina has set up a mobile alert that tells her when her balance goes below
£100.00. This alert was triggered on 28 February when she paid £72.39 at the
supermarket in Old Town. Her balance at the end of February is just in credit at
£14.46. Her employer, Kite and Raglan plc, pays her on the first Tuesday of the
month so she is expecting her next salary to be credited to her account on
4 March.
Tina has set up her standing orders and direct debits to be paid after she has
received her salary. She aims to transfer some money to savings every month
but does this manually online as the amount varies from month to month.
4.5 Switching and closing accounts
Providers offer a free service for switching between accounts at different providers.
This is discussed in more detail in Topic 7. They also offer a free switching process
between accounts held at one provider – for example, students may switch from
student current accounts to graduate accounts at the end of their course and from
graduate accounts to standard current accounts after about three years.
People who want to close their current account can do so at any time and at no cost,
although they must pay any fees and other money that they owe. They do not need
to give a reason, although many providers will ask, for marketing research purposes.
People need to return their payment cards and cheque books when they close their
account. The provider may need to delay closing the account if there are automated
payments due or cheques written on the account that have not been presented for
payment. People will need to tell the provider where to pay the balance on the
account – for instance, by a cheque made payable to the account holder or a transfer
to another account.
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65
Sometimes a provider will close a current account, for example if the customer no
longer meets minimum deposit criteria. In these cases the provider must give at least
two months’ notice.
Key ideas in this topic
◆ The different current accounts available and the different customer
requirements they are designed to meet.
◆ How to open an account.
◆ How to use statements to monitor transactions on an account.
◆ How to close an account.
References
BBA Enterprises (2009) Proving your identity [pdf]. Available at:
https://www.bsa.org.uk/BSA/files/dc/dca9a4a8-df89-47a3-aa26-95c0c111905b.pdf
Defaqto (2016) A review of personal current accounts [pdf]. Available at:
https://www.defaqto.com/siteassets/corporate-section/2016-releases/current-account-report--06062016.pdf
Ellison, A., Whyley, C. and Forster, R. (2010) Realising banking inclusion: the achievements and
the challenges. HM Treasury.
FCA (2013) FCA fines EFG private bank £4.2m for failures in its anti-money laundering controls
[online]. Available at: http://www.fca.org.uk/news/efg-private-bank
Nationwide (no date) FlexDirect current account [online]. Available at:
https://www.nationwide.co.uk/current-accounts/flexdirect/
Office of Fair Trading (2013) Review of the personal current account market [online]. Available at:
https://webarchive.nationalarchives.gov.uk/20140402182200/http://www.oft.gov.uk/shared_of
t/reports/financial_products/OFT1005rev
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Topic 5
Savings products
Learning outcomes
After studying this topic, students will be able to:
◆ differentiate between different financial services products for savings; and
◆ begin to evaluate lifelong financial planning, by understanding that people’s
savings needs change as they pass through the various life stages.
Introduction
This topic focuses on saving for the immediate and short term: time frames of a few
days to two or three years. Saving for the longer term, including making investments
by buying items such as stocks and shares, property and art, or by paying into a
pension, is covered in Unit 2.
People save so that they have the funds to pay for goods and services in the future.
Savings are therefore ‘delayed spending’. The future payments may be for:
◆ needs – such as paying a deposit on a rented flat;
◆ wants – items that savers cannot afford on a day-to-day basis, such as a computer;
◆ aspirations – goods or services that they would like to have or to experience in
the future, such as a holiday.
People may be motivated to save by wanting to buy a specific good or service.
Another important reason why people save is because they feel safer if they have
money to pay for unexpected
What is the
expenses or have surplus
rate of return
income (that is, they have some
(how much
interest will
of their income left after paying
Is the rate
I earn?)
for their usual spending).
How safe
When choosing a savings
product, people need to
consider the factors shown in
Figure 5.1. This topic explores
each of these factors.
Figure 5.1 Factors to
consider when choosing a
savings product
of return
higher than
inflation?
will my
savings be?
How will
I operate the
account online,
with a passbook, etc?
© The London Institute of Banking & Finance 2022
Choosing
a savings
product
How regularly
will I want to
save?
Will I have
to pay tax on
the interest
my savings
earn?
How often
will I be able
to withdraw
money?
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Savings products are available from a range of providers such as banks, building
societies, credit unions and friendly societies. These providers use the money
deposited in savings accounts to lend to borrowers. The difference between the higher
interest charged on loans and the lower interest paid on savings contributes to the
provider’s income. How providers earn money is explored in more detail in Topic 6.
The Martins: savings
People save at each stage of the life cycle, as the Martin family demonstrate.
Ross (aged 4) saves money in a piggy bank. Pat pays Ross his pocket money
every Saturday and Ross’s mother, Alice, keeps the cash in a separate purse for
him. Every Friday he puts any money that is left over into his piggy bank. If he
wants a toy and there is not enough money in his pocket money purse, Ross
and Alice open the piggy bank and use the money from his savings to make up
the difference, if possible. Sometimes Ross has to wait longer for his toy or
choose a cheaper option.
Pete (aged 16) is saving for a camera and has set himself a deadline of six
months. He knows the asking price of the camera he wants and has calculated
how much he must save from his allowance to accumulate this amount of money
in six months’ time.
Kathy (aged 19) is saving for the deposit and household items she will need
when she moves into a rented flat next year.
Alice (aged 23) does not have enough income to save money. If she has any
surplus money when her next unemployment benefit is paid, she keeps it in her
current account until she needs it. Alice makes saving decisions for Ross and
has opened a building society savings account for the money he receives as gifts
and any money left over from the Child Benefit she receives for him.
Pat (aged 43) is unable to save at the moment because most of her income is
spent on groceries and clothes for the family, and on allowances for Kathy, Pete
and Ross. Any surplus she has, she uses to help Alice. This situation will change
next year, however, when Kathy leaves home. Pat would like to save for her
retirement.
John (aged 45) saves about £250 per month for gifts and emergencies. Last
month, for example, he used some of his savings to replace badly worn tyres
on his car. The balance on this savings account is only £50 because he also
needed to buy birthday gifts for his sister. John is also paying into a pension to
provide an income for him and Pat in retirement. He has just received an
inheritance of £4,000 from an uncle’s estate.
Dora (aged 68) has a savings account for her funeral expenses. She also saves
whenever she has a surplus from her pension so she can buy gifts and treats for
her family.
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5.1 Return on savings
The return on savings is the interest that the provider pays the account holder and
is expressed as an annual equivalent rate (AER), such as 2.2% AER. The AER is the
interest that will be earned on the money in one year and takes into account how
often the provider pays the interest (for example, monthly or annually), the effect of
compounding the interest and any fees and charges. All providers must use the same
formula to calculate the AER they quote in advertising so that people can compare
the return on different savings products. This formula is set out in the Code of
Conduct for the Advertising of Interest Bearing Accounts published jointly by the
former British Bankers’ Association and the Building Societies Association.
When comparing the return on savings it is important that people compare like with
like, for example AERs or gross figures (before income tax). Some provider adverts
show a ‘headline’ interest rate using a large font. Potential savers need to explore
what this headline rate means before making a decision about which account to use.
For example, Figure 5.2 shows two adverts for savings accounts. The Dale Bank
savings account has a headline rate of 2.15% compared with a headline interest rate
of 0.95% on the Hill Bank Saver; it looks as though Dale Bank’s account offers more
than double the return offered by Hill Bank. However, the Dale Bank headline rate
includes a first year bonus of 1.75%. This means that from year two onwards the
saver receives 0.4% AER on their savings. Hill Bank Saver pays 0.95% gross every year.
To get the greatest return on their savings, people could save with Dale Bank for one
year and then switch to the Hill Bank Saver.
Figure 5.2 Example adverts for savings accounts
Dale Bank
The Hill Bank Saver
Our savings account
pays a generous
0.95% p.a.
2.15%
*
* AER including first year bonus of 1.75%
© The London Institute of Banking & Finance 2022
A safe haven for your family’s
savings with instant access
and great interest rate*
* AER gross
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Providers set the AER on a particular product in relation to the Bank of England’s
Bank rate and the savings rates offered by other providers in the market. The Bank
of England uses the Bank rate to control the interest rates that providers offer on
both savings and loans and so to control the rate of inflation. The Monetary Policy
Committee (MPC) of the Bank of England meets regularly to consider whether to
change the Bank rate. Bank rate was held at the low level of 0.5% from March 2009
to August 2016, when it was lowered again to 0.25%. After increasing slightly, it was
lowered to 0.1% in March 2020 in response to the economic shock caused by Covid19, ie coronavirus. In December 2021 it was increased for the first time in three years
to 0.25%. Figure 5.3 illustrates how much Bank rate has changed over time. In 1991
Bank rate varied between 10.38% and 13.38%.
Figure 5.3 UK Bank rate, 1975–2021
Source: Bank of England (no date a)
A low Bank rate means that savers receive low returns on their savings. The theory
is that this will encourage people to spend rather than to save and so ease the
recession. The effects of economic conditions such as recession or boom are
discussed in more detail in Unit 2.
There are a number of factors that impact the return offered by providers.
5.1.1 The amount of money that is saved
In general, larger sums of money earn higher rates of return. For example, Tom is
receiving 0.10% AER on his savings of £500 while Kevin has savings of £1,000 in the
same type of account and earns 1.50% AER. Usually, a minimum amount has to be
deposited in order to open a savings account, but this can vary from as little as one
pound to thousands of pounds.
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5.1.2 How often money is saved
People can usually achieve higher rates of return on their savings by saving a specific
amount each month. For example, Cho saves £100 a month in a regular saver
account that pays 1.35% AER. If he chose to save the money in an account with the
same provider that was not designed for regular deposits he would earn only 0.45%
AER on his savings.
5.1.3 How long the money is saved
The longer the term that the savings are held, the higher the interest rate tends to
be. For example, Claire has a six-month fixed savings bond that pays 1.30% AER
while her sister Diane has the two-year version of the product, which pays 2.10% AER.
Their older sister Rebecca has the four-year version of the product, paying 2.40%
AER.
There are different categories of savings account:
◆ Instant access accounts – a saver can withdraw money immediately from these
at any time with no charge.
◆ Notice accounts – a saver has to give notice, that is, to advise the provider a set
amount of time before withdrawing money. Notice accounts usually pay higher
AERs than instant access accounts. Failing to give notice usually results in the
loss of the interest earned during the notice period – for example, if the notice
period is 90 days, a saver who did not give notice would lose 90 days’ worth of
interest.
◆ Fixed period accounts or bonds – these products pay a fixed AER for a set period
of time, such as six months or two years. The provider may allow only limited
withdrawals or no withdrawals during the term. These products usually pay higher
AERs than instant access accounts and notice accounts with shorter terms.
One advantage of fixed period accounts or bonds is that the fixed rate of return
means savers know what the AER will be throughout the life of the product. Products
that are instant access or notice accounts usually have variable interest rates that
move up and down with changes in the Bank rate. Savers are therefore uncertain
about how much interest the provider will pay over the long term.
5.1.4 The number of withdrawals the saver can make
Savings accounts called ‘instant access’ or ‘easy access’ allow as many withdrawals
as the saver wants, whereas some accounts are called ‘restricted access’ and only
allow a certain number of withdrawals to be made each year. For example, Will’s
savings are earning 0.50% AER in an instant access account while Ted’s savings are
earning 2.00% AER from the same provider in a product that allows a maximum of
five withdrawals per year.
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5.1.5 The account application and operation channels
Accounts that the customer applies for and operates online tend to offer higher rates
of return than accounts that are operated by a passbook in a branch, or by cash card,
telephone or post. This is because the customer does most of the administrative
work themselves when operating a product online (such as typing in their name and
address details and transferring funds between accounts). Providers have to pay the
costs of running branches and paying staff for customers who want to go into a
branch. For example, Polly has an instant access savings account operated by cash
card in branch that pays 0.10% AER while Heather’s savings earn 0.45% AER in an
instant access online-only account with the same provider.
5.1.6 The tax status of the account
In the March 2015 Budget, the Conservative–Lib Dem coalition government
announced changes to the way that savings interest is taxed. (See section 5.3 for
more information about tax on savings interest.) The interest earned on some
accounts is tax-free while on other accounts the saver must pay tax on any interest
that exceeds their ‘personal savings allowance’.
5.1.7 Introductory bonuses
Some savings accounts have fixed introductory bonuses that boost the return in the
first year of the account. Earlier we looked at the example of Dale Bank (Figure 5.2).
Another example is Tai’s savings account, which pays 1.70% AER in the first year.
This includes a fixed 1.19% bonus for the first 12 months. After the first year, her
savings will earn 0.51% AER. Tai makes a note in her calendar to transfer her savings
after one year to an account with a higher return.
5.2 Impact of inflation
Topic 1 explained that inflation – that is, a general rise in the price of goods and
services – affects the purchasing power of money because £100 in one year’s time
buys less than £100 buys today. Savers need their money to earn an AER that is the
same as the rate of inflation to maintain the purchasing power of their money. If the
AER is higher than inflation, the real value of their savings will grow because its
purchasing power is increasing. People can find out the current rate of inflation at
the Bank of England website www.bankofengland.co.uk.
The Bank of England is tasked with managing inflation to meet the government’s
target of 2.0%. Two indices are used to measure inflation:
◆ the Consumer Prices Index (CPI); and
◆ the Retail Prices Index (RPI).
The CPI is used to measure the inflation rate managed and quoted by the Bank of
England.
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Both the CPI and RPI measure inflation by calculating the average change in prices of
a basket of goods over a 12-month period. An inflation rate of 1.8%, for example,
would mean that overall prices were 1.8% higher than they were 12 months ago.
Tablet computers are a recent addition to the basket of goods used to measure inflation.
The basket of goods used as the basis of the CPI or RPI is made up of around 700
consumer goods and services that represent the spending patterns of UK
households. Around 180,000 separate price quotations are used every month from
150 areas of the country to compile the indices. The prices are then weighted
according to the pattern of UK household spending, so if one good represents 10%
of an average household’s spending then it is weighted as 10% of the basket.
Goods and services are regularly added to and removed from the basket to reflect
current spending preferences – for example, coffee pods and microwavable rice were
added in 2016, half-chocolate-coated biscuits were added in 2017, body moisturising
lotion was added in 2018, smart speakers were added in 2019, and gluten-free
breakfast cereal was added in 2020, while during that time gloss paint, organic
apples and sliced turkey were removed (ONS, 2014; ONS, 2015; ONS, 2016; ONS,
2017; ONS, 2018; ONS, 2019; ONS, 2020).
The main difference between CPI and RPI is that RPI includes mortgage interest
payments and other owner-occupier costs, while CPI does not.
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Inflation caused prices to increase considerably over the 53 years between 1955 and
2008. Table 5.1 shows how much people needed to spend in 2008 for every £1 spent
on a good or service in 1955.
Table 5.1 Spending needed in 2008 for every £1 spent in 1955
Rail fare
£47.01
Petrol
£24.75
Football ticket
£85.52
Cooker
£10.64
Rent
£47.37
Haircut
£44.26
Gas
£22.73
Electricity
£30.80
Source: Bank of England (no date b)
Since 2008 prices have continued to increase. For example, private rents averaged
£153 per week in 2008–2009, compared with £201 per week in 2019–20 (GOV.UK,
2020). The average annual domestic electricity bill rose from £539 in 2010 to £696
in 2020 (Statista, no date).
Table 5.1 illustrates that the prices of different goods and services grow at different
rates over the period and that an inflation rate is an average across a wide range of
goods. The causes of inflation, such as a greater demand for goods and changes in
wages, are explored in Unit 2.
5.3 Taxation
Since April 2016, providers pay all interest on savings accounts gross (before tax)
and savers pay any income tax they owe. Savers have a ‘personal savings allowance’
for the amount of savings interest they receive before any income tax is charged.
This allowance is £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers.
Additional-rate taxpayers do not receive a personal savings allowance.
In addition, savers who earn less than the personal allowance for income tax can use
it to earn more interest tax-free. They benefit from a ‘starting-rate band’ of £5,000
above the personal allowance. For example, Heather was made redundant last year.
Since then she has had a job that is only part-time. She earns below the personal
allowance threshold and so does not pay income tax. Heather has money in a savings
account that she saved before being made redundant. The interest that she earns
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on these savings is tax-free, unless she earns enough interest to exceed the personal
allowance and the starting-rate band, which is very unlikely.
5.3.1 Individual savings accounts (ISAs)
The interest on individual savings accounts (ISAs) is paid free of tax. The government
introduced ISAs in 1999 to encourage people to save. They are popular with savers,
whether or not they pay tax, because the AERs tend to be very competitive. In 2014
a new ISA limit was introduced, and restrictions were removed on how much money
could be saved in stocks and shares.
The money in an individual savings account (ISA) can be invested in cash and / or
stocks and shares. Cash ISAs are available for savers from the age of 16, and stocks
and shares ISAs are available for savers from the age of 18. The interest on a cash
ISA is paid free of income tax and does not count towards the saver’s personal
savings allowance. The return on a stocks and shares ISA is paid free of income tax
where the return is in the form of interest (where the return is paid in the form of
dividends, income tax is payable). Any growth in the value of the capital invested in
a stocks and shares ISA is not subject to capital gains tax.
During the annual Budget speech, the Chancellor of the Exchequer sets the maximum
amount that can be deposited into an ISA in any one tax year. This amount can be
split in any proportion between cash and stocks and shares (GOV.UK, no date).
Savers are only allowed to contribute to one cash ISA and/or stocks and shares ISA
in a tax year.
There are different cash ISA products that offer instant access or fixed terms. For
example, Jenny opens an instant access cash ISA on 6 April. She deposits money into
the ISA whenever she can and reaches the maximum amount that can be paid in. In
the March 2015 Budget, the Conservative–Lib Dem government reformed the cash
ISA rules so that savers can withdraw money and replace it if the provider offers a
flexible ISA (GOV.UK, 2015). This means that Jenny can take money out of her ISA
and put it back in later, up to the maximum amount, without the money losing its
tax-free status.
Savers can transfer funds from a cash ISA into another cash ISA or into a stocks and
shares ISA during a tax year. They can also transfer funds from one stocks and shares
ISA to another stocks and shares ISA, and from a stocks and shares ISA to a cash ISA.
However, such transfers depend on the terms of both the original ISA and the new
one – some ISAs do not allow funds to be transferred in, for example.
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Transferring funds between ISAs
Reuben has an instant access cash ISA with a
bank that pays 0.5% AER. He paid in £2,000
during the tax year. Reuben wants to transfer all
his savings from this cash ISA to a cash ISA at a
building society that pays 2.10% AER. The
building society will accept transfers into its cash
ISA from other cash ISAs and there are no
penalties from the bank for transferring out of its
product.
Reuben was planning to move his funds by
withdrawing the money in cash from the bank ISA
at his local branch, and paying it into his new ISA
at the building society branch across the street. At the bank counter, the
assistant explains to him that he needs to complete a form for the building
society, which will then make the transfer for him. Transfers cannot be made by
withdrawing the cash from one ISA and paying it into another because of the
rules on how many ISAs a saver can contribute to in one tax year and the deposit
limits. There are no limits on the number of ISAs a saver can hold over time, just
on the number that they can pay into during any one year.
5.3.2 Junior ISAs
As well as the adult ISA described above, there is a Junior ISA designed for savers
under 18, with its own specified deposit limit. The Junior ISA also pays interest free
of tax and offers cash and / or stocks and shares options. The Junior ISA replaces
the Child Trust Fund (CTF) account, so is only available to young savers who do not
have a CTF. From 6 April 2015, savers with a CTF are able to transfer the funds to a
Junior ISA if they wish. Parents and guardians with parental responsibility can open
a Junior ISA for savers who are under 16 years old; people aged 16 or 17 can open
their own Junior ISA.
Anyone can pay money into a Junior ISA as long as they do not exceed the deposit
limit for the tax year – so, for example, parents and grandparents can pay into the
Junior ISA to save on the child’s behalf. However, only the child named on the Junior
ISA can withdraw money from the account, and they cannot do this until they are 18
years old.
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5.3.3 Help to Buy ISAs
Help to Buy ISAs were available from 1 December 2015 from a range of banks and
building societies.
◆ First-time buyers can save up to £200 a month towards their first home in a Help
to Buy ISA and the government will boost their savings by 25% when the account
is closed. That is a £50 bonus for every £200 saved and all interest earned is tax
free.
◆ First-time buyers who save £12,000 in their Help to Buy ISA will be eligible for
the maximum government bonus of £3,000.
◆ As the accounts are for individuals, couples can save separately and both receive
the government bonus.
The Help to Buy ISA was available for new savers until 30 November 2019. It was
replaced by the Lifetime ISA, available since April 2017. People with a Help to Buy
ISA can transfer their savings into a Lifetime ISA if they wish.
5.3.4 Lifetime ISAs
Anyone aged over 18 and under 40 can open a Lifetime ISA to help them buy their
first home or to save for their retirement. However, most providers do not offer
Lifetime ISAs.
Up to £4,000 can be saved into this ISA every year until the saver reaches the age of
50. The government will add a bonus of 25% of the saver’s contributions at the end
of every tax year. This means that savers who add £4,000 in one tax year will receive
a bonus of £1,000.
Savers can withdraw money from their Lifetime ISA when they buy their first home
or when they reach 60 and keep the government bonus. Savers who withdraw the
money before age 60 and who are not buying a first home will pay a 25% withdrawal
charge on the total, losing the government bonus.
Lifetime ISA contributions count towards the saver’s ISA limit for the tax year.
5.4 Safety
One of the reasons that people save is to have funds to call on in emergencies and
in old age. Safety – that is, the likelihood that the money saved will be available when
needed in the future – is therefore an important factor when people decide where to
save money. Most people place money in products they consider reasonably safe
before considering deposits in more risky products.
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5.4.1 Financial Services Compensation Scheme (FSCS)
The Financial Services Compensation Scheme (FSCS) guarantees up to £85,000 of
savings in UK banks, building societies or credit unions that are authorised by the
UK financial services regulator, the Financial Conduct Authority (FCA). This means
that if the provider is in default – that is, it is unable to pay account holders their
savings – the FSCS will pay 100% of what is owed up to £85,000 per person per
provider. According to the FSCS, 98% of the UK population has less than £85,000 in
savings and would therefore be covered for all of their savings under the
compensation scheme (FSCS, no date).
In some cases, a number of banks and building societies belong to a single financial
services group. This means that they share authorisation with the regulator and so
are counted as one provider. For example, the Bank of Scotland plc authorisation
covers the Bank of Scotland, Birmingham Midshires, Capital Bank, Halifax and
Intelligent Finance. All five banks count as one provider, so if a saver had £50,000
in an account provided by Halifax and £50,000 in a Birmingham Midshires account,
only the first £85,000 of their savings would be protected. Savers can check how
their provider is authorised on the FCA’s website (www.fca.org.uk).
The FSCS is an independent body set up under the Financial Services and Markets
Act 2000 (FSMA) and makes no charge to savers for using its service.
5.4.2 National Savings and Investments (NS&I)
People who want 100% of their savings guaranteed, regardless of the amount, can
save with National Savings and Investments (NS&I) which is backed by Her Majesty’s
Treasury. This provider offers a range of savings products including cash ISAs,
instant access savings accounts, and longer-term savings. Topic 7 provides more
details about NS&I.
5.4.3 Cash versus stocks and shares
This topic focuses on cash savings products rather than investments linked to stocks
and shares. These types of investment are much more risky than cash as they gain
or lose value according to movements in the stock market, which can be
unpredictable. Unit 2 explores the risk and reward of investing in stocks and shares.
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5.5 Choosing savings products
Table 5.2 summarises the product features that people need to consider when
choosing a savings product. To choose the most appropriate savings product, people
need to consider how these features match their personal circumstances, such as
their need to pay bills and have funds for emergencies, and the timing of their wants
and aspirations. The case study below uses the Martin family to illustrate how these
choices can be made.
Table 5.2 Summary of product features to consider when choosing a savings product
Features
Options
Considerations
Return
AER paid (the
gross amount).
◆ Is the AER higher than other savings options?
◆ Some products are tiered with larger amounts of
savings earning higher AERs.
Inflation
Tax status
Access /
term
An AER that is
higher or lower
than the rate of
inflation.
◆ An AER that is higher than inflation will maintain the
Tax-free ISA or
interest paid gross
(most savings
accounts).
◆ ISA limits for the tax year.
Instant access
accounts (also
known as easy
access).
◆ Money is available whenever the saver needs it with
Notice accounts.
◆ Require the saver to give notice – that is, to warn the
purchasing power of the money saved.
◆ Cash ISAs are safer than stocks and shares ISAs.
no charge, but the product may have a lower AER
than notice or fixed accounts.
◆ Variable AER so the rate will fall and rise as Bank rate
changes.
provider a set amount of time before withdrawing
money, such as 90 days.
◆ Usually pay higher AERs than instant access accounts.
◆ Failing to give notice usually results in the loss of the
interest earned during the notice period.
Frequency
of deposits
Fixed accounts,
also known as
bond.
◆ Fixed AER for a set period of time such as six months
Regular savings
accounts.
◆ Require the saver to deposit the same amount of
or two years. Savers know what return they will
receive.
◆ Limited or no withdrawals allowed during the term.
◆ Usually pay higher AERs than instant access accounts.
money each month.
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Operation
Safety
Passbook or cash
card in branch,
cash card in an
ATM, online,
telephone, post.
◆ Tend to offer higher AERs.
Covered by the
FSCS or provided by
NS&I.
◆ FSCS covers UK providers authorised by the FCA.
◆ Convenience.
◆ Access to a computer.
◆ Speed of transactions, especially by post.
◆ Check that different providers are authorised
separately so savings are covered.
◆ NS&I products are backed by HM Treasury and 100%
guaranteed whatever the amount saved.
Provider
Bank, building
society, credit
union, NS&I.
◆ Convenience such as location or the saver already
holds other products with the provider.
◆ Preference – for example, the saver likes the
customer service offered.
Eligibility
◆ Age limits.
◆ New or existing
customers.
◆ Some products are only available to savers in a
specific age bracket or for existing customers of
other products, for example people who hold current
accounts with the provider.
The Martins: choosing the right savings products
The town where the Martins live has a number of financial services providers
including Penway Bank* where they hold their current accounts and MutualSave
Building Society** where Pete and Alice hold accounts. The Martins decide to
review how they save their money. They start by checking that both providers
are covered by the FSCS and are reassured that their savings will be covered up
to £85,000 per person per provider, although it is very unlikely any of them will
be able to save so much.
Aged 16 and still at school, Pete is saving for a camera and wants to buy it in
six months’ time. So far Pete has saved in an instant access account with
MutualSave that he opened shortly after his 16th birthday. This account pays
0.50% AER variable, is linked to his current account with the building society
and is operated online.
Although Pete wants to save he finds it difficult because there is always
something he would like to buy. In the three months since he opened the savings
account he has paid £60 in and withdrawn £55. He thinks that if he has a savings
account that prevents him from making so many withdrawals, he is more likely
to save up the £140 required for the digital camera he wants.
Pete thinks that saving online would be a good option for him and decides
to change from his instant access savings account to an online account that pays
2.00% AER variable as long as he makes five withdrawals or fewer in a year.
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Kathy, aged 19, is saving for the deposit and household items she will need
when she moves into a rented flat next year. Kathy has a job as an apprentice
hairdresser. She does not earn enough to pay income tax this year but is
expecting a substantial pay increase next year when her apprenticeship ends
and she is given a full-time job. She has been saving money in her current
account but this money earns no interest so she wants to move her savings and
continue saving in an account with a return. Kathy has heard about cash ISAs
and likes the idea of starting a savings account now that will still suit her when
she starts paying income tax next year.
Kathy visits the websites of various providers and notices that cash ISAs tend to
have high AERs compared with other savings products. She cannot find one that
has an AER that is higher than inflation though and decides to find the best AER
for the small sums that she can afford to save during the year. She wants instant
access in case she needs the money in an emergency and is willing to operate
the account online. She rejects cash ISAs that require a minimum deposit of
£1,000 or more and ones that require her to move her current account from
Penway Bank to the cash ISA provider. She decides to open an online cash ISA
with MutualSave because the AER is competitive at 2.25% and the minimum
deposit is just £100, which she can afford.
Alice needs to choose a savings product for her son Ross, aged 4. She has
opened an instant access savings account with the MutualSave building society
that is operated by passbook in the branch. The AER it pays is only 0.10% and
when she hears the AER that Pete is getting on his new savings account, Alice
realises that she could earn more interest on Ross’s money.
Alice rejects the idea of putting all the money that Ross receives as gifts and
she gets as Child Benefit into a Junior ISA because the money cannot be
withdrawn until Ross is 18 and some of it will be needed before then. However,
she likes the idea of putting some money into a Junior ISA for him so that it
cannot be accessed until he is an adult. Alice pays £500 into the Junior Cash ISA
now and plans to add more money next tax year.
Alice closes the passbook account and puts the rest of the savings into an instant
access online savings account that earns 0.45% AER. This account is in her name
but she thinks of it as belonging to Ross.
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John (aged 45) already saves about £250 per month for gifts and emergencies
in an instant access savings account operated online that offers 0.45% AER. He
also has his inheritance of £4,000 to save.
After researching products online, John decides to deposit the £4,000 in an
instant access online cash ISA with Penway Bank which pays 2.55% AER, and the
cash ISA is a tax-free product. John qualifies for this product because he holds
a Penway current account and can deposit more than £2,000 immediately. John
decides to close his low-interest savings account and put the £50 balance into
the cash ISA too so it earns a greater return. He will also pay £250 a month into
this ISA until he reaches the cash ISA limit.
When John has used his cash ISA limit for the tax year, he will open an
online regular savings account with MutualSave that currently pays 1.85%
AER on monthly deposits between £200 and £499. This account allows
unlimited free withdrawals so John knows that he can access the money in
emergencies.
Pensioner Dora has an instant access savings account for her funeral expenses,
which she holds at Salise Bank* in the town where she grew up, more than 100
miles away. Dora operates this account by telephone and post because she
enjoys talking to the customer service representatives on the telephone. As she
feels she has already saved enough money for her funeral, Dora has not
deposited any more money into this account this year. If she has any surplus
money she keeps it in her current account until she needs it.
* Fictitious banks and ** a fictitious building society created for the case study.
Key ideas in this topic
◆ Why people save.
◆ The impact of inflation and tax on savings.
◆ Product features that affect the return savers receive.
◆ How safe the deposits in savings accounts are.
◆ Ways of choosing between savings products, taking into consideration
personal circumstances and product features.
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References
Bank of England (no date a) Official Bank Rate history [online]. Available at:
https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp
Bank of England (no date b) The prices machine.
FSCS (no date) FSCS protects you when financial firms fail [online]. Available at:
https://www.fscs.org.uk/
GOV.UK (no date) Individual Savings Accounts (ISAs) [online]. Available at:
https://www.gov.uk/individual-savings-accounts
GOV.UK (2015) HMRC overview [online]. Available at:
https://www.gov.uk/government/publications/budget-2015-hm-revenue-and-customsoverview/hmrc-overview
GOV.UK (2020) English Housing Survey Headline Report 2019–20 [pdf]. Available at:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data
/file/945013/2019-20_EHS_Headline_Report.pdf
ONS (2014) Consumer Price Inflation Basket of Goods and Services [online], 13 March. Available at:
https://webarchive.nationalarchives.gov.uk/20160107230830/http://www.ons.gov.uk/ons/rel/c
pi/cpi-rpi-basket/2014/index.html
ONS (2015) Basket of goods 2015: what’s in and out? [online]. Available at:
https://webarchive.nationalarchives.gov.uk/20171102124936/https://visual.ons.gov.uk/basketof-goods-2015-whats-in-and-out/
ONS (2016) Consumer Price Inflation Basket of Goods and Services: 2016 [online]. Available at:
https://www.ons.gov.uk/economy/inflationandpriceindices/articles/consumerpriceinflationbask
etofgoodsandservices/2016
ONS (2017) Consumer Price Inflation Basket of Goods and Services: 2017 [online]. Available at:
https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationba
sketofgoodsandservices/2017
ONS (2018) Consumer price inflation basket of goods and services: 2018 [online]. Available at:
https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationba
sketofgoodsandservices/2018#changes-to-the-baskets-in-2018
ONS (2019) Consumer price inflation basket of goods and services: 2019 [online]. Available at:
https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationba
sketofgoodsandservices/2019
ONS (2020) Consumer price inflation basket of goods and services: 2020 [online]. Available at:
https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationba
sketofgoodsandservices/2020
Statista (no date) Average annual domestic electricity bill In the United Kingdom [online].
Available at: https://www.statista.com/statistics/496661/average-annual-electricity-bill-uk/
© The London Institute of Banking & Finance 2022
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Topic 6
Borrowing products
Learning outcomes
After studying this topic, students will be able to:
◆ outline the key features of the financial services products for borrowing;
◆ identify the key features of the costs of borrowing; and
◆ begin to evaluate lifelong financial planning by understanding that people’s
borrowing needs change as they pass through the various life stages.
Introduction
People borrow money so that they can buy goods or services now that they cannot
afford out of their current income. In effect providers ‘sell’ money to borrowers, and
borrowers pay back the money from the income that they will earn in the future.
Repayments cover the original amount borrowed and the cost of borrowing – that is,
the interest the provider charges and any additional fees. For example, Stella has
borrowed £7,000 from her bank over four years. She needs to repay the original
£7,000 plus £1,291 of interest and charges, giving her a total repayment of £8,291.
She pays this in 48 monthly repayments of £173.
This topic focuses on borrowing for the immediate and short term. It covers
overdrafts, credit cards and personal loans provided by banks, building societies and
credit unions.
In Unit 2, we will be looking at secured borrowing. This is where the provider lends
money to buy a specific item, such as a house, and this item or another asset is used
as security. This means that if the borrower is unable to repay the debt on time, the
provider can sell the security (eg the house) and use the sales proceeds to repay the
debt. Borrowing products that are secured include mortgages (secured against
property) and hire purchase agreements (often used to buy cars or electrical goods).
The borrowing products covered in this topic are unsecured. This means that the
provider does not have rights over any of the borrower’s goods if the borrower
cannot repay the debt. However, providers can go to court to reclaim outstanding
debt. This is discussed in Topic 11.
People may decide to borrow money for a short time at any stage in the life cycle.
Some of this borrowing is informal, such as between family members or friends.
Some of the borrowing is formal, that is part of an agreement with a bank, building
society or credit union.
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Different borrowing needs
Pete Martin (aged 16 and therefore in the teenage life
stage) borrows from his mother Pat by getting an advance
on his allowance. Pat either transfers the money into
Pete’s current account using online banking or gives him
cash. Pete usually repays Pat from his income in the
following month by giving Pat cash. Last Christmas,
however, Pete borrowed £45 from Pat to buy Christmas
presents. As this is a large sum of money for Pete to repay
from his monthly allowance of £60, Pat allowed Pete to
repay £15 a month in January, February and March. She
does not charge him any interest.
Pete
Jenna (aged 21 and therefore in the young adult life
stage) borrowed money from her building society to buy
a moped to travel to work. She took out a loan for £2,000
and is repaying it at £66.00 per
month over three years.
Jenna
Raj (aged 30 and therefore in the
mature adult stage of life) borrowed
£386.45 from his credit card
provider last month. He is going to
repay the debt in full from this
month’s salary so that no interest will
be charged on this borrowing.
Raj
Maria (aged 48 and therefore in the middle age stage of
life) has made arrangements with her
bank to borrow up to £250 a month
if she needs it.
Maria
Tess
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Henry (aged 56 and therefore in the
late middle age stage of life) has
borrowed £400 from his credit union
for car repairs. He will repay the debt
Henry
over 12 months at £37.82 per month
and pay £53.89 in interest and
charges. Henry is eligible for this loan because he lives
and works in the city where the credit union is based.
Tess (aged 67 and therefore in the old age stage of life)
is borrowing money from her daughter to replace her
fridge. She will repay the £329 loan from her pension over
six months in five repayments of £60 and one repayment
of £29. Her daughter has not asked for any interest.
© The London Institute of Banking & Finance 2022
Borrowing money is also known as ‘taking credit’ or ‘consumer credit’. This can cause
some people confusion because ‘credit’ is also the term used for having funds in
their current account such as credit balances and for money being paid into a current
account such as direct credit payments.
Only people who are aged 18 years or older can borrow from a provider. This is
because, under UK law, people need to be at least 18 years old to enter into a
contract. In the case of borrowing products this contract is called a credit agreement
and the terms and conditions of this agreement must be provided to the borrower
in writing.
When choosing how to borrow money, people need to consider:
◆ what they can afford to repay;
◆ the costs and risks of different borrowing methods;
◆ how long they need to borrow for; and
◆ how they apply for and manage the debt.
When providers are deciding whether to make a product available to a potential
borrower, they take into account the type of borrowing, the personal financial
circumstances of the borrower and their history of repaying previous borrowing
products.
People who take out credit cards or personal loans have a 14-day cooling off period
when they can change their minds, cancel the agreement and return the card or the
loan without any penalties. The cooling-off period starts from the date that the loan
agreement was signed or the date that the customer received a copy of the
agreement, whichever is later.
6.1 The cost of borrowing
The cost of borrowing is the interest rate and the fees that providers charge
borrowers. Providers must quote the cost as an annual percentage rate (APR) for
credit card borrowing and personal loans. The APR is a standard measure that
includes the interest rate and certain charges to show the true cost of borrowing for
most customers.
The regulations that implement the Consumer Credit Directive 2008 require
providers to quote an APR in adverts for borrowing products; this allows people to
compare the relative costs of different products on a ‘like for like’ basis. To fulfil the
requirements of the regulations on advertising, providers must give a representative
example, which is defined as the APR that they expect will be offered to at least 51%
of the people who apply for the borrowing product as a result of seeing the advert.
This means that up to 49% of applicants are likely to be offered a higher APR based
on their personal circumstances (see section 6.5 on credit history), how much they
want to borrow and for how long.
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Comparing APRs enables borrowers
to work out which product is the
cheapest option.
APRs can be fixed for the full period of the borrowing product: personal loans, for
example, are usually at fixed APRs. Other products, such as credit cards, have APRs
that are variable – in other words, the provider may raise or lower the rate. Providers
set their APRs in relation to the Bank rate (see Topic 5), the risk of the customer not
repaying the loan and what other providers charge.
Overdraft costs were traditionally presented as an interest rate only (the equivalent
annual rate [EAR]), but are now often presented as an APR.
6.2 Overdrafts
Overdrafts enable people to borrow from their current account provider by
withdrawing more money from the account than they have paid in. Overdrafts only
apply to current accounts.
Borrowing by overdraft is sometimes called ‘going into the red’ on the current
account because, in the days of handwritten ledgers, bank clerks wrote negative
balances in red ink. Having a positive balance is known as ‘being in the black’
because positive balances were written in black ink.
Figure 6.1 Borrowing using an overdraft
Salary payment received
£0.00
Account holder’s own funds
Positive balance
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Overdraft
limit
Provider’s
funds
Negative balance
© The London Institute of Banking & Finance 2022
Priya’s overdraft
Priya is paid on the first Friday of the month.
Her employer pays her £1,200 on 4 October by
direct credit into her current account. During
the month, Priya makes payments from these
funds by standing order, direct debit, online
transfer and cheque, and by withdrawing cash.
By 30 October Priya’s balance is zero. She needs
to buy fuel so she can travel to work and pays
using her debit card, although she has no funds
of her own left in her account. Because she has
arranged an overdraft of up to £250 with her
current account provider, Penway Bank, she can
make this payment by borrowing from the bank. At this point the balance on her
current account is -£30.
When her next month’s salary is paid into her account, the first £30 is used to repay
the overdraft automatically and the positive balance on Priya’s account is £1,200 £30 = £1,170. Figure 6.2 shows the entries on Priya’s current account statement.
Figure 6.2 Extract from Priya’s current account statement
Date
Details
Payments
Receipts
29 Oct
Direct debit paid to Magazines Ltd
5.00
0.00
30 Oct
Debit card payment to ABC Fuel Ltd
30.00
-30.00
01 Nov
Direct credit from Hanmer Retail PLC
1,200.00
Balance
1,170.00
Penway Bank sends an email to Priya on 14 November to tell her that they will charge
her £0.03 for borrowing £30 for 2 days at 19.9% APR and that they will debit this fee
from her account at the end of November.
6.2.1 Using an overdraft
Overdrafts are designed for current account holders to use for just a few days or
weeks at a time. This borrowing enables the account holder to bridge the time
difference between making a payment and receiving enough income to cover it. This
situation may arise because of unexpected payments, because the account holder
makes a mistake about how much money is in the account or because the account
holder’s monthly salary does not cover all that month’s expenses.
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6.2.2 Overdraft costs
The costs of an authorised overdraft (also known as a planned or an arranged
overdraft) can vary from zero to 40% APR up to the agreed limit. Overdraft borrowing
that is not authorised used to be charged at a much higher rates, but since April
2020 this is not allowed. All APRs are variable – that is, they can vary over time.
Providers usually alter APRs in line with changes in Bank rate.
The interest rate offered to account holders for agreed overdrafts varies ‘subject to
status’ – in other words, depending on the personal circumstances and credit history
of the borrower. For example, Ed’s provider advertises an overdraft rate of 9.37%
APR but when he telephones to arrange an overdraft limit of £250 he is quoted 15.9%
APR. By comparison, Ed’s father Morris is charged the advertised rate of 9.37% on
his overdraft of up to £500. The personal financial circumstances of Ed and his father
are very different, as Table 6.1 illustrates.
Table 6.1 Comparison of personal financial circumstances or ‘status’
Ed
Morris
Length of time he has
held current account
9 months
25 years
Regular monthly deposit
(salary)
£1,000
£2,800
Overdraft limit requested
£250
£500
Unauthorised overdraft:
£278 last month
No unauthorised
overdrafts. Always repaid
borrowing within one or
two months.
Previous borrowing
history
The provider decides that Ed presents a greater risk of not repaying the overdraft
and / or exceeding his overdraft limit and therefore charges him a higher APR than
they charge his father. This decision is based on Ed’s past behaviour, but also on
the element of uncertainty. Because Ed has only held an account with the provider
for a short period of time, it cannot be sure how he will manage the debt.
Overdraft interest costs are calculated on a daily basis. This is an advantage for
account holders as they only pay interest on the amount they have borrowed that
day and for the number of days that they are overdrawn.
From April 2020, the FCA banned banks and other providers from charging fixed
fees for using an overdraft. Previously, customers who used an unauthorised
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overdraft were often charged high fees as well as a rate for going overdrawn.
Providers may still charge the following fees:
◆ Unpaid transaction fee: providers can return transactions such as cheques,
standing orders and direct debits to the payee’s bank unpaid and charge a fee
per item – for example, £8 per item up to a maximum of £40 per day.
◆ Paid transaction fee: providers must honour certain transactions, such as debit
card payments, even though the account has insufficient funds to cover them.
Again, an example would be a fee of £8 per item, up to a maximum of £40 per
day. Under the FCA’s rules, from April 2020 unpaid or paid transaction fees
should correspond to the provider’s costs for refusing payments.
Providers used to charge one-off daily or monthly fees for using an overdraft. From
April 2020, such fees are banned. One of the FCA’s concerns was the price of
unauthorised overdrafts; its actions aimed to improve the position of vulnerable
customers who are most likely to use these products (FCA, 2019).
Because unauthorised overdrafts were more expensive than authorised ones, account
holders who made a mistake about their balance and had no planned overdraft
incurred significant costs as Scott’s experience (see case study) indicates.
Unauthorised overdrafts: then vs now
In January 2020, Scott uses his debit card to buy
£25 of groceries from a supermarket. He does
not realise that his current account has a balance
of only £15. His bank, MayBank*, must pay the
transaction because it has been made on a debit
card and the supermarket is guaranteed to
receive the funds. Scott’s current account goes
overdrawn by £10 and as he has not agreed an
overdraft with MayBank he also incurs a one-off
charge of £20.
Scott does not check his balance for another five
days. Each day he is overdrawn, MayBank charges
another £5 unauthorised overdraft fee. When
Scott realises his mistake, he transfers money
from his savings account to cover the £10
overdraft. At the end of the month the total
charge for his unauthorised overdraft comes
to £20 + (5 x £5) = £45 as well as the APR on
the £10.
Scott’s situation is different since April 2020. Under the FCA’s rules, MayBank
can no longer charge Scott daily fees for using an unauthorised overdraft.
*Fictitious provider
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There are a number of ways for current account holders to avoid the costs of an
overdraft’s high interest rate:
◆ They could sign up for an alert service from their bank that sends a text message
when the account balance is below a set amount or a large transaction has been
received for payment.
◆ They could check their account balance regularly – online, for example, or at an
ATM, or by using a mobile banking app.
◆ They could choose a basic bank account as their current account; as we saw in
Topic 4, basic bank accounts do not have an overdraft facility and so it is not
possible to go overdrawn.
People who regularly borrow by overdraft may find it difficult to repay the debt. For
example, Nancy has an agreed overdraft for £250. She borrows £50 by overdraft
every month and only repays £20. After six months her overdraft has grown to £180
of unpaid debt from past months.
6.3 Credit cards
People use credit cards to make payments both in face-to-face transactions (for
example, in shops and restaurants) and at a distance, such as over the telephone or
online (paying for travel tickets, for instance). Instead of paying the transaction
amount from their own funds (as would happen with a debit card), people use credit
cards to borrow the transaction amount from their credit card provider.
6.3.1 Using credit cards
Credit cards are offered by a range of providers including banks, building societies
and finance companies. They are accepted by most – but not all – sellers. Collectively
these sellers are known as merchants and they display the brands of the credit cards
that they accept at the point of sale. The main brands for credit cards are Visa and
MasterCard.
When people pay using a credit card four parties are involved:
◆ the cardholder;
◆ the merchant;
◆ the merchant’s bank, which is called the acquirer; and
◆ the cardholder’s bank, which is called the issuer.
When a cardholder makes a transaction on a credit card the merchant passes the
transaction details to its bank (the acquirer) and the acquirer pays the merchant the
value of the transaction. The acquirer then sends the transaction details to the
cardholder’s bank (the issuer) and the issuer pays the acquirer for the transaction.
The issuer records the transaction on the cardholder’s statement. When the
cardholder pays the issuer for the transaction, the cycle is complete (see Figure 6.3).
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Figure 6.3 The movement of money in a credit card payment
Cardholder pays with card
Cardholder
Merchant
Merchant accepts payment
Issuer sends
statement
Cardholder pays
transaction
Merchant sends
transaction details
Acquirer pays
transaction
Acquirer sends
transaction details
Cardholder’s
bank (issuer)
Merchant’s bank
(acquirer)
Issuer pays acquirer
Source: Author (2013)
Visa and MasterCard are two different payment organisations that run computer
networks connecting acquirers and issuers, as well as developing the types of card
and security measure that are used at the point of sale. One of the key security
measures is the chip and PIN identification system used on payment cards, which
was discussed in Topic 3. Another is the use of authorisation. This means that
merchants must get the issuers’ permission to accept transactions on a payment
card above a certain value, known as the merchant’s floor limit.
When cardholders use their credit cards to make transactions online or by telephone
they are asked for the last three digits on the signature panel on the back of the
card. These are called the card verification value (CVV). This is to identify the person
as holding the genuine card. Providers must now use enhanced identification
methods known as ‘strong customer authentication’. For instance, they may send a
one-time security code to the phone number associated with the card. The customer
enters the code during the purchase, as well as the CVV.
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Case study: using a credit card
Cora has a credit card issued by Penway Bank*. She
wants to buy clothes worth £150 in a shop called
Fashion Buys and decides to use her credit card to pay.
Penway Bank has given Cora a credit limit of £500 on
the card so she can borrow up to this maximum
amount. At present she has a zero balance on the card
so there will be no problem borrowing £150.
The Fashion Buys shop assistant puts Cora’s card into
the card reader at the till, enters the transaction details
and then asks Cora to enter her PIN to prove she is the
cardholder. At this point the card reader sends an electronic message to the
shop’s bank requesting authorisation for the transaction as £150 is above
Fashion Buys’ floor limit. The shop’s bank, Corp Bank Plc, is called the
merchant’s acquirer. This bank requests authorisation from Penway Bank to
allow Cora to make the transaction. Penway replies with an authorisation code
confirming that this transaction can go ahead. Corp Bank forwards this
authorisation code to Fashion Buys and it is recorded with the transaction
details. The shop assistant gives Cora her card and her transaction is complete.
Now Fashion Buys requires payment for the card transaction. It sends the
transaction details to the acquirer, Corp Bank, and Corp Bank pays the shop the
transaction value. Corp Bank then sends the transaction details to Penway Bank,
which issued the card. Penway Bank pays Corp Bank the transaction value and
records the transaction details on Cora’s credit card account.
At the end of the month Penway Bank sends Cora a statement that lists all the
transactions she made that month. The statement also tells her the minimum
payment that she must make and the deadline by which the minimum payment
is due. This due date is important because if Cora does not make the minimum
payment by this date the issuer will charge a late payment fee. Cora can decide
whether to pay only the minimum required, the whole balance, or an amount in
between.
*Fictitious providers
Some people use credit cards as a way of delaying payment for a few weeks or
spreading costs over a number of months. For example, Barry buys new trainers
using his credit card in the first week of the month. He will not receive his credit card
statement for three weeks and does not need to make any repayments until the
payment due date, which is four weeks later. The credit card issuer does not charge
interest for the period of time between making the card transaction and the payment
due date. Depending on when the next statement is due, a cardholder can have an
interest-free period of up to 56 days. When Ralf uses his credit card to buy a new
computer there is six weeks until the payment due date. After this interest-free
period Ralf makes his first repayment. He cannot afford to repay the cost of the
computer in one month so he repays over three months.
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The Consumer Rights Act 2015 gives protection for goods or services valued between
£100 and £30,000 which are paid for in full or in part (for example, just a deposit) on
a credit card. For instance, if goods which have been ordered online do not arrive or
prove faulty, cardholders can claim their money back from the credit card provider.
This is particularly useful if the merchant has gone out of business or refuses to deal
with the complaint. If there is a problem with goods worth less than £100 cardholders
can still approach their card issuer for help, as it may be possible to charge the
transaction back to the merchant and so get a refund (Citizens Advice, 2018).
6.3.2 Credit card costs
The costs of using a credit card are the APR on the amount borrowed plus any fees
that apply. When someone applies for a credit card the issuer offers that individual
a specific APR and credit limit based on their personal financial circumstances. The
APR quoted in advertisements is representative, so 51% of applicants must be
likely to receive it. The APR quoted is also based on applicants being offered a
certain credit limit and on their past borrowing and repayment history (discussed in
section 6.5) The APR is variable so it may change in line with Bank rate and the
issuer’s assessment of the risk that the cardholder may not repay. APRs are usually
calculated on a daily basis on the account balance.
Credit cards may have different APRs for purchases, balance transfers and cash
withdrawals, for example:
◆ purchases
17.9%
◆ balance transfers
17.9%
◆ cash withdrawals
27.9%
Most of the transactions made on credit cards are for purchases. Balance transfers
are when cardholders move their debt from one credit card to another one and are
discussed in more detail later in this topic. Cardholders can also withdraw cash (also
known as taking a cash advance) using a credit card at an ATM or in a branch but
this is very expensive. Not only is the APR usually much higher than for purchases,
but the interest is charged from the day the withdrawal is made to the day the issuer
receives repayment for the cash.
There are a variety of fees that can be charged on a credit card account including:
◆ annual subscription fees charged for holding the account, such as £12 or £24;
◆ late payment fees charged when the cardholder does not make any repayments
by the payment due date shown on the statement;
◆ over-limit fees charged when the cardholder makes transactions that take the
total amount borrowed over their credit limit; and
◆ cash advance fee charged when cash is withdrawn on the card.
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The cost of borrowing on a credit card also depends on the order in which the card
issuer uses repayments to pay off transactions and fees. This is known as payment
allocation. Some providers allocate payments to the most expensive debt first but
others allocate payments in the order that the debts were incurred. This can make a
big difference to the overall cost.
For example, Teri uses her credit card to withdraw £100 cash at an ATM five days
before her credit card statement is sent to her. She is unable to pay her balance off
in full and repays £200. Her issuer allocates her payment to her earliest transactions
first. This means some of her purchases are repaid but not her cash advance. The
issuer continues to charge interest on the £100 withdrawal at the high cash advance
APR until Teri makes her next repayment. If Teri’s issuer had allocated her £200
payment to her most expensive debt first, she would have repaid the cash advance
and no more interest would be charged at the higher rate.
How long the APR is charged on transactions depends on how much cardholders
choose to repay when they receive their credit card statement. Statements always
give a minimum amount that must be paid by the due date. This is often between
3% and 5% of the total balance with a set minimum such as £5 or £25.
Cora’s credit card
Cora has received her credit card statement from Penway Bank*.
Last month Cora repaid her credit card borrowing in full (£80) so she has been
charged no interest or late payment fees.
This month she is not able to repay all £258.84 that she has borrowed. She could
make the minimum payment of £7.77 which is 3% of the total balance. Her
statement provides the estimated amount of interest and charges that she will
pay on the borrowing if she only makes this minimum payment and it is £6.82.
So next month Cora would owe £257.89 before making any more transactions.
This is calculated as (£258.84 total balance – £7.77 minimum repayment) +
£6.82 interest charged.
Cora uses a reputable online credit card repayment calculator to consider her
options. If she continued to repay just the minimum 3% of her balance and made
no further payments with her card, it would take 4 years and 11 months to repay
the debt and cost her £116 in interest.
By comparison, repaying £25 per month would clear the debt in 11 months at a
cost of £22 in interest; repaying £75 per month would clear it in 3 months at a
cost of £7 in interest.
Cora decides to repay £75 this month and plans to repay at least this amount in
the following month. Cora has therefore spread the cost of buying her clothes
at Fashion Buys over several months by borrowing on her card.
*Fictitious provider
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Credit card statement
Your Account Summary as at 31 January 202X
Credit limit
£500.00
Available credit
£241.16
Balance from previous statement
£80.00
New transactions
£258.84
Payments & credits to your account
£80.00
Fees
£0.00
Interest
£0.00
New total balance
£258.84
Minimum payment due
Payment due date
£7.77
20 Feb 202X
Estimated interest amount
£6.82
Minimum payments
If you make only the minimum payment each month, it will take you longer and cost you more to clear
your balance. If you are unable to make the minimum payment, please contact us as soon as possible.
Your transaction details
Date
Description
Location
Paid in £ Paid out £
Balance from previous statement
80.00
10/01/2X
Payment received – thank you
14/01/2X
Fashion Buys
Medtown
150.00
17/01/2X
SuperMart
Medtown
33.84
17/01/2X
High Street Petrol Station
Medtown
40.00
22/01/2X
Pizzeria Italia
Medtown
24.80
22/01/2X
Flicks Cinema
Medtown
10.20
Total Balance
80.00
258.84
Interest summary
Purchase Interest
17.9%
Balance Transfer
17.9%
Cash Interest
27.9%
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6.3.3 Different types of credit card
There is a wide variety of credit cards available on the market, designed to appeal to
people in different circumstances. They include the following:
◆ Low APR cards – credit cards that offer a long-term low APR such as 7% are
usually only available to people with a certain level of income and / or a good
history of repaying borrowing on time. These cards are particularly attractive to
people who want to borrow and spread the cost of repayment over several
months, as the interest charged is so low compared with other credit cards. Some
issuers charge an annual fee for holding a low APR credit card or require
cardholders to make repayments online.
◆ 0% introductory APR and handling fee on balance transfers – cardholders who
have a large balance can transfer the amount they owe from one credit card to
another one, usually with a different provider. The new card issuer pays the
cardholder’s debt with the old card issuer. The balance is transferred to the new
card and there is 0% interest for a period of time (for example, 6, 12 or 18
months); the cardholder will therefore find it easier to repay the debt because it
is not increasing.
The new card issuer usually charges a handling fee to make the transfer. For
example, Lottie is transferring £3,000 of debt from one credit card to another
because it offers 0% APR on all balance transfers for 12 months. The new card
issuer charges a 3% handling fee, which is £90; this amount is added to the
£3,000 balance of the new card. Lottie’s first repayment pays this fee. She repays
£260 per month and clears her £3,000 debt within the 12-month 0% APR period.
At this point her credit card’s APR changes to the issuer’s standard rate, which is
18.9% APR variable.
◆ Cashback cards – these cards give the cardholder back a percentage of all
transactions made on the card as cash. The percentage varies from card to card
and may be subject to certain rules, for example 2% on all purchases or 5% on
purchases at certain merchants. The ‘cash reward’ is usually credited to the
account once a year and is deducted from the total that the cardholder owes.
Some cashback credit cards charge an annual fee such as £12 or £24, while some
have no fee.
These cards are particularly attractive for cardholders who repay their credit card
borrowing in full every month as they do not pay any interest. If cardholders need
to borrow for several months, the APR charged will be far greater than the
cashback earned. For example, Doug has a 3% cashback credit card with an 18.7%
APR, variable. He has set up a direct debit to repay his credit card bill in full every
month so he is never charged interest or fees. By comparison his brother Neal
rarely repays his credit card balance in full. If Neal had the same credit card as
Doug he would pay 18.7% on borrowing and earn 3% cashback. Instead, Neal
chooses a credit card with a low APR of 7.9% which works out less expensive for
him.
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◆ Reward cards – some credit
cards offer reward schemes such
as points that cardholders can
use to get discounts off their
shopping or on gift vouchers. For
example, Saira’s credit card
offers her 2 points for every £1
spent at supermarkets and 3
points for every £1 spent at
selected shops, restaurants,
entertainment venues and travel
companies. These points can be
exchanged for vouchers to spend
on goods and services at these merchants. Hetty’s credit card offers her reward
vouchers to spend in her favourite shop. She earns 1 point for every £1 she
spends on her credit card in the shop and 2 points for every £1 she spends on
the card elsewhere: her provider offers higher points for purchases in other shops
to encourage Hetty to use her card as often as possible and so borrow more
money. 100 reward points equal a £1 voucher to spend in the shop. Jane’s credit
card offers her Avios which she can use to get discounts on air travel and other
travel costs such as hotels, car hire and package holidays.
◆ Charity donation cards – people can use charity credit cards to donate to a
particular charity. For example, Pippa has applied for a credit card that makes
donations to a children’s charity. The charity will receive £15 when she opens her
credit card account and 25p for every £100 she spends on the card. Charity credit
cards are a type of affinity credit card: a bank provides the card but it is also
branded with another organisation’s name and logo. Both parties benefit from
this partnership. The charity’s supporters are likely to apply for and use the card,
so benefiting the bank, and the charity gets a donation when the card is used.
◆ First credit cards – people who have never had a credit card before are likely to
be offered a higher APR and lower credit limit than people with a history of
repaying debt on time. This is because the issuer does not know how new credit
cardholders will manage their borrowing. For example, Kylie is offered 29.9% APR
variable on her first credit card, although her credit card issuer has other products
at a lower APR.
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◆ Cards with low costs for foreign transactions – when people use credit cards
abroad some issuers charge a foreign transaction fee (also known as a foreign
usage fee), such as 3% of the transaction value. For example, Sean spends two
weeks on holiday in Spain. Each time he uses his credit card his issuer charges a
3% fee, so Sean’s spending of £400 costs him an extra £12. A card that charges
no foreign transaction fee would enable Sean to spend £12 more and stay within
his holiday budget.
◆ Gold, Platinum and Black credit cards – these ‘premium’ credit cards are offered
to people on higher incomes and have high credit limits (such as £15,000). They
also offer a number of benefits, such as travel insurance and entry to exclusive
airport lounges. Another benefit is a personal assistant service – the cardholder
can ask for restaurant bookings or purchases such as gifts to be made on their
behalf. Issuers usually charge a high annual fee, for example £120 for a Platinum
card or £250 for a Black card.
The APRs charged on credit cards tend to be higher than those charged on a loan
– for example, 18.9% on a credit card compared with 5.1% on a loan from the
same provider. This is because lending money through a credit card is more risky
for a provider than lending money through a loan. Although issuers place credit
limits on cards and they can control some spending through the authorisation
process, it is possible for cardholders to spend more on their credit cards than
they can repay.
6.3.4 Store cards
Some retailers offer credit cards that can only be used in their own stores. These
cards are branded with the store name only and are not part of the Visa or
MasterCard payment systems. The APRs on store cards tend to be higher than on
other credit cards. Tina, for example, has a card with an APR of 29.9% from a retail
group. The card is branded with the name of the store and the card programme is
run by a bank.
A store card may provide free gifts and a range of special offers for cardholders. It
may offer previews of sale goods or new ranges, and discounts on goods bought at
the time of opening a store card account.
6.3.5 Charge cards
Charge cards are credit cards that must be repaid in full every month. As cardholders
cannot borrow money beyond the interest-free period, charge cards do not charge
interest and do not have an APR. Issuers charge fees, however, such as service fees,
cash advance fees and charges, and annual fees. American Express offers a range of
charge cards.
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6.4 Personal loans
People take out personal loans to be able to pay for expensive items now and spread
the cost of repayment over years. Typical items that people buy with personal loans
are cars, home improvements such as new kitchens, audiovisual equipment such as
televisions, and large electrical goods such as ovens, freezers and washing machines.
Personal loans allow people to borrow a fixed amount of money over a fixed amount
of time at a fixed APR. This means borrowers pay fixed repayments every month,
making it easier for them to budget. The amount borrowed is known as the principal
and tends to be between £1,000 and £10,000. The period of time over which the
borrower will repay the loan is known as the term and tends to be between one and
seven years. The APR is fixed for the term of the loan and is determined by the
borrower’s ability to repay. People who can afford to borrow larger amounts of
money over shorter periods of time tend to pay lower APRs. Table 6.2 shows the
loans held by different borrowers with one provider.
Table 6.2 Example loans
Borrower
Loan
amount
Term in
years
APR
fixed
Monthly
repayment
Total
interest
paid
Total
amount
paid
John
£3,000
3
12.6%
£100
£584
£3,584
Ari
£5,000
3
6.9%
£154
£533
£5,533
Simon
£7,500
3
5.0%
£225
£579
£8,079
Beth
£7,500
7
7.1%
£113
£1,972
£9,472
John is being charged 12.6% APR fixed on his loan of £3,000 but Ari is charged 6.9%
APR fixed on her loan of £5,000 over the same term. Ari can afford higher monthly
repayments than John as she has a higher income. This is one of the factors that the
provider took into account when offering Ari and John APRs. The difference in APRs
makes a lot of difference to the total amount each repays. John is paying less per
month but will pay £584 interest in total. Ari will pay only £533 interest in total
although she has borrowed more because she has a lower APR.
Simon and Beth have borrowed the same amount of money but Beth has spread her
repayments over seven years compared with Simon’s three-year term. The length of
the loan makes a significant difference to the cost. Beth has monthly repayments
that are almost half of Simon’s but she will pay £1,972 in interest, more than three
times as much as Simon who will pay £579. Beth chose to repay over seven years
because she can afford the repayments easily. Simon decided to repay his loan more
quickly because it is cheaper overall, although the £225 monthly repayments mean
he must be careful with his spending.
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When people take out a loan
the provider opens a separate
loan account for them. Often,
the provider pays the merchant
direct for the goods – for
example if a borrower uses a
loan from a car manufacturer’s
finance company to pay for a
new
car.
In
other
circumstances, the provider
will deposit the funds in the
borrower’s current account
and the borrower can make
payments directly from this Often, when people are planning a major project such as
account. Providers tend to send home improvements, they take out a personal loan to pay
for it.
borrowers statements showing
the repayments made to date
and the outstanding balance on
the loan at least once a year.
Compared with borrowing by overdraft or on a credit card, personal loans are more
straightforward because the repayments are a set amount each month. However,
loans are designed to be used for larger sums of money over a longer period of time.
Overdrafts and credit cards offer borrowers greater flexibility. For example, Lee has
just received a promotion at work and receives an extra £50 in salary. He can use
this money to repay his overdraft and his credit cards earlier than he had planned. If
he had taken out a personal loan and wanted to repay it early, he might have had to
pay an early repayment penalty.
6.4.1 Payday loans
Payday loans are an interesting contrast to personal loans. Payday loans are a form
of short-term, high-cost credit designed to help a person meet their commitments
until their next payday. They provide same-day access to funds (sometimes within
30 minutes of applying), which is useful for people who feel they have no other way
to get extra cash. Payday loans tend to be for relatively small amounts: hundreds,
not thousands, of pounds. Used responsibly, they can help people who have run out
of money before the end of the month, such as to meet emergency expenses.
However, payday loans have extremely high interest rates. The amount owed quickly
adds up and many people used to get into serious debt because they could not repay
the loan quickly. The FCA took action in 2014 that included introducing a total cost
cap of 100 per cent, meaning that no customer ever has to repay more than twice
the amount they borrowed. Before choosing a payday loan, people should think
about whether they can truly afford it and when they will be able to repay it. They
should also consider whether there are other viable options, such as using savings
or selling unwanted items for cash.
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6.5 Credit history
When people apply to borrow money, providers check their credit history – that is, their
record of borrowing and repaying money – with credit reference agencies such as
Experian, Equifax and TransUnion. These agencies record the credit that people have
applied for, the amounts they have borrowed over the last six years and how often they
were late making payments. They also record defaults, county court judgments (CCJs)
made against an individual for non-payment of debts, and bankruptcies.
Providers use this information to decide whether or not to lend money to someone
who has applied for a borrowing product and on what terms – the APR, EAR, credit
limit and repayment term. People with poor credit histories can often find a provider
to lend them money but will usually have to pay more for the product.
6.6 Choosing products
When choosing borrowing products people should consider:
◆ how much they wish to borrow;
◆ what they can afford to repay;
◆ when they plan to repay;
◆ what the different borrowing options are;
◆ what the costs of the different options are; and
◆ what the other consequences of borrowing are.
Choosing borrowing products
Anya, Dom, Kim and Piotr are flatmates in their mid 20s. They all work for the
same fashion retail company. Each of them is considering borrowing products.
Anya (aged 27)
Anya drives to work at an out-of-town store. Her car
needs repairs and the garage has provided a quote of
£476.18 to do the work. Anya does not have enough
money in her current account to pay this bill so she
wants to borrow the money. She can afford to repay
£165 a month and wants to repay the amount over three months. Her options
are to use her credit card or request an overdraft from her bank. The garage can
carry out the repairs next week. If Anya paid on her credit card, she would have
three weeks until her credit card statement arrived. She gets paid in two weeks’
time. So Anya could repay £165 of the garage transaction immediately and
borrow the remaining £311.18 over two months. At 22% APR the borrowing
would cost her around £8.
Anya contacts her bank and discovers that cost of an arranged overdraft for the
full £476.18 over three months is about £14 at 19.9% APR.
Anya realises that borrowing on her credit card will be cheaper because of the
interest-free period between paying the garage and the ‘payment due’ date on
her credit card statement. She tells the garage to go ahead with the repairs and
pays them on her credit card.
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Dom (aged 27)
Dom wants to buy one of the latest mobile phones
but keep his existing sim card. He has seen a deal
on an internet site for £129.95 but does not have
enough money in his current account to pay for it.
He does not want to wait until his next pay is
deposited in two weeks’ time. When Dom is browsing
the internet he finds adverts for payday loans. Visiting one of the websites, Dom
finds out that borrowing £130 for 14 days would cost him £24.21. This sounds
okay to him until Anya points out that the APR is over 4,000%, and if he
borrowed the money on his credit card he could repay the amount in full on the
due date next month and be charged no interest at all.
Kim (aged 26)
Kim borrows £100 every month on an authorised
overdraft because she finds it difficult to manage on
her salary. As she works in fashion she feels she
should dress well and she enjoys socialising.
Unfortunately, she does not earn as much as some
of her friends and cannot afford to match their
lifestyle. She intends to repay her overdraft during
the following month but never does. After six
months the amount has risen to £600 plus the APR, and Kim has exceeded her
agreed overdraft limit of £550. Kim has other borrowing as well and owes over
£2,000 on her credit card. She decides to take out a personal loan to clear her
debts, as a loan has a lower cost. She plans to repay the loan in three years by
making monthly repayments of £97 and then be debt free. Kim’s plan will only
work if she can stop going overdrawn and stops using her credit card until the
loan is repaid. Kim is motivated by wanting to improve her credit history because
she wants to borrow money to buy a flat in the future.
Piotr (aged 28)
Piotr is buying a car. He has just signed a personal
loan agreement for £8,000 over three years at 5.0%
APR fixed. The APR is low because the loan is only
for people who are part of a store loyalty scheme and
who have a good credit history. There are also
financial penalties for repaying the loan early. This
loan will cost him £617 in interest and charges and his monthly repayments are
£239.37. Piotr can change his mind within the 14-day cooling off period from
the date that the loan agreement is signed, or the date that he receives a copy
of the agreement, whichever is later. Piotr is confident he can afford the loan so
he does not cancel it.
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Key ideas in this topic
◆ Why people borrow.
◆ The cost of borrowing, including APR.
◆ Key features of overdrafts, credit cards and personal loans.
◆ The different borrowing needs that the different products are designed to meet.
References
Citizens Advice (no date) Getting your money back if you paid by card or PayPal [online].
Available at: https://www.citizensadvice.org.uk/consumer/somethings-gone-wrong-with-apurchase/getting-your-money-back-if-you-paid-by-card-or-paypal/
FCA (2019) High-cost credit review: overdrafts policy statement [pdf]. Available at:
https://www.fca.org.uk/publication/policy/ps19-16.pdf
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Topic 7
Providers
Learning outcomes
After studying this topic, students will be able to:
◆ differentiate between different types of financial services provider; and
◆ critically compare the communication methods used by financial services
providers.
Introduction
The financial services providers that people tend to be most familiar with are the
banks and building societies with branches on the high street. These providers
usually offer a full range of financial products and services that enable people to
make transactions, save, invest, borrow and protect themselves by taking out
insurance. Banks tend to provide these products themselves. Building societies tend
to provide savings and borrowing products themselves and work with partners to
provide insurance and longer-term investments.
Many banks and building societies can trace their history back for hundreds of years.
For example, the Bank of Scotland was founded in 1695 and is now part of the Lloyds
Banking Group; the Yorkshire Building Society was founded in 1864 as the
Huddersfield Equitable Permanent Benefit Building Society. Credit unions are a less
well-known type of provider but they have been in existence since the nineteenth
century, although they were not legally recognised until the Credit Unions Act was
passed in 1979.
Some providers operate from grand old buildings on the
high street; others operate only online and via telephone.
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There are also financial services
providers that have been
established more recently – for
example, Metro Bank was set up
in 2010 and has branches
across London. There are also
comparatively new financial
services providers that are part
of
other
businesses.
For instance, Tesco Bank,
founded in 1997, is part of
the
Tesco
retail
group;
Virgin Money, founded in 1995,
is part of a wider business
investment group.
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Some of the financial services providers that have been formed more recently
specialise in various ways, such as the following:
◆ using only some of the possible communication channels – for example, first
direct (established 1989) operates solely online and by telephone;
◆ offering only certain types of product – for example, Sheilas’ Wheels (established
2005) offers car and other insurances;
◆ allowing only certain groups of people to be customers – for example, Bristol
Credit Union (established 2005) has members who live or work in Bristol.
Figure 7.1 shows the main providers of short- and medium-term products that are
covered in this topic.
Figure 7.1 Main providers of short- and medium-term products
Banks
Building
societies
Post Office
Main
providers
National
Savings and
Investments
(NS&I)
Credit
unions
Topic 10 covers insurance companies. Unit 2 covers investment companies and
financial advisers. It also discusses Islamic banking.
Financial services providers make money by charging fees and from their interest
rate margin. This margin is the difference between the interest rate (APR or EAR)
charged on borrowing products and the interest rate (AER) paid on savings. For
example, suppose Yellow Bank charges its borrowers 7% APR on its loans and pays
its savers 2% AER. The bank uses the difference of 5% to cover its costs
(administration, staffing and premises, etc) and its profit. How this interest rate
margin is set and how the profit is used varies according to the type of provider.
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When people choose a financial services provider they should consider:
◆ the advantages and disadvantages of the type of provider (such as bank, building
society or credit union);
◆ how they wish to operate their accounts and communicate with their provider
(such as by visiting a branch, via the internet or by mobile phone); and
◆ how safe their funds are (such as membership of the Financial Services
Compensation Scheme, which is covered in detail in Topic 8).
There are a number of organisations that protect the interests of financial services
customers. One of these is the Financial Services Compensation Scheme (FSCS). The
FSCS covers deposits in UK banks, building societies and credit unions up to a
maximum of £85,000 per person, per provider. If the provider cannot repay the
deposit, the FSCS will do so. Another example of consumer protection is that
providers must be checked and authorised by the Prudential Regulation Authority
before they can offer services such as lending or accepting deposits for current
accounts and savings. The Prudential Regulation Authority (PRA) and the Financial
Conduct Authority (FCA) work together to supervise providers, ensuring that they
use appropriate operating procedures, manage risk effectively and treat consumers
fairly. Topic 8 focuses on how these regulators work.
When people buy products and services from authorised, regulated providers, they
can expect to be treated well and they have protection (for example from the FSCS)
if problems arise. There are also unauthorised firms operating in the financial market,
and people should avoid dealing with them. People can find out if providers are
regulated by checking the Financial Services Register, which can be accessed via the
FCA website (www.fca.org.uk). Banks, building societies and credit unions are all
regulated by the PRA and the FCA.
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7.1 Banks
Banks are usually public limited companies that sell a wide range of financial
products and services to businesses as well as to individual customers. The part of
their banking business that deals with individual customers is known as retail
banking. Banks offer products and services that enable people to:
◆ make transactions – for example, current accounts, cash cards, debit cards and
cheques, standing orders and direct debits;
◆ save – for example, cash ISAs, savings accounts and bonds;
◆ invest – for example, by buying stocks and shares;
◆ borrow – for example, overdrafts, personal loans, credit cards and mortgages;
and
◆ protect themselves – for example, home and contents insurance, car insurance
and life assurance.
Banks raise money to fund their operations by selling shares. The people who buy
shares are called shareholders and they own a part or share of the organisation.
These investors are motivated to buy and keep their bank shares by receiving part
of the profits that the bank makes, for example 6.5 pence per share. These profit
payments are called dividends and are usually paid to shareholders once or twice a
year.
Banks, just like other commercial organisations, will decide how much dividend to
pay shareholders; they may decide not to pay any dividend at all if profits are low.
However, the directors are under pressure to pay dividends if possible, because
otherwise shareholders may sell their shares. If a significant proportion of
shareholders sell their holdings, the share price will fall, and the bank will find it
difficult to raise further money because other investors will not want to buy shares.
Banks therefore need to take account of their need to make dividend payments when
they calculate their interest rate margin. This may mean that banks charge higher
interest rates to borrowers and pay lower interest rates to savers than other types of
provider.
Many financial institutions are based in the ‘Square Mile’ of the City of London.
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7.1.1 Banks as global businesses
The main UK banks are very large organisations that operate in all aspects of financial
services globally. Banking groups are formed when financial services providers merge
or acquire (that is, buy) other providers. Lloyds Bank was founded in 1765. From the
mid nineteenth century it merged with or acquired more than 200 banks. In 2009 it
acquired HBOS and became Lloyds Banking Group. It now has a range of different
brands, including:
◆ banks that each provide a full range of financial services (Lloyds Bank, Halifax
and Bank of Scotland); and
◆ firms that specialise in, for instance:
– mortgages and savings (Aldermore);
– motor loans (Black Horse);
– insurance (St Andrew’s Group);
– long-term financial products like pensions and investment (Scottish Widows).
Some of the banks operating in the UK have headquarters in other countries.
Santander UK plc is a wholly-owned subsidiary of the Santander Group, a Spanish
provider with headquarters in Madrid. Other big UK banks were founded abroad.
HSBC Bank plc was founded in Hong Kong as part the Hongkong and Shanghai
Banking Corporation; in 1992 it took over Midland Bank in the UK and its
headquarters are now in London. There are also many foreign banks operating in
the UK as London is an international financial services centre.
7.1.2 Advantages and disadvantages of banks
An advantage of buying products from a large bank is that customers have easy
access to different products and services. Another advantage is that the size of the
bank means it can afford to invest in new products and services. For example, in
1989 HSBC launched the first bank in the UK that operated by telephone, 24 hours
a day and seven days a week. That bank is first direct which has no branches,
operating by telephone and online only. In 2011 first direct made another innovation
by launching the first mobile banking app in the UK that enabled account holders to
make transactions from their current accounts. Another example of innovation is
Barclays launching contactless payment cards.
A disadvantage of dealing with a large bank is that customer service may be less
efficient than in smaller organisations. A Which? magazine report identified that the
most common complaints about banks involved poor customer service (for example,
being unwilling to help with a problem), difficulty getting through to someone who
could answer a question and mistakes on statements (Which?, 2013).
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The global nature of the financial services market means that events in other
countries can have an impact on UK banks. The financial crisis known as the ‘credit
crunch’ that began in 2007 affected financial services providers around the world.
In 2008 the UK government ‘bailed out’ some banks that had made significant losses
– in other words it provided financial support to prevent the banks from collapsing.
The government bought shares in the banks and in May 2013 owned 39% of the
Lloyds Banking Group and 81% of The Royal Bank of Scotland Group. The main reason
that the government invested approximately £37 billion in these banks was to
safeguard the banking system. These banks were considered ‘too big to fail’ because
so many people and businesses had funds deposited with them and relied on
borrowing from them. Topic 8 looks at the financial crisis in more detail.
Some people feel that the banks that have government backing are now safer than
their competitors. For example, Marek wants to open a current account and is
considering which provider to use. He is particularly interested in Lloyds Bank and
The Royal Bank of Scotland because he argues that the government will ensure his
money is safe. Marek’s friend Adrian points out that the government bailed these
banks out because they would otherwise have become bankrupt. He also tells Marek
that the government has been selling its shares in these banks; for example, by May
2017 the government had sold all its remaining shares in Lloyds Banking Group
(government ownership is a short-term measure). Adrian explains that there is
protection for customers of all banks, building societies and credit unions from the
Financial Services Compensation Scheme. He recommends that Marek choose his
provider based on other criteria.
7.2 Building societies
Building societies are mutual organisations owned by their customers, who are called
members. Originally, building societies were set up to offer savings accounts and
mortgages; these kinds of product still make up a large proportion of their business.
Nationwide Building Society, for instance, is one of the UK’s largest savings providers
and second-largest mortgage lender. As well as these main products, building
societies now provide a wide range of other financial products, including current
accounts, credit cards and insurance. Many of these are provided by the building
society itself; others, such as longer-term investments and insurances, are often
provided by firms that have a long-term relationship with the building society. For
example, the Yorkshire Building Society focuses on providing mortgages and savings;
it introduces customers who want investments or life assurance to Legal and General,
and those who want car insurance to Royal and Sun Alliance Insurance. This is
different from a bank, which tends to offer these products directly or from another
provider in its banking group.
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7.2.1 Advantages and disadvantages of building societies
A key advantage of building societies is that all
customers are members who have a say in how
the society is run: they can vote on key issues
and attend and speak at annual meetings. Each
member gets one vote, regardless of how much
money they have deposited or how many
products they hold.
Another advantage of building societies is that
they do not have shareholders and therefore do
not need to pay dividends from their profits.
They also do not have the running costs
associated with paying dividends. According to
the trade association that represents them, the
Building Societies Association (BSA), paying
dividends to shareholders increases a bank’s
running costs by around 35% (Your Mortgage,
2014). All the profits made by a building society
are used to benefit its members; this may
enable building societies to charge lower
interest rates on borrowing and pay higher Traditionally, building societies offered
interest rates on savings than banks.
mortgages for property purchases.
These products are still an important
The customer service offered by building part of their business.
societies also tends to score more highly than
the service offered by banks. A YouGov poll
found that 79% of customers would recommend their building society to a friend,
while only 60% would recommend their bank (Your Mortgage, 2014).
Their mutual status is one reason why building societies are able to offer a better
service than banks; another reason is that they are smaller organisations than banks.
For example, according to BSA statistics, the largest building society in the UK was
Nationwide with assets of over £250 billion as at November 2021. The next largest
was Coventry Building Society with assets of over £50 billion (BSA, 2021).
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Building societies are larger than credit unions, which are also mutual organisations.
Credit unions restrict who can be members, tend not to offer the range of services
that building societies do and usually make much smaller loans. For example, one
of the largest credit unions is the Number 1 CopperPot Credit Union Ltd with assets
of over £145 million (No1 CopperPot Credit Union, 2019).
Figure 7.2 Comparison of assets held by banks and building societies (£ billions)
Sources: Barclays (2017), Lloyds Banking Group (no date), Nationwide (2017),
Yorkshire Building Society (2017)
The size of building societies can be considered a disadvantage as well as an
advantage. They are unlikely to be able to spend the same amounts of money on
research and development as large banks can. They also need to rely on partners to
offer members certain services such as insurance policies.
7.2.2 Why building societies are smaller organisations than banks
One of the reasons why building societies are smaller organisations is that they tend
to operate within the UK only and often have quite a local focus. The smallest
building society is the Penrith Building Society with one branch and a few thousand
members, most of whom live in and around Penrith in Cumbria's Lake District.
Another reason why building societies are smaller than banks is that legal restrictions
are placed on their business activities. At least 75% of their assets must be mortgages
and at least 50% of their total funding must come from members’ deposits, that is,
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the balances in savings and current accounts. There are also restrictions on the
amount of unsecured loans that building societies can make. These restrictions mean
that building societies take fewer risks than banks when making loans and borrowing
funds for their business.
7.2.3 Demutualisation
Some building societies claimed that these restrictions prevented their businesses
from growing and so they changed from their mutual status to banks, a process
known as demutualisation. This option is only possible if the majority of members
agree and it is only open to the largest building societies because of the costs
involved in the process. Some building society members vote for demutualisation
because they receive shares and cash ‘windfall payments’ when the building society
becomes a bank and can sell shares. Other building society members vote against
demutualisation because they consider that the benefits of being mutual (especially
better customer service, lower running costs and better interest rates) outweigh the
benefits of being a larger organisation.
Examples of building societies that became banks include Abbey National (now part
of Santander), Halifax (now part of Lloyds Banking Group) and The Woolwich (now
part of Barclays). None of the building societies that demutualised to become banks
are operating as individual providers now.
The Building Societies Association represents all building societies in the UK. The
number of building societies is low compared with the number of banks, partly
because of demutualisation but also because many building societies have merged
over the years. For example, the Yorkshire Building Society has merged with the
following building societies: Huddersfield, Bradford, West Yorkshire, Haywards
Heath, Barnsley, Chelsea, and Norwich and Peterborough.
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7.3 Credit unions
Credit unions are similar to building societies because they are also mutual
organisations owned and run by the individuals who are their members. The key
difference between a credit union and a building society is that the majority of a
credit union’s members must share a common bond. The common bond might be
that they all:
◆ live and work in a certain area, for example Bristol;
◆ work for a specific employer, for example a local authority, the Co-operative
Group, the police, or Royal Mail;
◆ work in a particular industry, for example transport;
◆ belong to a specific organisation, such as a church or housing association.
Credit unions operate as financial cooperatives focusing on savings (including
cash ISAs), loans and insurance. Members
pool their savings to make loans to other
members and any profits are returned to
the members. This means that the
amount of money a small credit union is
able to lend may be quite small.
The Association of British Credit Unions
Limited (ABCUL) is the leading trade
association for credit unions in England,
Scotland and Wales, representing around
70% of the credit unions and 85% of the
British credit union membership.
For the No1 CopperPot credit union, the
common bond is that its members work for
police forces in England and Wales or have a
pension from one of these forces.
7.3.1 Membership of credit unions
Credit unions are much smaller organisations than banks and most building
societies. The No1 CopperPot Credit Union Ltd has over 34,000 members, whose
common bond is that they all work for the police in England and Wales or receive a
pension from these police forces. Bristol Credit Union has about 13,000 members
who all live or work in Bristol, Bath and the surrounding areas and Suffolk Credit
Union has 600 members, whose common bond is that they all deliver a public sector
service and live or work in Suffolk (ABCUL, no date). The attraction of a credit union
for many members is that it benefits people like them because of the common bond,
and it keeps funds in the local economy.
On 8 January 2012 the law changed to allow credit unions to:
◆ offer membership to more than one group of people, so reducing the focus on
the common bond;
◆ include organisations such as community groups, businesses and social
enterprises, as well as individuals.
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There are still restrictions, however, as organisations can only make up 10% of a
credit union’s membership and can be offered a maximum of 10% of its loans. Credit
unions whose common bond is a geographical area can have a maximum of two
million members. The option of having some members who do not share the
common bond will make it easier for credit unions to attract more savings deposits
and so make more loans available to their members. The changes in legislation also
mean that people who leave the area or change jobs do not have to leave the credit
union. These people are classified as non-qualifying members (NQM). It is up to the
individual credit union to decide how many NQMs they will allow.
7.3.2 Products offered by credit unions
Credit unions offer two main products: savings and loans. Before January 2012, credit
unions were restricted to paying returns on savings in the form of annual dividends
which were a percentage of the profits made, for example 1%–2% per year with a
maximum legal limit of 8%. Dividends are only paid if the credit union makes a profit
or, if it makes a loss, if the board decides to use its cash reserves to pay the dividend.
Since the legal changes introduced in 2012, credit unions can choose to pay a
guaranteed rate of interest instead of a dividend. This will make it easier for people
to compare the rate of return on savings from a credit union with the rates offered
by other providers. Not all credit unions will wish to offer interest rates, however, as
those that do must show that they have the necessary systems and controls in place
to make the payments, and must hold reserves of at least £50,000 or 5% of total
assets, whichever is the greater.
A key role of a credit union is to offer members affordable loans. The APRs and fees
charged are set by the individual credit union and can be as low as 1% of the reducing
debt balance each month which is 12.7% APR. Legally, the monthly charge cannot be
greater than 2% of the reducing balance of the loan which is 26.8% APR.
As well as savings and loans, credit unions offer a range of other products, including:
◆ life assurance;
◆ the Credit Union Current Account with cash or debit card; and
◆ a pre-paid payment card.
7.3.3 Advantages and disadvantages of credit unions
The benefits of credit unions are that:
◆ they have lower operating costs than other providers, such as banks;
◆ the profits generated are used for the benefit of members, not external
shareholders;
◆ they provide a local, community-focused service;
◆ they inspire customer loyalty through the common bond.
The disadvantage of credit unions is that they may offer only a limited product range,
depending on their size.
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7.4 National Savings and Investments (NS&I)
National Savings and Investments (NS&I) is an executive agency of the Chancellor of
the Exchequer. It was originally set up by the Government in 1861 as the Post Office
Savings Bank. In 1969 it was renamed National Savings and became a government
department, reporting to government ministers in the Treasury. The savings and
investment deposits were used to provide funds to the Exchequer. In 1996 it changed
from a government department to an executive agency, giving managers more
autonomy in the day-to-day running of the organisation. Then in 2002, its name was
changed to National Savings and Investments (NS&I). When people buy its products
they are lending money to the government. In return, all of the money in NS&I
products is guaranteed to be 100% safe by the Treasury.
NS&I offers a number of savings and investment products, including:
◆ a cash ISA;
◆ a savings account;
◆ an investment account;
◆ income bonds; and
◆ Premium Bonds.
According to the NS&I website (www.nsandi.com), the AERs on NS&I products are set
to achieve a balance between the interests of:
◆ customers, by offering them a fair rate;
◆ taxpayers, by raising cost-effective finance for the government; and
◆ the wider financial services sector, to support stability.
NS&I does not pay interest on Premium Bonds. Instead, a rate is used to calculate
how much money would be paid in interest and the money is placed into a prize
fund. Every month two Premium Bonds are selected at random to win £1 million and
there are over a million other cash prizes. People buy Premium Bonds because of the
chance of winning a prize, although the odds are 34,500 to 1, and because the
money is 100% safe. People can save between £25 and £50,000 in Premium Bonds,
and the funds can be withdrawn with no notice and no penalty.
People can apply for Premium Bonds and all other NS&I products online, by telephone
or by post.
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7.5 The Post Office
The Post Office has over 11,500 branches across the country and also operates
mobile vans that visit rural locations, making access to Post Office financial services
convenient for a large proportion of UK consumers. According to the Post Office
website (www.postoffice.co.uk), 93% of adults live within 1 mile of a branch and 99%
live within 3 miles.
The Post Office offers a range of financial products and services, which are provided
by its partner banks and insurance companies. These include:
◆ savings accounts, mortgages and a credit card;
◆ loans: personal loans, car loans, home improvement loans and debt consolidation
loans;
◆ a cash ISA;
◆ home and car insurance policies;
◆ travel insurance;
◆ life cover, including free new parent life cover; and
◆ pet insurance.
The free parent life cover is assurance that is free of charge, has a 12-month term
from the date of the baby’s birth and pays out £15,000 on the death of either parent
(or £30,000 if both die).
The Post Office used to offer current accounts but it reduced its product range. It
still allows free deposits and withdrawals from most other UK banks in branch and
at its ATMs, and sells foreign currency with no commission fees.
In many small towns and villages the Post Office is the only provider with a local branch.
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Some of the products that the Post Office used to offer were designed to meet the
needs of people on low incomes in particular. The Budget Card Plus, for example,
was an electronic purse that people used to store money until they needed to pay
a range of bills including car tax, electricity and the balance of a Post Office
credit card.
Another example was the Post Office Card Account, a basic current account that
enabled people to receive their benefits and / or pension from the government and
to withdraw cash using their account card at any Post Office branch.
As with banks, building societies and credit unions, deposits in Post Office products
and services are covered by compensation schemes. Deposits in the Bank of Ireland
UK products are protected by the UK Financial Services Compensation Scheme (FSCS)
which covers amounts up to £85,000.
7.6 Communication methods
The ‘Big Five’ banks in the UK (in terms of assets) are Barclays, HSBC, Lloyds Banking
Group, Standard Chartered and the Royal Bank of Scotland Group. These banks
communicate with customers and potential customers via branches on the high
street, websites and online banking, telephone banking, post and mobile phone
texts. Other providers may use only some of these communication channels (also
known as distribution channels). For example, first direct uses online and telephone
banking only. Customers use a mixture of the channels depending on what they need
and where they are. For example, they might visit a branch at the weekend to ask a
question, check their account balance on their mobile phone and make transactions
online through their provider’s website.
There are advantages and disadvantages of each of these communication methods.
7.6.1 Branches
The advantages of branches include the following:
◆ Customers can go in and talk to someone in person, which many customers
prefer, feeling that they trust the process more than telephone or online banking.
◆ The branch can advertise all of its products, which means that when a customer
of one product – a savings account, for example – goes into the branch, they may
become aware of, and interested in, another – such as a loan account.
◆ Branch staff offer a personal service – customers feel that local staff know them
and understand their requirements.
The main disadvantage of branches for customers is that it may not be convenient
to visit them, as they are open when most people are at work or school / university.
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For a provider, the main disadvantage of branches is that it is expensive to run
branches in every town in which it has customers. The cost of this ends up being
passed onto customers through higher product charges.
7.6.2 Online banking
The main advantages of online banking for customers are that they can:
◆ have access 24 hours a day and 7 days a week;
◆ carry out banking transactions immediately, such as making transfers between
accounts and payments;
◆ research products and use online tools to make calculations such as the likely
repayments on a loan (these tools only give indications as the final cost is subject
to the customer’s status);
◆ apply for products online.
The main advantage for the provider is that websites are low cost compared with
branches, and administrative costs are reduced because the customer completes
forms or makes transactions themselves.
The main disadvantages of online banking are the security issues and the lack of
personal contact to ask questions. Providers have reduced the potential security risks
by introducing security systems (such as anti-fraud software, customer passwords,
and card readers that customers use at home with their account card and PIN to
generate codes). These protections were strengthened in 2019 due to rules on strong
customer authentication; that is, ensuring an online banking customer is who they
say they are.
Providers have also addressed the issue of personal contact by giving customers easy
access to staff via the website. This may be via email, by requesting a telephone call
or by an automated assistant that is programmed to respond to frequently asked
questions.
7.6.3 Telephone
The advantages of the telephone as a communication method include the following:
◆ Customers can contact their bank from wherever they are.
◆ The call centre often has longer opening hours than branches and some (such as
first direct) operate 24 hours a day.
◆ Call centres are less expensive than branches for providers to operate.
◆ Customers can access specialist advice that is not available in the branch – for
example, by speaking to the credit card department.
◆ Customers can ask questions to clarify information or raise concerns and get
tailored responses.
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The main disadvantages of telephone banking are potential fraud and the quality of
the customer service. Providers use security systems to check that a caller is the
genuine customer, such as passwords and details from the customer’s last
statement. They also support call centre staff with computer systems that help them
to answer customer queries. Customers can still experience problems in dealing with
call centres, however, especially if the person they are talking to does not understand
the product they are enquiring about.
7.6.4 Mobile banking
Mobile banking combines the benefits and disadvantages of online and telephone
banking. The main advantage is that it is quick and convenient for both customers
and providers to use. The main disadvantage is that it requires sophisticated security
to ensure data remains safe.
7.6.5 Post
The main advantage of post as a communication method is that it delivers a physical
message that customers can spend time considering and keep for future reference.
Providers can use statement inserts and mail shots to advertise their products to
existing and potential customers. Post is also the most convenient method for
customers who need to return a signed contract (for example, for a loan) or to supply
other paperwork.
The main disadvantages of using post are the time it takes for information to arrive
and the potential risk of documents being lost in transit.
7.7 Choosing a provider
When people are deciding which financial product to buy, they start by assessing
their personal circumstances and working out what type of product they need – for
example, a cash ISA or a current account with a low-cost overdraft facility. The next
step is to research the best rates available to them (some products may require
minimum deposits, for example). Price is not the only consideration, however,
because people are also influenced by how safe the product is, how convenient the
communication methods are and the values of the organisation. Once people have a
shortlist of possible products, the choice of provider becomes important. The
following are some of the questions that people consider.
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Should they stay with their existing provider or buy a product from
a different one?
Some people stay with their existing provider because they are more
comfortable buying new products from an organisation they know or
because they trust the provider and are pleased with the customer service
they receive. There are practical reasons why using the same provider can
be an advantage, such as:
◆ knowing where the local branches are;
◆ using a familiar online banking site; and
◆ knowing the helpline telephone numbers.
However, some people stay with one provider because they think it is difficult
to buy a new product from a different one or to switch their existing accounts.
This reluctance to change is called inertia and explains why some customers
stay with providers even though they are dissatisfied with the products and
service.
The Current Account Switch Service is run by Bacs and makes switching current
accounts quick and easy. Providers must switch a current account to another
provider within seven days. This includes moving all automated payments such
as direct debits and standing orders.
Another reason why some people buy all their products from one provider is
because they assume they will be rewarded for their loyalty. While some
providers offer better interest rates for existing customers, many offer their best
rates to new customers only.
How do they want to communicate with the provider?
When deciding which main methods of communicating with a provider
suit them best, people consider convenience and personal preference.
Some people have easy access to the internet and wish to check balances and
make transactions themselves, other people prefer to talk to staff on the
telephone and others prefer visiting branches.
What type of provider do they prefer?
One saver might prefer to buy from a credit union because their money is
used to support the local community, while another saver may prefer to
go to a large bank because it has been established a long time and is well
known. Some people may prefer to deal with a mutual organisation such
as a building society or credit union because such providers do not need
to pay shareholders. Someone with more than £85,000 to save (the
maximum covered by the FSCS) may wish to save with NS&I because their funds
will be 100% safe.
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The Fords: choosing a provider
Several members of the Ford family are making decisions about providers.
Gordon (aged 68) has just retired. He has a current account
with an online-only bank but now that he no longer receives
payments of at least £1,000 per month the bank wishes to
close the account. Gordon plans to walk into the local village
most days to meet friends or visit the library and keep fit.
The only financial services provider in the village is one of
the ‘Big Five’ banks, so Gordon decides to open an account
there to receive his state pension.
Kurt (aged 44) is dissatisfied with his bank. When he received
his statement last month he discovered that the bank had
charged him a returned payment fee although he had money
in his account. Kurt telephoned the bank but was passed
from one member of staff to another. No one could help him
so he had to make an appointment to see an adviser and take
time off work to go to the meeting. Eventually the problem
was sorted out but Kurt wishes to switch his current account
to another provider. Kurt would like to open a current
account with a building society because he has read that they
tend to offer better customer service. He prefers communicating with his
provider by telephone and face-to-face in branch so he switches his account to
a building society that has a branch nearby.
Meg (age 42) wants to open a cash ISA for the current
financial year. She has a cash ISA from the last financial year
with her bank. Looking at the AERs her savings could earn,
she decides to stay with her bank as it offers a bonus to
existing customers who buy and operate a cash ISA online.
Meg does most of her banking online anyway so being
restricted to online communication does not cause her
concern.
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Sally (aged 23) has moved to a new town to start a new job.
She has a current account with a building society but it does
not have a branch in the new town. She is considering
switching her account and discovers that there is a credit
union for people who work with her new employer. After
investigating the details, Sally decides to switch her account
to the credit union because she likes the idea that it exists
to benefit her and her colleagues. Sally was concerned that
she might have to change current accounts again if she
leaves the employer but is assured that she can remain a
member.
Nigel (aged 20) is at university. He chose his provider
because it offered him the most mobile banking features. He
finds the text alerts very helpful, particularly the ones that
tell him when his current account balance is low. When this
happens he can use his mobile phone to transfer funds from
savings and avoid becoming overdrawn.
Key ideas in this topic
◆ Differences between banks, building societies, credit unions, NS&I and the
Post Office in terms of their:
− products;
− ownership;
− size;
− history; and
− trade associations.
◆ The different communication methods that providers offer:
− branch;
− online;
− telephone;
− mobile; and
− post.
◆ The advantages and disadvantages of each method.
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References
ABCUL (no date) Find Your Credit Union [online]. Available at:
https://www.findyourcreditunion.co.uk/
Barclays (2017) Investor relations: 2017.
BSA (2021) Factsheet: November 2021 [pdf]. Available at:
https://www.bsa.org.uk/BSA/files/4c/4c973a8a-cfb5-4901-af3e-c51669e943e0.pdf
Lloyds Banking Group (no date) Investor news: 2017.
Nationwide (2017) Results and accounts: 2017.
No1 CopperPot Credit Union (2019) Annual report [pdf]. Available at:
https://www.no1copperpot.com/wp-content/uploads/2020/02/AGM_2019.pdf
Which? (2013) Is your bank a good problem solver? [online]. Available at:
https://conversation.which.co.uk/money/banks-complaints-best-and-worst/
Yorkshire Building Society (2017) Our financial results: 2017.
Your Mortgage (2014) Guide to Building Societies.
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Topic 8
Consumer protection
Learning outcomes
After studying this topic, students will be able to explain the roles and
limitations of:
◆ the Prudential Regulation Authority (PRA) and the Financial Conduct Authority
(FCA);
◆ the Financial Ombudsman Service, the Financial Services Compensation
Scheme and the Competition and Markets Authority; and
◆ the codes of conduct that providers set themselves.
Introduction
There are several organisations that provide consumer protection in the UK financial
services market, each with a distinct role to play:
◆ the regulators that set out the rules providers must follow and supervise their
operations – these are called the Financial Conduct Authority (FCA) and the
Prudential Regulation Authority (PRA);
◆ the Financial Ombudsman Service, which handles customer complaints about
providers;
◆ the Financial Services Compensation Scheme, which protects consumers if their
provider defaults, including repaying customers’ deposits of up to £85,000 if
their provider cannot; and
◆ the Competition and Markets Authority, which aims to make the financial market
(as well as all other markets in the UK) work well for consumers, businesses and
the economy (GOV.UK, no date).
Providers also regulate themselves by following codes of conduct such as the
Standards of Lending Practice, which set out how they should act when offering and
managing borrowing products.
Regulations protect
consumers when
they buy financial
products.
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8.1 Background to consumer protection
8.1.1 The credit crunch
Many of the consumer protection measures that are now in force were set up as a
direct result of the global financial crisis that started in 2007 and is known as the
‘credit crunch’. The timeline highlights key events that contributed to the global
financial crisis.
There were many causes of the credit crunch:
◆ Banks lent money to people who were likely to be unable to repay. Lehman
Brothers, for example, lent mortgages to the sub-prime market – that is, highrisk customers – and then sold on this debt to other providers.
◆ Banks used money from their retail business (that is, current accounts, savings
and loans for individuals rather than businesses) to pay the losses made by their
investment operations – the sections within a bank that buy stocks and shares
and complex and risky investment products called derivatives. This meant that
the providers did not have enough money to repay depositors when their retail
customers wanted to withdraw their money.
◆ The UK market was dominated by very large banking organisations that were
considered ‘too big to fail’ – the impact of their going out of business would have
been disastrous for the rest of the economy.
Timeline of the credit crunch
2004
In the USA interest rates were very
low at only 1% and many US banks
lent mortgages to people with poor
or no credit histories. This is called
the ‘sub-prime’ market because
these customers are high risk and
so much less likely to repay loans than the best (‘prime’) customers. Some
sub-prime mortgages were nicknamed ‘NINJA loans’ because the
customers had No Income, No Job or Assets.
The banks that provided these mortgages sold the mortgages on to other
banks and organisations around the world as investments.
2006
128
In the USA interest rates rose to 5.35% and many sub-prime customers
could not make their mortgage repayments. Banks tried to sell the homes
that the mortgages were secured on but there were so many to sell that
house prices dropped significantly. Banks lost large amounts of money
and so did the organisations that had bought investment products based
on the sub-prime mortgages.
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Banks would normally borrow money from other banks but so many banks
were impacted by the sub-prime mortgages or the investments based on
them that lending between banks was greatly reduced. Big global banks
such as UBS and Citicorp reported multibillion-dollar losses and many
banks found it difficult to access cash, also known as liquidity.
2007
In the UK Northern Rock bank was unable to borrow the money it needed
to fund its operations from other banks and turned to the Bank of England
for help. The Bank of England gave Northern Rock emergency financial
support and this was reported by the media.
Alarmed by the media reports about Northern Rock, on 14 September
2007 many of its customers tried to withdraw all their deposits. When this
happens it is known as a ‘run’ on a bank, and it was the first time it had
happened to a British bank for more than a century.
On 17 September the government announced that it would guarantee all
deposits in Northern Rock; by doing this it hoped to reassure depositors
that their money would be safe and so encourage those who had already
withdrawn their funds to leave them in the bank.
2008
On 17 February 2008 the government announced that Northern Rock
would be nationalised.
The largest investment bank in the USA, Lehman Brothers, became
bankrupt on 15 September. Financial services organisations around the
world are interconnected, partly because they lend money to and buy
products from each other and partly because large banking groups own
providers operating in different countries. When Lehman Brothers failed,
the consequences were that providers around the world lost money. Stock
market prices around the world fell as people realised the problems that
the banks faced.
On 29 September the British bank Bradford and Bingley was broken up
and the mortgages and loans side of the business was nationalised.
On 13 October the government announced it was bailing out the large
banking groups Halifax / Bank of Scotland (HBOS), Lloyds and The Royal
Bank of Scotland (RBS) by buying shares. This action was taken because
the impact of these banks becoming bankrupt would be extremely
damaging for many individuals and organisations and so for the country
as a whole. HBOS was taken over by Lloyds Banking Group on 31 October.
The government bought 40% of the Lloyds Banking Group and 82% of The
Royal Bank of Scotland.
2009
In February RBS reported losses of £24.1 billion, the largest annual loss
in British corporate history.
The Dunfermline Building Society announced losses of £26 million and
was taken over by the Nationwide Building Society. The Nationwide later
also bought the Cheshire and the Derbyshire building societies.
Sources: Edmonds (2010), BBC News (2009), Cairns (2012)
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8.1.2 Responses to the credit crunch
There were so many consequences of the credit crunch for the financial services
market that in June 2010, the government set up an Independent Commission on
Banking, led by Sir John Vickers, to recommend how such a situation could be
avoided in the future. This included ways to make the market better able to withstand
future banking crises and to ensure that the industry, rather than the taxpayer, bore
the cost of any losses.
The commission reported back in September 2011; its key recommendations are shown
in Figure 8.1. The aim was that reforms would lead to greater stability in the financial
services market and this in turn would help to support a sustainable UK economy.
Figure 8.1 Key recommendations of the Independent Commission on Banking
Improve
regulation of
providers
Separate retail
banking from
investment banking
Make sure banks
are able to absorb
any losses
Key
recommendations
Reduce the amount
of risk banks take
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Make it easier and
less costly to deal
with banks in
financial trouble
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The government passed the first legislation to implement these recommendations,
the Financial Services Act, on 19 December 2012. This legislation came into force
on 1 April 2013 and focuses on regulation (see section 8.2 for further details).
Further legislation, the Financial Services (Banking Reform) Bill, was introduced on
4 February 2013 and focuses on the structure of the UK banking sector. The Bill
includes these main changes:
◆ UK banks must separate everyday banking activities from more risky investment
bank activities, such as trading in stocks and shares and other risky products.
This is called ring-fencing.
◆ Depositors who are covered under the Financial Services Compensation Scheme
(FSCS, see section 8.4) must be repaid as a priority if the bank fails.
◆ The government will have powers to ensure that banks can absorb losses more
easily, for example by keeping larger reserves of cash.
In a press release issued by HM Treasury on 4 February 2013, the Financial Secretary
to the Treasury, Greg Clark, is quoted as saying:
The Banking Reform Bill, introduced to Parliament today, will bring about the
biggest shake-up of the structure of banking for decades, making the banking
sector safer and better able to serve the needs of individuals and businesses.
The Bill will mean that taxpayers are never again on the hook when banks fail.
The Government will implement the Independent Commission for Banking’s
recommendation to ring-fence [separate] day-to-day banking from investment
activities. To ensure that banks do not flout the rules the Government will ensure
that the Bank of England has a reserve power to completely separate an individual
bank if necessary (GOV.UK, 2013).
The Banking Reform Bill received Royal Assent in December 2013, and its
requirements came into effect on 1 January 2019.
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8.2 Regulators
Regulation is the process of supervising the actions and businesses of financial
services providers. It is desirable because a well-regulated financial system operates
more safely, enhancing financial stability and averting crises; the credit crunch
timeline in section 8.1.1 indicates that problems in the financial system can quickly
become serious. Regulation also promotes consumer confidence and protects people
from dishonest, incompetent or financially unstable providers.
8.2.1 Overview of the regulatory system
The Financial Services Act 2012 established the new system of regulation that came
into force on 1 April 2013. The system is set up in the following way:
◆ The Financial Policy Committee (FPC) is part of the Bank of England; it was formed
in 2010 in anticipation of the regulatory changes that followed. It monitors and
responds to risks posed to the whole of the financial services market. Because it
looks at problems that could arise for the market as a whole (rather than
individual providers only), the FPC is called a macro-prudential authority.
◆ The Chancellor of the Exchequer in the Treasury has powers to direct the Bank of
England to take action if there is a serious threat to the financial stability of the
market and public funds (such as the money raised from taxes).
◆ There are two regulators that work together: the Prudential Regulation Authority
(PRA) is a part of the Bank of England and the Financial Conduct Authority (FCA)
is an independent organisation. The PRA is responsible for micro-prudential
regulation – this involves looking at the risk that individual providers might
present to the stability of the financial services market. The FCA is responsible
for ensuring that all providers conduct their businesses in a way that benefits
consumers and the market as a whole.
The PRA and FCA replaced the Financial Services Authority (FSA), which was the single
financial services regulator from 2001 to 2013. The FSA has acknowledged that it
was too slow to react to risks in the market. It also failed to identify misconduct by
providers that led to a series of scandals. These included providers selling an
insurance policy called payment protection insurance (PPI) to people who could not
claim under it, or charging customers for PPI when the customer was unaware it was
included in their product. Providers who mis-sold PPI compensated customers, and
the FSA estimated that over £5 billion would be paid in compensation by the time
the scandal was resolved. In fact, by 2021 over £38 billion had been paid in PPI
compensation (FCA, 2021a). The Financial Conduct Authority (FCA) has taken over
the FSA’s role as supervisor of individual providers and delivered on its promise,
stated by Margaret Cole of the FSA, to be more proactive and interventionist than
the FSA was (BBC, 2011). It also has powers to ban or impose restrictions on financial
products and promotions.
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The work of the regulatory system is supported by the:
◆ Financial Ombudsman Service – to handle customer complaints;
◆ Financial Services Compensation Scheme – to compensate consumers if their
financial services provider fails and so rebuild trust in the industry;
◆ MoneyHelper – a consumer information service set up by the government to help
people make informed financial decisions.
These three bodies receive funding from providers via levies (fees that must be paid)
and, for the Financial Ombudsman Service, by providers also paying case fees.
Figure 8.2 The UK regulatory system
Parliament
Chancellor of the
Exchequer and
HM Treasury
Chancellor can instruct
Bank of England to take
action if financial stability
is threatened
Bank of England
Financial Policy
Committee
monitors risks to whole
financial services market
Prudential Regulation
Authority
Financial Conduct
Authority
}
Two regulators work
together
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8.2.2 The Prudential Regulation Authority (PRA)
Since 1 April 2013 the Prudential Regulation Authority (PRA) has been responsible
for the prudential regulation of banks, building societies, credit unions, insurers and
major investment firms. The PRA is part of the Bank of England and the Board of the
PRA reports to Parliament. It is funded by fees paid by providers.
The Financial Services Act (2012) identified two objectives for the PRA:
◆ promoting the safety and soundness of providers; and
◆ securing an appropriate degree of protection for insurance policyholders.
The purpose of the first objective is to ensure that the UK financial system is better
able to cope in a crisis and can support a successful economy. The PRA has not been
given the responsibility of preventing providers from failing – its task is to ensure
that, if a provider does fail, it does not cause significant disruption to the UK’s
financial services.
The PRA sets standards and requirements that providers must meet to manage risk
including ‘threshold conditions’ for continuing in business – in other words, a
minimum requirement. These threshold conditions include:
◆ holding enough cash (also known as liquidity) and having enough capital (that is,
funds) to absorb a certain level of losses;
◆ having suitable management;
◆ being fit and proper; and
◆ conducting business prudently, that is, managing risk well to ensure the business
is safe and sound.
The PRA uses a judgement-based approach to assessing the risk that providers pose.
It is forward-looking, taking into account risks that could arise in the future. It has a
focused approach, concentrating on the providers that pose the greatest risk to the
stability of the UK financial system. It has powers to take action to reduce the risks
it identifies. For example, it has required banks to
raise extra capital from their shareholders so that
they are less likely to fail in a crisis. The PRA could
also require providers to change their lending criteria
if it judges they are lending to people or businesses
that cannot repay the loans.
The Financial Policy Committee (FPC) can direct the
PRA to investigate and take action to manage the
risks it has identified for the financial system as a
whole. The PRA also works with the other regulator,
the Financial Conduct Authority, which focuses on
preventing misconduct by providers, such as selling
inappropriate products to consumers.
The Bank of England plays an important role in ensuring the
stability of the financial system
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8.2.3 The Financial Conduct Authority (FCA)
The Financial Conduct Authority is an independent body. It reports to the Treasury
and can receive direction from the Financial Policy Committee. Providers that are
regulated by the FCA have to pay fees to cover its running costs.
The FCA describes its aim as ‘to make financial markets work well so that consumers
get a fair deal’ (FCA, 2022). The FCA has a single strategic objective, which is to ensure
that the relevant markets function well. This is supported by three operational objectives:
◆ to secure an appropriate degree of protection for consumers;
◆ to protect and enhance the integrity of the UK financial system; and
◆ to promote effective competition in the interests of consumers.
Since 1 April 2013 banks, credit unions and building societies have been regulated
by the FCA and must be authorised by it before they can carry out activities such as
accepting deposits, or advising on and offering mortgages. From 1 April 2014,
regulation of all consumer credit (ie borrowing products) moved to the FCA from the
Office of Fair Trading. The FCA also regulates independent financial advisers (IFAs)
and providers that are not regulated by the Prudential Regulation Authority, such as
individuals who manage investments.
The FCA meets its objectives by supervising providers to ensure they are conducting
their businesses appropriately. It sets out rules relating to the way they carry out
their business activities. It has investigative powers to gather information from
providers and consumers. It also has enforcement powers so that it can take action
when it discovers providers have broken rules. These actions include:
◆ imposing fines on providers and/or individuals;
◆ withdrawing or suspending a provider’s authorisation to operate; and
◆ ordering providers to compensate customers.
The FCA
investigates the
way providers
carry out their
business.
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It describes its regulation as forward-looking (in other words, it aims to prevent
further problems from arising) and judgement-based. For example, the FCA has fined
a bank £4.2 million for failing to put in place suitable money laundering controls –
that is, measures to prevent criminals from using the banking system to hide money
(FCA, 2021b). It has also made a bank contact customers to clarify information about
a product that the FCA judged was unclear (FCA, 2016). It has banned an individual
from being a director of a firm for 15 years after they acted as an unlicensed
consumer credit lender (FCA, 2017a).
The way that the FCA supervises providers varies according to their size and the type
of business they conduct. There are three categories of provider, from largest to
smallest, with less intense supervision for smaller providers. This is partly because
the largest providers have the largest number of customers and partly because their
actions can have the biggest impact on the market as a whole. Large providers are
assessed continuously while the smallest providers are assessed at least once every
four years.
The FCA gathers information by making supervisory visits to providers, monitoring
transactions, contacting consumers directly, and monitoring markets and the
economy. It manages risk in two ways:
◆ by investigating individual providers or linked providers; and
◆ by investigating themes or issues in the market.
The FCA takes a proactive approach to identifying issues that affect many providers
in the market. For example, it requires providers to give it data on the number of
complaints they receive and what the complaints are about. This data is published
on the FCA website so people can see how many complaints their provider received.
As larger providers have the most customers, statistically they are likely to receive
the greatest number of complaints, so data needs to be interpreted with care. Data
published in September 2014 (FCA, 2014), however, clearly shows that there were
more customer complaints about payment protection insurance (PPI) than any other
issue (see Figure 8.3). The FCA supervised how providers gave customers
compensation for PPI mis-selling and fined providers for failing to handle complaints
fairly.
As of the first half of 2020, PPI was still most complained about financial product
(FCA, 2021c). The FCA deadline for customers to make PPI complaints passed on 29
August 2019, bringing to a close over a decade of such complaints (FCA, 2017b).
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Figure 8.3 Most complained-about products in the UK, January–June 2014
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
PPI
Current
accounts
Other general
insurance
Credit cards
Savings
Source: FCA (2014)
Another example of how the FCA protects consumers is the cap it has imposed on
the loan charges that can be made by payday lenders (Peachey, 2015). The cap is set
at 0.8% per day of the amount borrowed, and borrowers will pay back a maximum
of twice the amount of the loan. Prior to this cap, payday lenders could charge very
high rates that meant some borrowers were unable to ever repay the loan in full.
The FCA does not get involved in resolving individual customer complaints (that is
the role of the Financial Ombudsman Service). Instead, it investigates the market as
a whole and the conduct of individual providers.
8.3 Financial Ombudsman Service (FOS)
The Financial Ombudsman Service (FOS) is an independent body set up by Parliament
under provisions in the Financial Services and Markets Act 2000. The FOS was ‘set
up by parliament to sort out complaints between financial businesses and their
customers’ (FOS, 2022). The service the FOS provides is free to consumers. It is
funded by levies on providers and case fees paid by the providers that have
complaints brought against them. These case fees are payable whether the FOS finds
against the provider or not.
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The FOS promises ‘We won’t take sides – and we’ll look at every problem with an
open mind’. It considers both sides of every complaint – the customer’s and the
provider’s. If it decides that the provider has treated the customer fairly it will explain
why. If it finds that the provider has acted incorrectly, and the customer has lost
money as a result, it will order the provider to put things right.
The FOS can order providers to pay compensation up to a specified maximum, which
depends on when the case was brought to the FOS. This does not include any interest
or costs that the FOS might order the provider to pay on top of compensation. If a
complaint is upheld and the compensation needs to be greater than the maximum
to cover the customer’s losses, the FOS can ask the provider if it is willing to pay
more but it cannot force the provider to pay. The customer could take the provider
to court to claim the compensation.
Customers who wish to make a complaint about their provider should follow the
steps set out below.
1. Contact the provider directly
Customers should contact the provider as soon as possible, explaining the
situation and asking the provider to put things right. Providers that are regulated
by the FCA must respond to the complaint within eight weeks. Whether or not
they offer compensation or another form of redress, providers must advise the
customer how to refer their complaint to the FOS if they are dissatisfied. If the
provider fails to respond within eight weeks, the customer can refer the matter
to the FOS immediately.
There are companies that will make complaints on a customer’s behalf, called
claim handlers, claims firms or claims management companies. These are
businesses that make a charge, either as an upfront fee or as a percentage of any
compensation. Customers can get free, impartial help to make a complaint,
however, from places such as Citizens Advice.
2. Contact the FOS
As outlined above, if the customer is dissatisfied with the provider’s response,
or if the provider has not responded eight weeks after the customer complained,
the customer can refer their case to the Financial Ombudsman Service. This
service is free but there is a time limit. Customers must take complaints to the
FOS within six months of receiving a final response from the provider, or within
six months of making the initial complaint if the provider did not respond. The
FOS will contact the provider for an explanation and then make a decision.
FOS decisions are binding on providers – so if the FOS orders the provider to pay
compensation to the customer or take other action, it must do so.
3. Take the matter to court
Customers do not need to accept FOS decisions in favour of the provider. They
can take the provider to court; however, this is a costly process and the court
might not find in their favour.
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Suzanne’s complaint
When Suzanne checked the balance of her current
account online it was £620 overdrawn, although she
had expected it to be £100 in credit. Checking her
statement online, Suzanne saw it listed 16
transactions for £45 each, made on her debit card at
a clothes shop. Suzanne had not made any of these
transactions herself so she telephoned her bank. The
first person she spoke to could not help her so
Suzanne was put through to another department.
The member of staff told Suzanne that all the
transactions were authorised so Suzanne must have
made them or given someone her card and PIN.
Suzanne was certain that her debit card had not been
lost and she had not told anyone her PIN, but the member of staff said the
transactions were her fault for ‘being careless’ about keeping her debit card safe
and her PIN secret. When Suzanne asked for the transactions to be removed, the
member of staff laughed, said ‘I don’t think so’, and put the telephone down.
Suzanne wrote a letter to her bank explaining what had happened and what she
wanted the bank to do to put matters right. After eight weeks she had not had
any reply. At this point Suzanne visited Citizens Advice and the adviser helped
her to write a second letter of complaint. Two weeks later she received a letter
from the bank acknowledging receipt of the second letter but giving no more
details. Three weeks later Suzanne had still not heard from her bank. By this
time she had repaid the £620 overdraft and the interest charge of £8.20, leaving
her £628.20 out of pocket. Her friend Alec said she should just forget about it
but Suzanne decided she would go to the Financial Ombudsman Service.
Suzanne completed the online form on the FOS website, giving as many details
as she could and attaching copies of the letters she had written and received.
The FOS got in touch with her a few days later to say that they were requesting
information from the provider. About six weeks later the FOS wrote to Suzanne
to say that they had found in her favour. The provider wrote her a letter of
apology, refunded her the full £628.20 and paid an extra £50 as a gesture of
goodwill for the inconvenience she had suffered.
It turned out that the sales assistant at the clothes shop, Billy, had taken
photographs of Suzanne’s debit card details when she made a genuine
transaction one month earlier. He had used his mobile phone camera under the
counter while he distracted Suzanne by chatting to her. Billy then used a manual
procedure to make the payments and had not requested authorisation from the
bank. Instead he had handwritten the card details and made up an authorisation
code so his boss would accept the payments. Billy took goods from the store
that cost the full amount of £620 and sold them at the local market. The police
caught him two months later and he explained how he was stealing.
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8.4 The Financial Services Compensation Scheme
(FSCS)
The Financial Services Compensation Scheme (FSCS) will repay customers their
deposits in providers authorised by the Financial Conduct Authority (FCA) if the
provider is unable to do so or is likely to be unable to do so. This is usually because
the provider has stopped trading, has insufficient funds or is insolvent. The FSCS
covers deposits in banks, building societies and credit unions. The Financial
Ombudsman Service deals with complaints against providers that are still in business.
The FSCS was set up under the Financial Services and Markets Act 2000 and started
operations on 1 December 2001. It is an independent body that makes no charge to
consumers for its service. It is funded by levies on regulated providers which are
made in proportion to the size of the provider. This means larger providers pay more
in levies than smaller ones because the costs of compensation if a large provider
became insolvent are much higher than for a smaller one.
There are limits to the amount of compensation that the FSCS can provide, depending
on the type of financial product involved. Deposits, investments and mortgages are
covered up to a maximum of £85,000 per person per provider. A single provider is
one that has an individual authorisation with the FCA. The brands that belong to a
banking group may have just one authorisation. This may mean that customers with
current and savings accounts in different brands may only be covered to the
maximum of £85,000 for all their accounts. People can check provider authorisations
by visiting the FCA website (http://www.fca.org.uk). Figure 8.4 provides an example
of brands covered by an individual authorisation.
Figure 8.4 Brands covered by individual authorisation
Source: FCA (2021)
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Most foreign banks operating in the UK have UK subsidiaries with FCA authorisation
so deposits are covered under the FSCS. For example, Bank of Ireland UK is
authorised with the FCA; this means deposits in the savings accounts that it operates
for the Post Office are covered by the FSCS. Deposits in foreign banks that are not
authorised by the FCA are covered by the compensation scheme operating in the
country where their headquarters are based.
Savings in joint accounts are assumed to be split equally between account holders.
For example, Beverley and Jim have a joint savings account with Penway Bank and
no other products with this provider. If the bank failed their savings would be covered
up to a maximum of £85,000 each, that is £170,000 in total.
If a provider becomes insolvent, the FSCS automatically refunds savings up to the
limit of £85,000 within 7 days. According to the FSCS website, 98% of the UK
population have savings of less than £85,000 and would therefore be covered in full.
In the first 10 years of its operation, the FSCS has paid out more than £26 billion in
compensation and helped 4.5 million people (FSCS, 2022).
The FSCS does not only cover deposits. It can also provide compensation to
consumers if they lose money because their insurance, investment or mortgage
provider goes out of business.
8.5 Competition and Markets Authority (CMA)
The Competition and Markets Authority acquired its powers on 1 April 2014, when
it took over many of the functions of the Competition Commission and the Office of
Fair Trading (OFT).
The CMA is an independent, non-ministerial government department that works to
promote competition between providers for the benefit of customers. The CMA’s
role is to ‘ensure consumers get a good deal when buying goods and services, and
businesses operate within the law’ (GOV.UK, no date). It is responsible for:
◆ investigating mergers that could restrict competition;
◆ conducting market studies and investigations in whole markets where there may
be competition and consumer problems;
◆ bringing criminal proceedings against businesses and individuals who take part
in cartels (when competitors agree to fix prices, rig bids, share markets or limit
output at the expense of customers);
◆ enforcing consumer protection legislation to tackle practices and market
conditions that make it difficult for consumers to exercise choice;
◆ co-operating with the government and sector regulators and encouraging them
to use their competition powers.
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The CMA is investigating competition in the retail banking market.
The CMA is continuing market investigations started by the Office of Fair Trading
(OFT), for example by launching an inquiry into competition between banks.
The OFT investigated whether there is enough competition between providers in the
bank current account market (BBC News, 2013). In January 2013 it found that the
major banks Lloyds, RBS, Barclays and HSBC held 75% of the market. The OFT made
a number of recommendations, including ways to make it easier for customers to
switch accounts. This change was implemented in September 2013 when the
Payments Council launched its switching service.
The CMA launched a further inquiry due to concerns that the retail banking market
was still not working well for customers (BBC News, 2014). For example, the CMA
stated that:
◆ many customers saw little difference between the largest banks in terms of the
services they offer;
◆ switching between banks remains low – at just 3% a year for personal accounts;
◆ current account overdraft charges are very complex, making it harder for bank
customers to choose the cheapest or most appropriate accounts.
In 2017 the CMA implemented a number of reforms to improve the banking system
for consumers, including:
◆ open banking to make it easier for people to find out which bank account is best
for them;
◆ publication of banks’ data on the quality of their service (GOV.UK, 2017).
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8.6 Voluntary codes of conduct
As well as formal regulation by the consumer protection organisations discussed in
this topic, providers regulate themselves by agreeing to voluntary codes of conduct.
There are a number of codes, such as the Standards of Lending Practice that set out
minimum standards of good practice for banks, building societies and credit card
providers.
The Standards of Lending Practice were created by the former British Bankers’
Association (BBA), the Building Societies Association (BSA) and the former UK Cards
Association. They cover good practice for loans, credit cards, charge cards and
current account overdrafts. The providers that subscribe to the Standards tell their
customers that they follow the principles and give them information about the service
they should expect. This includes:
◆ advertising that is fair, clear and not misleading;
◆ giving customers information before, at and after the point of sale about how
products work, including terms and conditions, interest rates and charges;
◆ giving customers information about any changes to their product or service, such
as a change in interest rates;
◆ lending responsibly;
◆ dealing with customers quickly and sympathetically when things go wrong and
acting sympathetically and positively when considering a customer’s financial
difficulties;
◆ keeping personal information on customers private and confidential and
providing secure and reliable banking and payment systems; and
◆ training their staff to put the Standards into practice.
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Key ideas in this topic
◆ The background to current consumer protection.
◆ The regulators: the Prudential Regulation Authority (PRA) and the Financial
Conduct Authority (FCA).
◆ The Financial Ombudsman Service (FOS).
◆ The Financial Services Compensation Scheme (FSCS).
◆ The Competition and Markets Authority (CMA).
◆ Voluntary codes of conduct.
References
BBC News (2009) Timeline: credit crunch to downturn [online], 7 August. Available at:
http://news.bbc.co.uk/1/hi/business/7521250.stm
BBC News (2011) Financial regulation to be ‘tougher and bolder’ [online], 27 June. Available at:
https://www.bbc.co.uk/news/business-13926886
BBC News (2013) Bank accounts: OFT says significant change needed [online], 25 January.
Available at: https://www.bbc.co.uk/news/business-21192053
BBC News (2014) UK banks to face competition inquiry [online], 6 November. Available at:
https://www.bbc.co.uk/news/business-29929493
BBC News (2015) Payday loan charges cap takes effect [online], 2 January. Available at:
https://www.bbc.co.uk/news/business-30641877
Cairns, D. (2012) Newsbeat’s guide to RBS troubles [online], 23 February. Available at:
http://www.bbc.co.uk/newsbeat/17138772
Edmonds, T., (2010) Financial crisis timeline [pdf]. Available at:
https://researchbriefings.files.parliament.uk/documents/SN04991/SN04991.pdf
FCA (2014) Complaints data.
FCA (2016) Santander UK to contact more than 270,000 borrowers after raising cap on mortgage
standard variable rate in 2008 without being clear [online]. Available at:
https://www.fca.org.uk/news/press-releases/santander-uk-contact-more-270000-borrowersafter-raising-cap-mortgage-standard
FCA (2017a) FCA takes first criminal action against an individual acting as unlicensed consumer
credit lender [online]. Available at: https://www.fca.org.uk/news/press-releases/fca-takes-firstcriminal-action-against-individual-acting-unlicensed-consumer
FCA (2017b) FCA starts countdown to PPI complaints deadline with advertising campaign
featuring Arnold Schwarzenegger [online]. Available at: https://www.fca.org.uk/news/pressreleases/fca-starts-countdown-ppi-complaints-deadline-advertising-campaign
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FCA (2021a) Monthly PPI refunds and compensation [online]. Available at:
https://www.fca.org.uk/data/monthly-ppi-refunds-and-compensation
FCA (2021b) FCA fines EFG Private Bank £4.2m for failures in its anti-money laundering controls
[online], 24 April. Available at: https://www.fca.org.uk/news/press-releases/fca-fines-efg-privatebank-£42m-failures-its-anti-money-laundering-controls
FCA (2021c) Aggregate complaints data: 2020 H1 [online]. Available at:
https://www.fca.org.uk/data/complaints-data/aggregate-complaints-data-2020-h1
FCA (2022) About us [online]. Available at: https://www.fca.org.uk/about
FOS (2022) Our aims and values [online]. Available at: https://www.financialombudsman.org.uk/who-we-are/aims-values
FSCS (2021) List of banking brands – October 2021 [online]. Available at:
https://www.bankofengland.co.uk/prudential-regulation/authorisations/financial-servicescompensation-scheme
FSCS (2022) FSCS protects you when financial firms fail [online]. Available at:
https://www.fscs.org.uk/
GOV.UK (no date) CMA, Competition & Markets Authority, About us [online]. Available at:
https://www.gov.uk/government/organisations/competition-and-markets-authority/about
GOV.UK (2013) Government published Banking Reform Bill [online], 4 February. Available at:
https://www.gov.uk/government/news/government-published-banking-reform-bill
GOV.UK (2017) Open banking revolution moves closer [online]. Available at:
https://www.gov.uk/government/news/open-banking-revolution-moves-closer
Peachey, K. (2015) Payday loan charges cap takes effect [online], 2 January. Available at:
https://www.bbc.co.uk/news/business-30641877
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Topic 9
Budgets and forecasts
Learning outcomes
After studying this topic, students will be able to:
◆ identify the key elements of a budget;
◆ interpret a cash flow forecast for short-term financing;
◆ describe some of the key components of the cost of living in Britain; and
◆ begin to evaluate lifelong financial planning, by understanding that the way
people manage money changes as they move through the various life stages.
Introduction
This topic introduces some of the tools and skills people need to manage money –
that is, to decide how to use their income to achieve their financial goals. People in
different personal circumstances will have different goals – their priority might be to
be able to pay their living expenses, to repay borrowings or to save.
The main tools people use to manage their finances are:
◆ budgets – plans of their expected incomings and outgoings over a set time period
such as a month;
◆ cash flow forecasts – plans of their expected incoming and outgoings over several
time periods, such as the next three months; and
◆ records of actual income and expenditure and any difference between the
planned and actual figures.
Topic 2 discussed how sources of income and
likely expenditure vary over the life cycle. For
example, Pete Martin (in the teenager life stage)
has a monthly allowance from his parents and is
responsible for paying his mobile phone charges
(over a basic amount agreed with his parents),
and his wants: these include fashionable clothes,
expenses relating to his social life, such as travel
to meet friends or cinema tickets, and hobby
equipment, such as a camera. His parents pay for
all his needs – the essentials he needs to live,
such as a home, food and drink, and clothing.
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In contrast, Pete’s father, John, is in
the middle-age stage of life. He has a
monthly salary from a full-time job
and he pays for the family’s home and
car, household bills and insurance
policies. Pete’s mother, Pat, is also in
the middle-age stage of life. She has
a monthly income from a part-time
job and spends most of it on food and
clothing for the family and allowances for her children and grandchildren. Both Pat
and John spend most of their income on needs. They have very little income left over
for things they want but do not need, and Pat is unable to for save for emergencies
and her old age. They consider managing money an important skill to be able to
provide for their family now and in the future.
Everyone manages money differently because individuals have different needs,
wants, aspirations and priorities. People who enjoy cooking, for example, are likely
to spend money on kitchen tools and a range of ingredients, while people who are
less interested will buy simpler foods to prepare. Many people find their choices are
constrained by their income – in other words, they can only buy what they can afford.
Alice Martin, for example, is unemployed so she has a very limited income from
benefits and her family. She buys clothes very rarely and shops at charity shops and
the market rather than the fashion stores her sister Kathy visits.
9.1 Budgeting
A budget is a financial plan that shows a person’s income and expenditure for a
defined period of time, such as one month. The main objective of a budget is to
provide information that enables people to take control of their finances and make
decisions such as:
◆ what they can afford to spend, repay and / or save;
◆ what their financial goals and priorities are; and
◆ what to do if they are spending more than they are receiving.
The main components of a budget are income, expenditure over a specific period of
time, and the difference between the two figures, which is the balance.
9.2 Income
Income means money received and it includes money coming in from all sources,
both earned and unearned.
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9.2.1 Earned income
Earned income is from work on either an employed or a self-employed basis. People
who work for an employer will receive income paid weekly or monthly which is either
the same or a very similar amount each time. Some employers pay a basic salary that
is supplemented by bonus payments if the company or the employee performs
particularly well. For example, the department store John Lewis is owned by its
employees who receive a bonus if the store makes sufficient profits. Another example
is Barney, who works for a television group as a sales adviser. He earns a low basic
salary but receives a commission on sales and can earn up to 100% more if he meets
his sales target for the year. Some employers also pay overtime if staff work more
hours than they are contracted to do – for example, Pat Martin is paid £9.50 for every
extra hour the bakery asks her to work.
People who are self-employed often receive earnings of a less predictable amount
and on a less predictable schedule than people who work for an employer. They may
be paid a deposit before they start working on a project and / or are paid on
completion of a part or the whole of a project. For example, Stefan is a self-employed
painter and decorator. His clients pay him a small deposit at the beginning of a
project to cover some of the cost of the supplies he will be using; they pay the rest
of the fee when he has completed the job. Kirsten is a self-employed chiropractor
and is paid by clients at the end of each treatment. The amount she earns varies
from month to month, depending on how many clients she treats. Derek runs his
own company manufacturing soaps and bath oils. He pays himself once a quarter if
the company is in profit.
9.2.2 Unearned income
Unearned income is from any source that is not work and includes:
◆ benefits, which may be paid weekly, once every two weeks or monthly;
◆ state and private pensions, which are usually paid monthly;
◆ interest on savings, which may be paid monthly or, more usually, once a year;
◆ returns on investments such as dividends, which are paid to shareholders once
or twice a year if the company performs well;
◆ allowances paid by family members, which may be paid weekly or monthly;
◆ financial gifts that may be received on birthdays and at Christmas and other
celebration days;
◆ one-off payments (also known as windfalls), such as an inheritance or a win on
the Premium Bonds; and
◆ loans, which are incomings that must be repaid with interest and charges.
People usually prepare a budget that has the same time period as the frequency with
which they receive income. So someone who received income on a weekly basis
would prepare a weekly budget and someone who is paid monthly would prepare a
monthly one.
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9.3 Expenditure
Expenditure means outgoings and includes money used to make payments, to repay
borrowing and / or to save. Expenditure falls into three broad categories: mandatory,
essential and discretionary.
9.3.1 Mandatory expenditure
Mandatory expenditure means the payments are compulsory; they do not
necessarily apply to everyone but if they do apply, they must be paid. Examples
include the following:
◆ Income tax and National Insurance (NI) contributions – people who work for
an employer receive their income after income tax and National Insurance
payments have been deducted. This is termed net income. The employer pays
income tax and NI contributions to HM Revenue and Customs (HMRC) on its
employees’ behalf. People who are self-employed must make these mandatory
payments to HMRC themselves. This is discussed in more detail in Topic 12.
◆ Council tax – this is a payment to the local authority towards the cost of local
services, such as refuse collection, fire and rescue services and sports facilities.
The amount that people pay depends on the value of their home, whether it is
rented, owned or being paid for on a mortgage. Each council sets its own charges
for each valuation band. A full council tax bill is based on two or more adults
(people aged 18 or over) living in the household. People who live on their own
can get a discount. There are also exemptions for different groups of people such
as people on apprentice schemes, full-time college and university students and
live-in carers. People on low incomes or benefits can have their council tax
reduced and may not need to make any payments. Council tax is usually paid in
10 instalments over the financial year.
◆ TV licence – people need a TV licence if they watch live TV or record TV as it is
being broadcast. This applies to all devices that can receive broadcast signals,
such as TV sets, computers, laptops, mobile phones, tablets, DVD and video
recording devices, and digital boxes. A TV licence is also required to catch up on
TV online with the BBC’s iPlayer service. One TV licence covers all the devices in
a home.
◆ Motor insurance, road tax and an MOT – motor insurance is a legal requirement
for everyone who drives on public roads. This applies to all vehicles such as cars,
vans, motor cycles and mopeds. Third-party insurance is the minimum level of
cover required as this protects other people, vehicles, animals and property if the
motorist causes them damage or injury. Topic 10 coversthe different types of
motor insurance available. Road tax must be paid for all vehicles that are driven
on public roads; if the vehicle is more than three years old, it must also have an
MOT certificate. MOT stands for Ministry of Transport and means the tests that
are carried out to ensure a vehicle is safe to be on the roads and meets
environmental standards.
If people do not pay these expenses they are breaking the law and can be fined; in
extreme cases, they may be sent to prison.
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John Martin’s mandatory expenditure
John Martin gets paid monthly and so is preparing a
monthly budget. His income is paid net of income tax and
National Insurance. His employer also contributes to an
occupational pension for him.
Table 9.1 shows the top rows of John’s budget.
Table 9.1: Income and mandatory expenses on John Martin’s budget
£
Income
Mandatory expenses
2,400.00
£
Council tax
178.00
TV licence
13.25
Car insurance
18.00
Road tax
14.60
MOT
4.57
John entered his next monthly salary as his income figure. He has £4,000 in a
cash ISA but this will not pay any interest for a year.
John pays the council tax on the family home by direct debit which works out at
£178.00 per month for 10 months. To make sure that he has made sufficient
allowance for this expense in his budget, John uses the full monthly figure in
his budget rather than working out the cost over 12 months. John also pays his
TV licence and car insurance by monthly direct debit to spread the cost.
He pays the road tax and MOT for the family car once a year but makes an
allowance in his budget for these payments by allocating one-twelfth of the cost
to each month. For example, the vehicle tax (often called road tax) on his car is
£175: dividing by 12 means that each month John sets aside £14.60 towards
the next road tax payment. The money accumulates in his current account over
the 12 months.
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9.3.2 Essential expenditure
Essential expenditure is spending on items that people need to live and includes:
◆ rent or mortgage repayments on a home;
◆ food and drink;
◆ water supplier;
◆ gas and electricity suppliers;
◆ basic clothing; and
◆ travel that enables people to earn their income.
People have to buy these types of item but they have a choice over which product to
buy and which supplier to use – they can shop around for the best prices on food
and switch suppliers to get a better deal on gas and electricity, for instance.
Loan repayments are also essential expenditure if people want to maintain a good
credit history, also known as maintaining creditworthiness (see Topic 6). People who
have made frequent late payments or defaulted on borrowing products may find it
difficult to obtain credit in the future. Providers may decline their applications or
only offer them borrowing products with high costs.
People may also prioritise certain items of expenditure and add these to their
essentials list; examples might include insurance to protect their possessions and
life cover to protect their dependents when they die. People may prioritise certain
types of saving, too, such as saving for their children or their old age.
John Martin’s essential expenditure
John’s largest expense is his monthly mortgage repayment.
John borrowed £133,000 to buy the family home and is
repaying it over 25 years. (Mortgages are discussed in
Unit 2.) Keeping the house is a top priority for John so he
is willing to use nearly one-third of his income to make the
mortgage repayments. His mortgage provider made it a
condition of the mortgage that he take out buildings insurance to cover
the cost of repairing any damage to the property; the insurance policy John
bought covers loss and accidental damage to the contents of his house, too.
The mortgage provider also made it a condition of the mortgage that he take
out cover on his life, so the mortgage would be repaid in the event of his death.
John has taken out further life cover to protect his family by paying a lump sum
when he dies. At the moment, all their children and their grandchild live with
him and Pat, and the two of them pay their living expenses.
Table 9.2 shows the essential expenses on John’s budget.
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Table 9.2 Essential expenses on John Martin’s budget
Essential expenses
£
Mortgage repayment
778.00
Buildings and contents insurance
25.00
Life cover to repay mortgage
30.00
Life cover to protect family
100.00
Water supplier
35.00
Gas and electricity supplier
85.00
Telephone (landline)
60.00
Internet
20.00
Own mobile
31.00
Pete's mobile
25.00
Car loan repayment
100.00
Petrol
60.00
Breakdown cover
36.00
Personal pension payment
230.00
John also pays for the utilities: the water supply to the house, the telephone
landline and the gas and electricity needed for heating, lighting, cooking, and
running equipment such as the fridge and the TV. All these expenses are paid
by direct debit because the suppliers offer a discount for doing so.
John considers paying for internet access an essential, as the internet is used by
all members of the family to get information, communicate with friends, shop
and be entertained. He has also put his mobile phone expenses on the essentials
list; however, he recognises that internet and mobile expenses are not needs
and that he and his family could do without them if they had to. The exception
is Pete’s basic expenses on his mobile phone because John considers it essential
that Pete can contact his family in an emergency.
The car loan repayment is definitely an essential, however, as John has entered
into a contract to repay this amount. If he misses or is late with a repayment it
will impact his credit history and may make it difficult for him to borrow in the
future; if he misses several payments his car might even be repossessed. John
considers the petrol and breakdown cover expenses to be essentials as he uses
the car to get to work and would find it very difficult to get there on public
transport.
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Last on the list of essential expenses is his personal pension contribution. John
knows that his wife Pat has no savings and will be entitled to only a state pension
when she retires. He wants to save into a personal pension so that he will be
able to pay for both of their living expenses when they retire and possibly
continue to pay some expenses for his children and grandchildren if they are
unable to find work or are in financial difficulties.
John has not included food and drink or basic clothing on his essential expenses
list because Pat pays for these.
9.3.3 Discretionary expenditure
Discretionary expenditure is voluntary spending on products and services that people
want now, and saving towards items that they aspire to buy in the future. These items
include fashion items, meals in cafes and restaurants, cinema tickets, music
streaming platform subscriptions, DVDs and games, gifts, hobby equipment,
holidays and other desirable but non-essential items. People may also save for highvalue items they want in the future, such as driving lessons or a wedding, or putting
down a deposit on a car or a home.
John Martin’s discretionary expenditure
Table 9.3 shows the discretionary spending in John’s budget.
Table 9.3 Discretionary expenses on John Martin’s budget
Discretionary expenses
£
Saving for gifts and emergencies
250.00
Day-to-day expenses
250.00
Football magazine
4.95
Charity
6.00
John has a maximum amount of £560.65 to use on discretionary expenses. This
is calculated as:
£2,400 income – (£228.42 mandatory expenses + £1,615.00 essential expenses)
= £556.58.
John has allocated £250 for saving towards gifts and for emergencies such as
replacement tyres or unexpected expenses. He has also allocated £250 a month
for day-to-day expenses. These include buying his lunch at work, taking the
family out at the weekend and helping Pat or the children if they want money.
John’s main item of personal expenditure is his football magazine. He also
supports two charities by paying them each £3 a month by direct debit.
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9.4 Balance
The budget balance is total income minus total expenditure. It is the person’s net
financial situation.
◆ If the balance is zero, the budget is balanced, with all income assigned to be used
on making payments, repaying borrowing or saving.
◆ A positive balance means that the budget is in surplus and there is money
available to increase spending, make larger debt repayments, if applicable, or to
save. People with budgets that are balanced or have a surplus are described as
living within their means.
◆ A negative balance means the budget is in deficit. If people calculate their budget
and discover that outgoings are greater than incomings, they can choose to
increase income (if possible), decrease spending or borrow. People with budgets
that have a deficit are described as living beyond their means.
9.4.1 Dealing with a budget deficit
Anya in Topic 6 chose to borrow £100 a month on an overdraft when her budget
was in deficit. Her essential living expenses plus her discretionary spending on
socialising and fashion were greater than her income. When Anya found that she
could not repay her borrowing easily she decided to reduce spending and spread the
cost of repaying her debt over a longer period of time.
If people decide to reduce spending they are more likely to be able to cut back on
discretionary spending than essential spending. Even within the essential spending
category, however, they may be able to reduce costs – for instance, by spending less
on food. They could make their own lunch to take to work, for example, rather than
buying a sandwich or they could visit the supermarket at the end of the day when
food that must be eaten soon is more likely to be reduced in price.
If people are aiming to reduce spending they could also consider using only cash for
discretionary spending and withdrawing a planned amount each week. Using cash
makes it easier to see how much is left from the amount allocated to that week’s
spending. A spending diary is also useful as it is easy to forget some purchases,
especially if they are for low values.
9.4.2 Setting out the budget
It is helpful to set out a budget so that income is at the top and expenses are
deducted in order of priority – that is, mandatory, essential and discretionary with
the balance at the bottom. Setting out a budget in this order allows people to identify
which expenses they have no choice over and which they could change.
When people draw up their initial budget they may find an imbalance that they
address by changing the amounts allocated to different expenditure. These changes
will be determined by the person’s priorities such as to save, to live within their
means or to repay borrowing.
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John Martin’s budget
John Martin has set out his budget with expenses listed in
order of priority, as Table 9.4 shows.
Table 9.4: John Martin’s full budget
£
Income
2,400.00
Mandatory expenses
Council tax
178.00
TV licence
13.25
Car insurance
18.00
Road tax
14.60
MOT
4.57
Essential expenses
156
Mortgage repayment
778.00
Buildings and contents insurance
25.00
Life cover to repay mortgage
30.00
Life cover to protect family
100.00
Water supplier
35.00
Gas and electricity supplier
85.00
Telephone (landline)
60.00
Internet
20.00
Own mobile
31.00
Pete's mobile
25.00
Car loan repayment
100.00
Petrol
60.00
Breakdown cover
36.00
Personal pension payment
230.00
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Discretionary expenses
Saving for gifts and emergencies
250.00
Day-to-day expenses
250.00
Football magazine
4.95
Charity
6.00
Total expenses
2,353.30
Balance (income minus expenses)
45.63
The balance on John Martin’s budget is £45.63. In practice, he sometimes has a
few pounds more left at the end of the month and sometimes he has a few
pounds less. This is because the amounts he spends on petrol and day-toexpenses can vary a little from month to month. John’s goal is to balance his
budget so he aims to keep his spending within the amounts listed on his budget.
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9.5 Monitoring incomings and outgoings
Once people have drawn up a budget for their planned income and expenditure, their
next step is to monitor their actual incomings and outgoings to see if they want to
change their budget and / or their financial habits. To track incomings and outgoings
people can view current account and credit card transactions online and on paper
statements, keep receipts, record transactions, and check account balances at an ATM.
Pat Martin’s budget
Pat has drawn up a monthly budget. She finds it more challenging than John
did, because, unlike John, few of her expenses are set amounts per month. It is
therefore difficult to predict what her expenditure will be. Table 9.5 sets out her
current monthly budget but she is not sure how accurate it is; she knows that,
in practice, she gives Alice as much money as she can and also gives cash to
Kathy occasionally, although she has not recorded this expenditure on her
budget.
Table 9.5 Pat Martin’s monthly budget – version 1
Income
£
Job
750.00
Child benefit (for Pete)
82.00
Total income
832.00
Essential expenses
Groceries and household items
520.00
Clothes and toiletries
120.00
Discretionary expenses
Extras
30.00
Pocket money for Ross
20.00
Allowance for Pete
60.00
Allowance for Alice
80.00
Total expenses
830.00
Balance (income minus expenses)
158
2.00
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To try to create a more accurate budget, Pat tracks her incomings and outgoings
for three months and notices the following:
◆ She does an extra morning at the bakery at least once a month.
◆ Her supermarket shopping bills vary between £110 and £140 a week,
depending on how many of the children eat at home and how much she uses
the food in the freezer. This gives her an average grocery cost of £125 per
week and £500 per month.
◆ She spends more than she had thought on extras for the children and Ross,
such as hair cuts, movies and games. Instead of the £30 per month she had
budgeted it is an average of £65 per month.
◆ She gives Kathy cash regularly and this averages out at £30 per month.
◆ She thought that she was withdrawing just £100 a week in cash to pay for
her main expenses but she is also buying items using her credit card and
withdrawing extra cash as she needs it.
Pat now records her actual income and expenditure on her budget (Table 9.6).
Table 9.6 Pat Martin’s monthly budget – planned and actual
Planned £
Actual £
750.00
750.00
Income
Job
Extra hours at bakery (£9.50 x 4)
38.00
Child benefit (for Pete)
82.00
82.00
Total income
832.00
870.00
Groceries and household items
520.00
500.00
Clothes and toiletries
120.00
120.00
Extras
30.00
65.00
Pocket money for Ross
20.00
20.00
Allowance for Pete
60.00
60.00
Essential expenses
Discretionary expenses
Money for Kathy
30.00
Allowance for Alice
80.00
80.00
Total expenses
830.00
875.00
2.00
- 5.00
Balance (income minus expenses)
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Pat’s actual budget is in deficit because she is spending more than her income
in an average month. Her options are to:
◆ increase her income by working more hours at the bakery, if possible;
◆ cut back on spending; or
◆ borrow money.
Pat decides to discuss working extra hours with her manager and to reduce her
expenditure, as she does not want to incur debt that she will find difficult to
repay. When Kathy gets her promotion and Alice finds a job, Pat’s expenses will
reduce by about £110 per month (£30 plus £80 she gives to her daughters at
the moment). Pat plans to save at least £50 a month at that point so she can
build up a fund for unexpected expenses.
9.6 Cash flow forecasting
Budgets tend to focus on one time period. People can use cash flow forecasting to
predict incomings and outgoings over several time periods and to identify:
◆ when irregular income will be received, such as earnings from self-employment;
◆ when unusually large payments must be made;
◆ options for how to finance short-term deficits; and
◆ when they might have surpluses they can use to save or to make larger
repayments on debts, if applicable.
Creating a cash flow forecast
Nathan is a freelance writer for magazines who rents a room
in a shared house. His earnings vary from month to month
depending on what he has been commissioned to write. He
can use a budget surplus from one month to pay expenses
when he has a budget deficit. Instead of writing a new budget
every month he writes a cash flow forecast that predicts
money coming in and money going out over the next six
months (Table 9.7).
This cash flow forecast shows the following:
◆ In month 1 Nathan will have a surplus of £69.00 because his earnings will
be greater than his total expenses.
◆ In month 2 he will have a deficit of -£331.00 because his earnings will be
less than his expenses. He can pay for this shortfall, in part, by using his
surplus from month 1 which he brings forward to month 2. This is shown in
the row labelled ‘balance brought forward from previous month’. This means
that Nathan’s net balance for month 2 will be a deficit of -£331 for month 2
plus last month’s surplus of £69 which equals a net deficit of -£262.
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Table 9.7 Nathan’s cash flow forecast for the next six months
Month 1
Month 2
Month 3
Month 4
Month 5
Month 6
1,200.00
800.00
2,400.00
1,000.00
800.00
2,000.00
Mandatory
expenses
205.00
205.00
205.00
205.00
205.00
205.00
Essential
expenses
526.00
526.00
526.00
526.00
526.00
526.00
Discretionary
expenses
400.00
400.00
400.00
400.00
400.00
400.00
Total
expenses
1,131.00
1,131.00
1,131.00
1,131.00
1,131.00
1,131.00
Monthly
balance
69.00
- 331.00
1,269.00
- 131.00
- 331.00
869.00
Balance brought
forward from
previous month
0.00
69.00
- 262.00
1,007.00
876.00
545.00
Net cash position
69.00
- 262.00
1,007.00
876.00
545.00
1,414.00
Total income
◆ In month 3 Nathan is expecting higher-than-usual earnings of £2,400. This
will give him a surplus for the month of £1,269. This money can pay for the
previous month’s deficit of -£262.00 and give him a net surplus of £1,007.00
to carry forward to month 4.
◆ In month 4 his expenses will be larger than his income and he is predicting
a deficit of -£131 for the month. He will have a net surplus of £1,007 at the
end of month 3 so he can pay for the month 4 deficit from this money that
he will have brought forward.
◆ In month 5 Nathan predicts his earnings will still be lower than his total
expenses. He can pay for this deficit from money brought forward from
month 4.
◆ In month 6 Nathan expects his income to increase and that his income will
be greater than his expenses. This means that the surplus he brings forward
from month 5 will not be used to finance any shortfall in month 6. Instead it
can be carried forward to finance any deficits in the future.
This cash flow forecast shows that Nathan needs to borrow £262 in month 2
because he will have a net deficit that month. It also shows that he will be able
to repay the borrowing in the next month. Nathan decides to ask his bank for
an overdraft limit of £300 on his current account to finance his predicted deficit
of -£262. He can also aim to reduce his discretionary spending that month to
reduce the need for borrowing and to repay the overdraft in full as soon as he
is paid in month 3.
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Although Nathan’s earnings will be lower than his expenses in months 4, 5 and
6 and each month will have a deficit, he can finance the shortfall from the
surplus he will carry forward because his earnings will be so high in month 3.
Nathan can also use this information to identify when he would like to earn
more. He can approach his work contacts for more commissions that will be
paid in month 4 and 5.
The cash flow forecast also shows that Nathan has a net surplus for all months
except month 2. He decides to put the surplus funds into an instant access
savings account. This means that Nathan will earn interest on the money and
that he can withdraw what he needs at any time without incurring penalties. This
will be useful for Nathan as he may have budget deficits in future months that
he wishes to fund from these savings.
9.7 The cost of living in the UK today
When people budget and forecast their cash flow they need to consider the impact
that the cost of living will have upon their outgoings, especially their essential
expenses such as housing, power (gas and electricity), food and transport (fuel for
cars and tickets on public transport). The current cost of essential items and inflation
– that is, the general rise in prices – are the main factors to consider. Topic 5
explained what inflation is and how it is measured. Inflation indices such as the
Consumer Prices Index (CPI) and Retail Prices Index (RPI) use a basket of goods that
the ‘average’ household may use. These days it is possible for people to calculate
their own inflation rate by using online tools that calculate a rate based on the goods
that the individual actually buys.
According to research conducted by the Office for National Statistics (ONS), the most
costly items of essential expenditure for UK households are housing, fuel and power
(gas and electricity). UK households spent an average £53.80 per week on these items
in 2005/06 and this had risen to an average £79.40 per week in 2019 (ONS, no date).
Increases in the cost of
living can make it very
difficult for people to
manage a budget,
especially if their income
is fixed, such as
pensioners.
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9.7.1 Housing costs
The costs of housing are rents and mortgages, both of which have risen since the
credit crunch. According to government figures, rents in England are rising by an
average of £150 per year with some local authority rents rising between £570 and
£1,700 per year between 2011 and 2016 (GOV.UK, 2017). There are many reasons
for these increases. An important one is that people find it difficult to move from
renting a home to buying because:
◆ wages are static or falling in real terms;
◆ essential expenses are rising;
◆ saving interest rates are very low; and
◆ prospective home buyers need large deposits before they can borrow money on
a mortgage and providers are lending less money than they used to.
As a result of all these factors, there is increased demand for properties to rent,
which in turn pushes up rents making it even more difficult for people to save the
deposit they need to buy a home.
9.7.2 Fuel costs
Fuel prices have increased significantly since 2007. The costs of fuel for cars and
public transport and power for homes are related to the cost of crude oil, which has
risen. The cost of oil has been magnified for the UK because it is traded in dollars
and the pound has weakened against the dollar, so one pound buys fewer dollars.
Another factor in the prices of petrol and diesel is the duty or tax that is paid. Figure 9.1
shows an example of how the price of one litre of unleaded petrol is made up in the UK.
Figure 9.1 Cost breakdown for one litre of unleaded petrol costing 134.66p
7.21p
Fuel duty and VAT
47.06p
Cost of petrol
80.39p
Retailer and delivery company
Source: UKPIA (2014)
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163
The Chancellor sets the amount of duty on fuel in the Budget. The duty paid on other
items such as beer, wine, spirits, cigarettes, and air passenger tickets, and the level
of value added tax (VAT), is also set in the annual Budget.
9.7.3 Food costs
Food is another essential expense that has risen significantly in the past. Food prices
rose 32% in the five years to 2012, according to the Department for Environment,
Food and Rural Affairs (Defra). This is due to reduced supply because changing global
weather patterns have caused poor growing conditions, such as droughts and floods,
both in the UK and in other countries that supply food to the UK. Increases in the
global population have also meant that demand for food has risen. In 2017, UK food
prices rose at the fastest rate in four years, as a result of the falling value of the
pound after the decision to leave the European Union (Jackson, 2017).
The cost of living index in the UK was ranked the 27th most expensive in the world
in 2022 according to Numbeo, which collects data from authoritative sources around
the world.
Key ideas in this topic
◆ Using budgets to manage money.
◆ Items of income and mandatory, essential and discretionary expenditure.
◆ The importance of repaying debt to maintain creditworthiness.
◆ Managing a balance that is in surplus or in deficit.
◆ Using cash flow forecasting to predict incomings and outgoings.
◆ Using short-term financing to manage a deficit.
◆ Elements that contribute to the cost of living in the UK today.
References
GOV.UK (2017) Live tables on rents, lettings and tenancies [online]. Available at:
https://www.gov.uk/government/statistical-data-sets/live-tables-on-rents-lettings-and-tenancies
Jackson, G. (2017) UK food prices rise at fastest rate in four years. Financial Times [online],
14 November. Available at: https://www.ft.com/content/84807466-c91d-11e7-ab187a9fb7d6163e Please note: FT.com requires a subscription.
Numbeo (2022) Cost of living index by country 2022 [online]. Available at:
https://www.numbeo.com/cost-of-living/rankings_by_country.jsp
ONS (no date) Expenditure [online]. Available at:
https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/expen
diture
UKPIA (2014) Understanding pump prices.
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Topic 10
Dealing with unexpected events
Learning outcome
After studying this topic, students will be able to:
◆ provide solutions for dealing with unforeseen events that impact on current
finances.
Introduction
Some unexpected events have a positive impact on people’s finances, such as an
unexpected promotion at work or a lottery win. Other events have a negative impact,
such as redundancy or reduced hours at work, repair bills, or an increase in rent or
mortgage payments. This topic explores the action that people can take to maximise
the positive impacts and minimise the negative impacts.
Insurance policies are financial products designed to protect people from the
financial losses associated with unexpected events. There are four main types of
insurance, shown in Figure 10.1.
Figure 10.1 Types of insurance
General insurance
Includes motor, buildings, home contents,
travel, and pet policies
Life cover
Designed to protect other people from the financial
consequences of someone’s death
Health insurance
Used to protect people against the financial loss of
being too unwell to work or being diagnosed with a
critical illness
Pensions policies
Enable people to save for their retirement.
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This topic focuses on general insurance.
Buying insurance is one way that people can deal with the risk of losses due to
unexpected events. Alternatively, people can save for emergencies or borrow to make
repairs or replace items. Depending on the measures that people have in place to
deal with financial loss, they may also need to change their budget to allocate funds
to cover unexpected expenses that they had planned to use elsewhere.
10.1 Key features of insurance
Insurance policies offer protection against the financial consequences of events that
might occur, for example, fire, theft or accident. Insurance is a financial product that
is provided by specialist companies called insurers and is covered by the Financial
Ombudsman Service. Drivers are legally required to take out motor insurance; people
buy other forms of insurance if they think the risk of something happening makes it
worthwhile paying the cost of the protection.
10.1.1 Premiums
The price of an insurance policy is called the premium. The premium is based on:
◆ how likely an event is to occur;
◆ the amount of money needed to put things right if the event happens (to replace
a bicycle that has been stolen, for instance), known as the sum insured;
◆ the length of time that the policy will be in force, known as the term;
◆ the amount of money the policyholder will pay towards repairs or replacement,
known as the voluntary excess; and
◆ how the premium is paid – that is, as one payment or in monthly instalments.
Insurance companies work out the risk of an event happening based on statistics,
for example how likely it is that a particular car driver will have a car accident. To
calculate the risk, insurance companies require detailed information from the person
applying to buy the insurance.
People who have insurance build up a no claims discount or no claims bonus for
each year they do not make a claim. For example a one-year no claims discount on
a motor policy can range between 27% and 57.5% depending on the insurance
company. The higher the number of years that someone has not made a claim, the
higher the no claims discount will be and so the lower the premium charged. Insurers
typically offer a maximum no claims discount on motor policies of between 60% and
75% for four or more years of no claims, although some insurers offer an 80%
discount for five years or more of no claims.
Insurance companies often offer a protection for their no claims discount (called
protected no claims discount). For a premium, this means motorists can make a small
number of claims each year without losing their no claims discount.
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Applying for motor insurance
Tanya and Rob are twins, aged 20, who are applying
for motor insurance. The application form asks for
personal information about them including the
following details:
◆ Where they live – cars are more likely to be
damaged or stolen in some areas than in others.
◆ Their age – younger drivers are more likely to be
involved in accidents than older, more experienced
drivers. In 2013, for example, over 6,500 drivers
were killed or seriously injured in car accidents and
24% of them were in their teens or early twenties
(RAC Foundation, 2015).
◆ How long they have been driving – this tells the insurer how much driving
experience they have.
◆ Details of any penalty points they have on their driving licence or convictions
for dangerous driving, or any accidents they have been involved in – the
insurer uses this information to decide how likely the applicant is to be
involved in accidents.
◆ Whether they have made a claim on a motor insurance policy in the past –
this is an indication of how likely they are to claim again in the future.
The insurance company also wants to know details about the car they will drive,
including its make and model, its engine size, its age and market value and if it
is kept on the road rather than in a garage or on a driveway. All these factors
will affect how likely the car is to be stolen or in an accident, and how much the
insurer would need to pay to repair or replace it.
Until December 2012, the twins would also have been assessed on their gender,
as statistically the accidents that involve young men are more expensive than
the accidents that involve young women. Insurers can no long use gender to
determine premiums however because the European Court of Justice ruled that
this contradicted laws on discrimination.
Most general insurance premiums are subject to insurance premium tax. This tax
was introduced by the Finance Act 1994 and is charged at 12% for most premiums
and 20% for travel insurance. The cost of the tax is included in the premium the
policyholder pays.
People may pay a one-off premium, for example for single-trip travel insurance, or
an annual premium, such as for home contents insurance and motor insurance.
People can spread the cost of an annual premium by paying monthly. Many providers
charge customers extra for paying monthly, however, as it is a form of credit.
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Insurers send renewal notices quoting the price of the next year’s premium to
policyholders who have annual insurance. Policyholders can shop around for the
policy that best meets their needs and decide whether to renew with their existing
insurer or to switch to another company.
The insurance company puts all the premiums that are paid for a certain type of policy
into a pool. Policyholders who actually experience the event for which they have taken
out insurance cover, such as a burglary, are paid from the pool. Policyholders who do
not experience the event they have insured against receive nothing.
10.1.2 Providing full information
Insurers use the information provided by people on their application forms to set
the premium for the insurance policy. It is therefore very important that this
information is accurate. If someone enters misleading information on an application
form the insurance policy will be void and the insurer will refuse any claims made on
it. For example, Miranda has bought travel insurance to cover her holiday to the USA.
When she completed the application form she did not disclose that she has epilepsy.
If she suffers a seizure while on her holiday, her insurance policy will not cover her
medical expenses because her epilepsy is a pre-existing condition that the insurance
company needed to know about before it accepted her risk.
In April 2013 the Consumer Insurance (Disclosure and Representations) Act 2012 came
into force. Before this law was introduced, people were responsible for telling insurers
any detail that might affect their policy, either at the application stage or while the
policy was in force. This could cause policyholders problems if they did not realise
that certain information was important, such as modifications made to their car. In the
past, insurance companies have rejected claims because, for example, the policyholder
did not tell the insurer about a childhood illness or a long-forgotten driving conviction.
The Act makes it the insurer’s responsibility to ask for all the information they require
to calculate the premium.
10.1.3 Policy documents
When people have paid the insurance premium they receive a policy document and
a certificate of insurance. The policy document details what is covered by the
insurance policy and the terms and conditions for policyholders making a claim. It is
often accompanied by a separate policy schedule that includes the specific details
relating to the policyholder (such as the sum insured and excess). It is very important
that policyholders check that the insurance they have bought:
◆ covers the events the policyholder wants to insure against; and
◆ will pay sufficient compensation if the event occurs.
The ‘sum insured’ is either a set amount of money or is described as ‘new for old’
(the insurer will pay for a new item) or replacement cost (the insurer will pay the
value of an item with similar wear and tear).
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The insurance certificate details who the policyholder is and provides a summary of
the cover given by the insurance. The certificate is proof that the policyholder is
covered by the insurance and includes the policy number. This evidence is needed if
the policyholder wishes to make a claim.
Motor insurance documents can be requested by the police following an accident. In
the past, drivers had to show their insurance documents when they bought road tax
for their vehicle at a post office. Now, however, when someone buys road tax at a
post office or online, the Driver and Vehicle Licensing Agency (DVLA) checks
electronically that an insurance policy is in place. If people need proof of insurance
before a certificate has been printed, the insurer can issue a temporary cover note.
This is particularly useful when people buy cars and need to have insurance cover
before they can drive the car home.
10.1.4 Claims
If any of the events covered by the insurance policy occur, the policyholder can make
a claim to the insurance company. The insurer’s claims department will assess the
details of the claim to determine whether or not the policyholder is covered and how
much the insurer will pay.
10.2 Motor insurance
The Road Traffic Act 1988 makes it compulsory for people who drive to have at least
third-party motor insurance. If the driver causes injury to another person (a ‘third
party’), or damages their car and other property in an accident, third-party insurance
covers that person. It does not cover injury to the driver or damage to their car.
People who are caught driving without insurance cover can be fined £300 and given
six penalty points on their driving licence. If the case goes to court they can be given
an additional unlimited fine and disqualified from driving. The police can also remove
and, in some cases, destroy their car.
After an accident a claims assessor investigates the extent of the damage and the costs of repair.
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10.2.1 Types of motor insurance
Third-party motor insurance is traditionally the lowest-cost motor insurance available.
Motorists have a choice of two other types of policy as well:
◆ third-party, fire and theft; or
◆ comprehensive motor insurance.
Third-party motor insurance usually covers the cost of:
◆ injuries to other people, including passengers (for example, their medical costs);
◆ damage to other people’s property;
◆ accidents caused by passengers; and
◆ damage caused by a caravan or trailer while attached to the car.
Third-party, fire and theft motor insurance usually covers the cost of:
◆ all the third-party items listed above; and
◆ repairs to or replacement of the driver’s car if it is damaged or destroyed in a fire
or is stolen.
Comprehensive motor insurance usually covers:
◆ all third-party and fire and theft items listed above;
◆ accidental damage to the driver’s car;
◆ a personal accident benefit: a sum of money paid on the death of the driver or
for specific types of permanent disablement that the driver (and sometimes their
spouse or family member) sustains in an accident;
◆ medical expenses related to an accident, up to a stated limit; and
◆ loss of or damage to personal possessions in the car, up to a stated limit.
When choosing which motor insurance product to buy, motorists need to consider:
◆ what they can afford;
◆ how much it would cost to make repairs to or replace their car; and
◆ whether or not their personal possessions are covered by another insurance
policy.
The terms and conditions of policies vary, so it is important that people read the
details of what is covered before choosing a specific insurance product. Some
premiums are quoted with standard ‘extra’ services, such as cover for legal costs,
for example. Comprehensive motor cover may be more expensive than third-party,
fire and theft, or it may turn out cheaper, because insurance providers have noticed
that drivers who only buy third-party insurance are more likely to make a claim
(Moneysupermarket, 2021). Different providers have different pricing structures,
however, so people can benefit from shopping around for the best prices for the
cover they need.
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10.2.2 Pay-as-you-go insurance
People who do not drive very often can reduce the costs of insurance by choosing a
pay-as-you-go policy. The insurer fits a telematic GPS tracking device, sometimes
called a ‘black box’, to the car. This device records the number of miles driven and
driving habits in terms of speed, the type of road the car is travelling on, the time at
which the journey is made, and how the driver is braking and cornering. This
information is transmitted to the insurer via satellite. The insurer uses the
information to charge a per-mile cost which is based on how safely the driver is
driving, when they drive and how long their journeys are. For example, people who
drive short distances during off-peak times are less likely to be involved in accidents
and therefore have lower per-mile costs. Many insurers give the driver access to the
data and advice on how to drive more safely to reduce the cost of the premium.
Pay-as-you-go insurance may not work out cheaper than conventional insurance if
drivers have to travel during peak hours such as the rush hour and cannot keep to a
low mileage. Further, some insurers charge a fee for the black box and/or for
installing it in a car.
10.2.3 Reducing the cost of motor insurance
The Association of British Insurers (ABI) gives the following advice for cutting the
cost of car insurance (ABI, 2022):
◆ When shopping around, compare the details of what is covered by different
policies, as well as the cost.
◆ Fit an approved alarm or immobiliser, as insurers offer discounts for cars that
are secure. Premiums may also be lower for cars kept in a garage, rather than
parked on the street or in a driveway.
◆ Pay a higher voluntary excess, as this will mean the insurer pays less on any
claims made.
◆ Only use the vehicle for social, domestic and pleasure purposes, as business use
increases premiums.
◆ Build up a no-claims discount. These discounts can be between 30% for one claimfree year and 60% for five claim-free years.
◆ Pay the premium as one payment if possible because some insurers charge extra
for paying in instalments.
◆ Drive a lower-powered car, as a smaller engine size usually means a lower
premium.
uSwitch (2021) adds the following tips:
◆ Pick the right cover: look at all three levels of cover as third party is not always
the cheapest.
◆ Protect your no claims discount: pay a fee to ensure you do not lose it in the event
of a claim.
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‘Fronting’
Neil’s daughter, Jasmine, is 17 years old and has
recently passed her driving test. He has decided to buy
her a small secondhand car. As car insurance is very
expensive for young drivers, Neil is thinking about
taking out an insurance policy that names him as the
main driver and adding Jasmine as a ‘named driver’,
that is, someone who might drive the car occasionally.
He thinks that this might be a good way of reducing the
cost of the insurance policy. Luckily, before he puts his
idea into action, Neil reads a newspaper report that
explains this practice is called ‘fronting’ and is illegal
because it is fraud. The penalties for fronting include a fine or even a prison
sentence for the older driver and the younger driver can be banned from driving.
10.3 Buildings and home contents insurance
Buildings insurance covers the cost of repairing or rebuilding a property if it is
damaged or destroyed, for example in a fire or by subsidence. Policyholders may be
able to add accidental damage for an extra premium, to cover risks such as a car
hitting the property. If people are renting a property, the buildings insurance will be
paid for by the landlord. People who own a property or are buying it will need enough
buildings insurance to cover the cost of rebuilding the property if necessary. Lenders
will insist that borrowers take out buildings insurance to protect the property on
which the mortgage is secured.
Contents insurance covers belongings kept in the home that people can take with
them when they move, such as:
◆ electrical goods like televisions, computers, fridges and freezers;
◆ personal items such as DVDs, CDs, books and mobile phones;
◆ furniture;
◆ furnishings such as carpets and curtains;
◆ clothing;
◆ money; and
◆ valuables such as jewellery and cameras.
The risks covered are usually loss or damage from events such as:
◆ fire, explosion, lightning and earthquake;
◆ storm and flood;
◆ aircraft and items dropped from aircraft;
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◆ collision involving vehicles or animals;
◆ theft or attempted theft;
◆ falling trees and branches;
◆ falling TV or radio aerials and satellite dishes; and
◆ water escaping from tanks or pipes.
Policyholders can pay extra and receive cover for accidental damage or loss as well.
There is usually a maximum limit on the value of goods that are covered by a policy,
such as up to £75,000. The policyholder chooses the maximum when applying for
the insurance and the insurer uses the maximum sum insured as part of the premium
calculation.
The details of what is covered vary from policy to policy. For example, some policies
cover personal belongings such as mobile phones when they are taken out of the
home for short periods of time. Others cover the contents of gardens, freezers or
students’ possessions at university. The exclusions also vary from policy to policy.
For example, some policies do not cover contents in a home that is left unattended
for long periods of time. People need to investigate the details of a policy before
buying it rather than basing their decision on price alone.
10.4 Other types of insurance
There are many different types of insurance to suit people with different needs.
Examples include the following:
◆ Pet insurance – this covers the cost of vet bills in case a pet needs treatment.
◆ Travel insurance – this covers people for the costs of medical treatment when on
holiday, and the cost of replacing luggage or belongings that are lost, stolen or
damaged. These policies often cover the costs of delays to a journey, too, for
example the cost of having to stay in a hotel for extra nights.
◆ Mobile phone insurance – this covers loss or damage to mobile phones. People
need to be careful not to overinsure their mobile phone as it may already be
covered under their home contents policy.
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10.5 Revising budgets
Another way in which people can deal with
unexpected expenses is to pay them from
current income by revising their budget. This
will not always be an option; it depends on the
scale of the unexpected expense compared
with
the
allowance
for
discretionary
expenditure in the budget.
For example, Brodie’s boiler needs to be
repaired and he has been given a quote for
£202. Brodie can afford to pay this unexpected
bill if he pays using his credit card and
allocates £101 from his discretionary expenses
in the current and the following month (around
£25 a week) to repayments. He plans to reduce
his discretionary spending on other expenses
over these two months by:
One way of dealing with an unexpected
car repair bill would be to use public
transport while saving up to pay for the
work to be done.
◆ reducing the amount he spends on socialising – rather than always meeting in
pubs, restaurants or at the cinema, Brodie will invite friends to his home for
supermarket pizza and to watch DVDs from his collection;
◆ cutting back on the coffees he buys on the way to work – as he buys a large
cappuccino most mornings at £2.50 each, he currently spends £12.50 over five
days; and
◆ delaying spending on clothes, DVDs and games until after he has repaid the bill.
10.6 Saving
People can also prepare for unexpected expenses by saving in an instant access
account such as an ISA. MoneyHelper (an independent service set up by the
government to help people make the best use of their money) suggests having
enough in emergency funds to pay mandatory and essential expenses for three
months (MoneyHelper 2021). For example, Meg Ford receives £2,200 a month from
her job as an IT project manager and allocates £1,500 of this to mandatory and
essential expenditure in her budget. She is concerned about what will happen to her
family if she loses her job as they would find it difficult to make ends meet on her
husband Kurt’s income alone. If she lost her current job, Meg thinks she could
probably find another one within three months because she has specialist skills that
are in demand in the local area. So every month she saves £150 in a cash ISA with
the goal of having an emergency fund of £4,500 (£1,500 x 3). It will take her
approximately two and a half years to build up this fund.
Another option when faced with an unexpected expense is to consider if it must be
paid immediately. For example, Piper’s television set has broken and she has received
a quote of £180 to repair it. She cannot afford this cost from her current finances.
She could, however, save enough over the next two months to pay for the repair. In
the meantime, she could watch television on her computer.
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10.7 Borrowing
Sometimes people find that they have to pay
an unexpected expense but are not covered
by insurance, they cannot afford the costs
by changing their budget and they do not
have enough in savings to pay for it. At this
point people will consider whether or not to
borrow. This decision should be based on
how much money they need and how much
they can afford to repay. Budgets are a key
tool in identifying a realistic repayment that
someone can afford to pay every month. We
looked at budgeting in Topic 9 and at shortterm borrowing products in Topic 6.
In emergencies, people can be tempted to borrow money they cannot afford to repay
and to use less reputable providers. There are a number of providers that offer shortterm loans at high costs. If people have been turned down by other providers, they
may consider these lenders as the only option. In these cases it is vital that borrowers
repay the loan as soon as possible. The danger is that people who can only afford
small repayments on expensive loans find their debts grow far faster than they can
afford to repay them. Topic 11 covers the help available for people who are finding
it difficult to repay debt.
The Debt Support Centre website (www.debtsupportcentre.co.uk) makes a distinction
between ‘good debt’ and ‘bad debt’. It defines a good debt as one that is ‘affordable
in terms of the interest and payments’ and ‘will improve your personal finances in
the long term’ such as repairing a car so you can travel to work. Another ‘good debt’
would be a student loan to help finance your studies, which should lead to better
employment prospects and a higher income later in life. A final example of ‘good
debt’ is a mortgage, borrowed over about 25 years to pay for a property; this
provides the borrower with a home which can one day be passed on or sold.
The Debt Support Centre defines bad debts as those that ‘are unaffordable or where
the money borrowed is for items that do not have a long term value’ (Debt Support
Centre, 2022). An example of ‘bad debt’ is not paying off a credit card balance in
full, meaning that the balance takes longer to pay off and ends up costing you more.
10.8 Benefits
The government can help with unexpected events that mean people are unable to
afford their living expenses. For example, if people lose their jobs or can no longer
work because of medical conditions, there are unemployment and disability or
incapacity benefits. The government can also help people on low incomes with bills
such as funeral expenses, fuel costs or the costs of emergency housing after a fire.
When the unexpected happens, people can get expert advice from Job Centre Plus or
Citizens Advice to ensure they apply for the benefits that are designed to help them.
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10.9 Unexpected income
Unexpected events do not always mean that people face unexpected expenses:
sometimes, they result in an increase in income, perhaps from a new job or a oneoff payment such as an inheritance. In these situations, people need to decide how
to use the additional funds. Figure 10.2 shows the main options.
Figure 10.2 Dealing with unexpected income
Save it?
Create
emergency
fund?
Unexpected
income
Pay back
borrowing?
Spend it?
People will have different priorities depending on their personal circumstances and
attitudes. In general terms, people should consider using the money in the following
ways.
10.9.1 An emergency fund
People can use the extra income to make sure they have savings they can access
instantly in an emergency. As we saw in section 10.6, MoneyHelper recommends an
emergency fund equivalent to mandatory and essential expenditure for three
months. However, people with expensive debts need to consider having a smaller
amount of savings and repaying their borrowing.
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10.9.2 Repaying debt
Once the emergency fund is in place, people should consider repaying outstanding
debt, starting with their most expensive borrowing. People usually pay more interest
on their debt than they can earn on their savings. So using extra money to reduce
the cost of borrowing means people are better off overall. Some borrowing products
such as loans have penalty charges for early repayment, however, so people need to
find out the full cost of repaying debt before making a final decision. The most
expensive borrowing products are usually credit cards or store cards, followed by
overdrafts and loans.
10.9.3 Saving
Once debt has been repaid, people can consider saving, for example by using their
cash ISA allowance for the year. If people already have sufficient instant access
savings, they can consider longer-term savings accounts that may offer higher
returns.
10.9.4 Spending
When people have repaid expensive debt and saved some of their unexpected
income, they may decide to spend on assets that will lower their living costs such as
replacing an old, unreliable car with a newer one that is likely to need fewer repairs.
They may also decide to spend it on products and services they want.
Key ideas in this topic
◆ Using insurance.
◆ Revising budgets to meet unexpected expenses.
◆ Emergency savings.
◆ Borrowing.
◆ Benefits.
◆ Dealing with unexpected income.
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References
ABI (2022) How to cut the cost of motor insurance [online]. Available at:
https://www.abi.org.uk/products-and-issues/choosing-the-right-insurance/motorinsurance/how-to-cut-the-cost-of-motor-insurance/ [Accessed: 18 January 2021].
Debt Support Centre (2022) The difference between good and bad debt [online]. Available at:
https://debtsupportcentre.co.uk/blog/good-debt-vs-bad-debt/
MoneyHelper (2021) Emergency savings – how much is enough? [online]. Available at:
https://www.moneyhelper.org.uk/en/savings/types-of-savings/emergency-savings-how-much-isenough
Moneysupermarket (2021) Compare third-party insurance quotes online [online]. Available at:
https://www.moneysupermarket.com/car-insurance/third-party-only/
RAC Foundation (2015) Teen driver crashes take toll on young passengers [online]. Available at:
https://www.racfoundation.org/media-centre/teenage-driver-crashes-take-high-toll-on-youngpassengers
uSwitch (2021) Top 10 tips for cutting the cost of car insurance [online]. Available at:
https://www.uswitch.com/car-insurance/top-10-tips-for-cutting-the-cost-of-car-insurance/
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Topic 11
Dealing with debt
Learning outcomes
After studying this topic, students will be able to:
◆ provide solutions for dealing with debts;
◆ identify organisations that can help with debt problems; and
◆ describe debt management options.
Introduction
Before they borrow money, people
often use a budget to work out
what they can afford to repay.
Unfortunately, personal circumstances
can change: people may lose their job
or have their hours reduced, child
maintenance payments might stop,
and essential expenses such as rent or
mortgage payments, food and energy
costs might increase. Then borrowers
will find it more difficult to repay debt.
There are several actions that people
can consider in these situations,
such as:
A number of organisations provide free advice for
people who have debt problems.
◆ getting free, impartial advice
from debt organisations and websites;
◆ using a budget to calculate what they can afford to repay and changing products
or negotiating agreements with lenders to repay a smaller, affordable amount
each month;
◆ selling an asset such as a car or jewellery and using the proceeds to repay debts;
◆ prioritising debts in terms of the consequences of not repaying and the cost of
the borrowing (APR and fees);
◆ using formal debt management processes such as a debt relief order (DRO), an
individual voluntary arrangement (IVA), bankruptcy, debt management plan or
administration order.
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When people enter into borrowing contracts they are agreeing to a legal obligation.
The consequences of not making repayments on time and in full are that the
borrower may be unable to borrow elsewhere, or may only be offered products with
high APRs. For example, Brandon signed a credit agreement when he applied for his
credit card. He has been repaying the minimum amount each month and now owes
£5,000. In the last six months he has missed two repayments. His credit card
provider, BTT Bank, has raised the minimum payment for the next repayment to £500
and warned him that if he does not repay in full within 12 months it could take him
to court to recover the money. Brandon wants to switch to another credit card with
an introductory 0% APR on balance transfers but the provider he applies to rejects
his application. He thinks this is because of his credit history.
Obtaining advice about debt
Free, impartial advice is available for borrowers from a
number of organisations, some of which are
described below. There are other organisations that
offer advice for a fee; however, paying a fee will reduce
the amount of money people have to repay lenders.
MoneyHelper – is an independent organisation set up by
the government to help people to understand financial
issues and manage their money better. It is funded by a
levy (compulsory charge) on the businesses that operate
within the financial services industry. It provides advice online
(www.moneyhelper.org.uk), over the phone and face to face.
StepChange Debt Charity – was established in 1993 as the Consumer Credit
Counselling Service (CCCS) and changed its name in 2012 as part of its plans to
raise awareness of its work in providing free debt advice. It provides online and
telephone support to help people to create a budget and work out a plan to
reduce their debts. Its website (www.stepchange.org) provides information on a
range of issues such as student debt, the link between mental health problems
and debt, and debt in retirement.
Citizens Advice – the Citizens Advice service is made up of a network of Citizens
Advice bureaux in England and Wales, supported by the central Citizens Advice
charity (www.citizensadvice.org.uk/). The service provides free, independent,
face-to-face advice on a wide range of issues and campaigns for consumer
protection.
National Debtline – is a free, confidential and independent service
providing personalised debt advice by phone, email or using the online tool My
Money Steps, for people living in England, Scotland and Wales. It also provides
a range of fact sheets and sample letters via its website
(www.nationaldebtline.org).
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11.1 Affordable repayments
People who are finding it difficult to repay debt may be able to increase their income
by:
◆ claiming all the benefits they are entitled to;
◆ taking on more work; or
◆ selling an asset.
They may also be able to reduce some of their expenses by choosing cheaper options
or buying less of a particular item. Increasing income and reducing expenditure is
not always possible, however, depending on personal circumstances. The next step
is for people to use their budget to work out a realistic repayment they can afford to
make every month. People can do these calculations on their own or get free help
from experienced advisers, such as Citizens Advice or the StepChange Debt Charity.
Once people know the repayments they can afford, they can consider:
◆ changing their existing borrowing products for ones that cost the amount they
can afford in repayments; or
◆ negotiating with their existing providers to repay their debt at the level they can
afford.
People who decide to negotiate with their existing providers can approach the
providers themselves, or ask a debt adviser to negotiate on their behalf.
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11.1.1 Changing products
If people have a good credit rating, they can consider switching credit card debt to
a card that does not charge interest on balance transfers. Doing this stops the
original debt growing and gives the borrower time to repay, but it only works if the
cardholder makes no new transactions on the card and can afford to repay within
the interest-free period.
For example, Kelly has been making repayments of £150 per month on her credit
card but still owes £5,000. She has stopped making new transactions on the card
but is frustrated that the 19.9% APR means her debt keeps growing. Kelly has a good
credit history so she applies for a 0% balance transfer to another card. The 0% deal
lasts for 18 months. Kelly uses an online calculator to work out that, if she repays
£300 per month, she can repay the full debt in 1 year and 5 months. This is three
months earlier than if she had stayed with her first provider and saves her £813 in
interest.
People who are struggling to repay a loan may wish to consider extending the term
of the loan. This is not always possible, but many providers would prefer that a
borrower repay a loan in full over a longer period of time than did not repay it all.
People in this situation need to approach their provider with a plan of how they can
afford to repay the loan over a longer period of time. Alternatively, it may be possible
for the borrower to take out a longer-term loan to repay the shorter one and so
reduce their monthly repayments.
Some of the factors to consider when extending the term of a loan or taking out a
longer-term loan to repay an existing shorter one are as follows:
◆ Repaying over a longer time, such as five years rather than three years, will reduce
the monthly repayment but increase the overall cost of the loan.
◆ There may be penalty fees for repaying the shorter loan early.
◆ There may be set-up or arrangement fees for the new loan.
For example, Eko has a loan with Canterbury Bank for £10,000. He is repaying it over
three years at 12% APR and has a monthly repayment of £330. Over the three years
he will repay £1,852 in interest. Eko is finding the repayments difficult so he
approaches Canterbury Bank. They agree to change his term to five years. This means
his repayments are £220 a month and he will pay £3,162 in interest. The loan is
much more expensive overall; however, Eko finds the monthly repayments much
more affordable.
People with a number of different debts, such as an overdraft and several credit
cards, may consider taking out a loan and using the funds to repay all the other
debts; from that point they then have only one repayment to make each month, to
the loan company. A loan used for this purpose is called a consolidation loan and it
can make it easier for the borrower to repay by reducing the monthly cost. There are
a number of factors to consider, however:
◆ Borrowers need to be very careful that they understand the full costs involved in
the new loan. Some loan providers charge very high interest rates.
◆ Borrowers must be able to afford the repayments on the loan if they are to clear
their debts.
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◆ The overall cost of borrowing can be greater than on the individual borrowing
products.
◆ This approach will not work if borrowers continue to borrow on their overdraft
and credit cards, as these debts will grow.
◆ Borrowers need to be very careful about the type of loan they use because some
products that are described as consolidation loans are mortgages secured on the
borrower’s home. This means that the borrower could lose their home if they do
not repay on time and in full.
If people owe money on a number of different borrowing products, it is important
that they prioritise the most expensive debt first so that they reduce the costs of
borrowing as quickly as possible. The most expensive borrowing is usually credit
cards and long-term overdrafts. If people have borrowed from payday lenders or
doorstep lenders these products will be the most expensive.
Guaranteeing a loan
Callie had been finding it increasingly
hard to pay her bills each month. She
approached her current account
provider for a loan but her credit
history is poor and she was turned
down. She had thought about
borrowing from a doorstep lender but
was worried that the interest rates
were very high. Instead, she found an
online provider that would offer her a
£3,250 loan, as long as she got a
friend or relative to guarantee the
loan repayments. The monthly repayment would be £158.57, over three years.
Callie decided to ask her neighbour Rosie to act as guarantor.
Rosie didn’t really understand what Callie was asking her to do but she didn’t want
to say no to her so she went round to Callie’s house and completed the online
application. A few days later the loan company rang her to check that she was
willing to be a guarantor and to ask for her bank details. She didn’t understand
the details about being a guarantor and she couldn’t understand why they wanted
her bank details as the loan was for Callie, not her, but she provided them anyway.
The loan company wrote Rosie a letter confirming the details of the call but she
was busy when she received it and filed it away without reading it properly.
Two months later, the loan company texted Rosie to advise her that Callie had
missed a repayment and they would be debiting the payment from Rosie’s bank
account. Angrily, she protested that the debt was nothing to do with her. She
contacted a debt advice charity for help. After looking into the process the loan
provider had followed, the adviser informed Rosie that she had entered into a
binding contract and would be liable for any of the loan repayments that Callie
missed for the term of the loan.
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11.1.2 Debt management plan
Sometimes people find that they have many debts and are struggling to repay all of
them. For instance, they might have outstanding amounts on borrowing products
and arrears (missed payments) on essential expenses such as rent or utilities. People
in this situation can set up a debt management plan with a debt management
company (DMC).
People pay the DMC what they can afford each month and the DMC divides this
payment among the organisations that are owed money. This means the person in
debt, known as a debtor, does not need to deal with the organisations they owe
money to, known as their creditors.
For example, Cheng owes money on his overdraft, three credit cards and a car loan.
He has been struggling to repay his debts for the last six months and has had some
telephone calls and letters from his providers pressing for payment. Cheng decides
he needs help so he contacts a debt charity. With their help he draws up a detailed
budget that shows he can afford to repay £125 per month. The debt charity contacts
Cheng’s creditors with a detailed debt management plan, which they all accept.
Cheng then sets up a direct debit from his current account to pay the charity £125
per month. The charity pays the money on to his creditors. Cheng has not received
any letters or telephone calls from his providers since his plan started. He has cut
up the two most expensive credit cards he held and keeps the other one for
emergencies only. Cheng knows it will take him years to repay all his debts but he is
determined to see the plan through.
A debt management plan can be set up to help a debtor make affordable repayments.
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Debt management plans are offered free of charge by some charities such as the
StepChange Debt Charity and Payplan. Most other organisations charge fees, which
means the debtor has less money available to make repayments to the creditors.
The advantages of a debt management plan are that:
◆ the person in debt makes one affordable monthly repayment to the DMC, which
is easier for them to manage;
◆ the DMC arranges the plan with the person’s creditors and shares the monthly
payment between them; and
◆ the person in debt has longer to repay what they owe.
The disadvantages of a debt management plan are as follows:
◆ DMCs only deal with non-priority debts such as repayments on loans and not
priority debts, such as mortgage and rent arrears.
◆ Creditors might still contact the person who owes them money and ask for further
repayments.
◆ Creditors do not have to accept a debt management plan. Many will, however, as
they recognise they will be repaid, just over a longer period of time.
◆ The debt will take longer to clear because the monthly repayments are smaller.
However, many creditors will stop adding interest and fees to the debt as long as
the repayments are being made.
11.1.3 Administration orders
County courts in England, Wales and Northern Ireland can arrange repayment plans
called administration orders. There are different arrangements in Scotland, which
are described below.
Administration orders apply to people who have less than £5,000 in unsecured debt
and at least one county court judgment (CCJ) against them. People can apply to the
court to have an administrative order issued. They then pay what the court decides
they can afford to the court once a month, and the court makes repayments to their
creditors.
For example, Arthur applies for an administration order because he has a total debt
of £3,750. His debt is all unsecured and comprises the maximum credit he is allowed
on his overdraft and two credit cards. Arthur also has one CCJ for non-payment of a
bill. The court decides that Arthur can afford repayments of £158 per month. He sets
up a direct debit to pay this amount to the court every month and the court pays his
creditors.
The advantages of an administration order are that:
◆ the person who owes money makes one monthly repayment that they can afford;
◆ creditors are not permitted to contact debtors directly to ask for further payments
and they are not permitted to add interest to the debt; and
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◆ if the debtor cannot repay the debt in a reasonable time, the court can set an end
date for the administration order. Creditors must write off any debt that is still
outstanding after this time. The court agrees that the debtor will not repay all of
the debt by issuing a composition order.
The main disadvantage of an administration order is that the court decides what the
debtor can afford to repay and this may mean that the debtor has to live on a very
tight budget while the debt is being repaid.
11.2 Insolvency solutions
People are insolvent if they cannot repay what they owe because their debts are
greater than their assets (the property and goods that they own), or they cannot meet
their financial obligations within a reasonable time of them falling due. Solutions for
insolvency in England, Wales and Northern Ireland are individual voluntary
arrangements (IVAs), debt relief orders (DROs) and bankruptcy (see Figure 11.1).
Scotland has different arrangements, which are described below.
Figure 11.1 Individual insolvencies in England and Wales, 2015–2017
Source: GOV.UK (2017)
People who owe money can apply for insolvency solutions themselves. They should
get advice before taking this step, however, to ensure that they understand all the
implications of each solution and have chosen the most appropriate one for their
circumstances. There are organisations that charge fees for this advice but people
can get free, expert advice from Citizens Advice, the StepChange Debt Charity and
other charities.
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11.2.1 Individual voluntary arrangements (IVAs)
Under an IVA people make reduced, affordable repayments for five or six years and
then their debt is written off. IVAs are legally binding arrangements on debtors and
creditors.
IVAs apply to people who have unsecured debts that are larger than the value of their
assets. An insolvency practitioner (IP) negotiates the arrangement with the person’s
creditors. As long as the creditors that hold 75% of the value of the debt agree, the
IVA can proceed. If they do not agree, or the person who owes the money does not
keep up their repayments, the person can be made bankrupt.
The advantages of an IVA are that:
◆ debtors make affordable repayments for a set period of time;
◆ outstanding debt is then written off;
◆ an IP (usually a solicitor or accountant) negotiates with creditors on the debtor’s
behalf;
◆ creditors cannot add any more interest or charges to the debt; and
◆ creditors cannot take court action against the debtor.
11.2.2 Debt relief orders (DROs)
Debt relief orders (DROs) enable people to write off their debts if they are unable to
repay them after 12 months. DROs only apply to people who:
◆ owe less than £30,000 in unsecured debts (DROs do not apply to student loans);
◆ are not homeowners;
◆ have no more than £2,000 in assets (although they can own one vehicle worth
up to £2,000); and
◆ have less than £75 a month left over after they have paid their living expenses.
Debtors must pay £90 for a DRO and apply to the courts through an authorised
adviser. Their debts are frozen for 12 months so creditors cannot add any interest
or charges to them. Creditors are also not permitted to contact the debtor to ask for
payment during this time. If the debtor’s ability to repay has not changed after 12
months, their debt is written off.
The advantages of a DRO are that:
◆ household goods and tools of the trade are not included in the asset calculation;
◆ it gives the debtor time to change their personal circumstances if they can, for
example by finding work;
◆ debtors will not be pressurised to repay during the 12-month period and their
debt will not grow;
◆ it is a cheaper insolvency solution than bankruptcy for people who have very low
incomes.
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The disadvantages of a DRO are that:
◆ it stays on the person’s credit history and a public register and will make it
difficult for them to borrow money during this time;
◆ the cost of £90, although lower than other options, can be difficult for people on
very low incomes to pay.
11.2.3 Bankruptcy
Bankruptcy is a court order that means a person’s assets are shared between their
creditors who write off the remaining debt. An official receiver is appointed who can
sell the person’s assets and use any savings and the debtor’s income to repay
creditors. People can apply to become bankrupt themselves, or one of their creditors
can apply to make them bankrupt.
Dealing with bankruptcy
Bob was a company
director
until
his
company failed in the
recession. He was used
to a large salary and
borrowed on several
credit
cards,
an
overdraft, two car loans
and a mortgage. When
he lost his income,
Bob’s
debts
were
greater than his assets
so
he
applied
to
become bankrupt.
The official receiver appointed to Bob’s case sold Bob’s home to repay the
mortgage and sold his luxury cars to repay the car loans. Some money was left
to repay his overdraft. The receiver also sold Bob’s collection of paintings, his
ride-on lawn mower and his camera equipment.
When all Bob’s assets were sold, he still owed £75,000. Bob could not get a job
as a company director because of his bankruptcy, so he got a job working in the
car showroom where he used to buy his luxury cars. Most of his income goes to
repaying his debts, leaving a small amount for him to live on. He has had to
move in with his sister and her children. After 12 months Bob’s remaining debts
were written off.
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The costs of going bankrupt vary across the UK. In England and Wales there is a
bankruptcy fee of almost £700 and in Northern Ireland the fee is slightly lower.
People on low incomes and benefits are charged between £100 and £150 less in
England, Wales and Northern Ireland because court fees are waived.
The advantages of going bankrupt are that:
◆ debtors do not deal with creditors directly;
◆ debts can be written off in 12 months;
◆ debtors keep certain possessions, such as household goods, and an amount to
live on;
◆ when the bankruptcy is over, debtors have a fresh start; and
◆ creditors have to stop most types of court action to recover their money.
The disadvantages of bankruptcy are as follows:
◆ There are costs involved in the bankruptcy process.
◆ Debtors cannot apply for more credit while they are bankrupt.
◆ Debtors can only use basic current accounts because they cannot go overdrawn.
◆ The record of a bankruptcy remains on the debtor’s credit history for six years
after the start of the bankruptcy. This makes it difficult for them to obtain credit
during these six years.
◆ Many of the debtor’s assets have to be sold to repay their debts, including their
home, car and any luxury goods.
◆ People who have been declared bankrupt are barred from certain occupations –
some jobs within financial services for instance cannot be carried out by a person
who has been declared bankrupt. In these circumstances, the debtor will lose
their job.
◆ If the debtor owns a business, it is likely
to be closed down and the assets sold.
◆ Details of the bankruptcy are published
and may be reported in the media.
◆ Some debts, such as student loans and
court fines, are never written off.
◆ If the court considers that the debtor
never intended to repay their debts or did
not co-operate with the official receiver,
it can issue a bankruptcy restriction order
that lasts for 15 years.
People declared bankrupt can keep items they need
to earn a living – a builder may keep their tools, for
example.
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11.3 Insolvency solutions in Scotland
People who live in Scotland have different solutions from people living in England,
Wales and Northern Ireland.
11.3.1 Debt Arrangement Scheme
The Debt Arrangement Scheme is run by the Scottish government and is similar to a
debt management plan. People must owe money to one creditor or more and must
be able to afford some repayments to be eligible for a debt payment programme
under the Scheme. They make payments to the programme, which are then shared
among creditors.
11.3.2 Trust deed
A trust deed is similar to an individual voluntary arrangement (IVA). An insolvency
practitioner helps people who are insolvent to make repayments they can afford and
after four years any outstanding debt is written off.
11.3.3 Minimal asset process (MAP) bankruptcy
The MAP bankruptcy was introduced in Scotland on 1 April 2015 to replace the low
income low assets (LILA) option. MAP allows you to write off debts that you are unable
to pay off in a reasonable time. You pay a fee and, if you are eligible, your debts may
be written off in around six months.
To be eligible, you must live in Scotland and prove that:
◆ you are on a low income;
◆ your debts are between £1,500 and a specified higher amount, which is usually
£17,000 but was raised temporarily to £25,000 due to Covid-19;
◆ you are not a homeowner;
◆ any vehicle that you own is worth less than £3,000;
◆ your assets are worth less than £2,000;
◆ you have not been made bankrupt in the last five years.
If you are made bankrupt via MAP, you remain on a public register for five years
(StepChange, 2022).
11.3.4 Sequestration
Sequestration is the term for bankruptcy in Scotland. A person who owes more than
£3,000 and has not been bankrupt in the last five years can apply voluntarily. A
creditor can usually apply for a debtor’s sequestration if they are owed more than
£3,000 and have got court judgments for payment against the debtor, but the
amount was raised to £10,000 during the Covid-19 pandemic. The court actions are
called a decree and a charge for payment, and a summary warrant. Sequestration
costs £150 and usually lasts for 12 months.
In the sequestration process, the individual transfers their assets to a trustee or
insolvency practitioner, who manages the sale of the assets to pay creditors.
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Key ideas in this topic
◆ Options for people who can afford to make some repayments.
◆ Options for people who are insolvent.
◆ The advantages and disadvantages of different solutions.
◆ The importance of getting free, expert advice when dealing with debts.
References
GOV.UK (2017) Insolvency Service official statistics: 2017.
StepChange Debt Charity (2022) Minimal asset process (MAP) bankruptcy [online]. Available at:
https://www.stepchange.org/how-we-help/minimal-asset-process-bankruptcy.aspx
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Topic 12
Earnings
Learning outcomes
After studying this topic, students will be able to:
◆ interpret legislative, regulatory and organisational requirements and
procedures relevant to earnings; and
◆ apply the key features of income tax and National Insurance.
Introduction
The UK has many laws and regulations that apply to people who work, employers
and the workplace. This topic focuses on those that apply to earnings, in particular:
◆ the national minimum wage and the national living wage;
◆ maximum working hours;
◆ income tax and National Insurance;
◆ the documents that employees receive relating to income tax and National
Insurance; and
◆ income tax returns.
The legislation and regulations surrounding the minimum wage, the living wage and
maximum working hours have been introduced to protect employees who might
otherwise be exploited by employers.
Everyone who earns money from work on an employed or a self-employed basis must
pay income tax and National Insurance (NI) contributions. The government uses the
money raised from these payments to pay for essential services such as the National
Health Service (NHS), education,
police and defence. The NI
contributions in particular are
used to pay for benefits that
working
people
will
use
themselves, such as the state
pension, and for benefits for
others such as the unemployed.
Income tax is also paid on
unearned income including most
pensions, the interest on savings
and
dividends
paid
on
investments.
Employed people have income tax and NI contributions
deducted from their pay by their employer.
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The amount of tax and NI that must be paid is set by the Chancellor of the Exchequer
in the Budget and tends to change each tax year. The tax year runs from 6 April in one
calendar year to 5 April in the following year. People who work or receive income from
unearned sources are responsible for ensuring they pay the correct amount of income
tax and NI contributions. There are penalties for people who pay too little: they may
be fined or, in more extreme cases, receive prison sentences. People who pay too much
tax and NI can claim the additional amounts back. These are called tax rebates.
12.1 National minimum wage
The national minimum wage (NMW) was introduced in the National Minimum Wage
Act 1998. This Act established the Low Pay Commission, which advises the
government what the NMW and the national living wage (NLW) should be every year.
The NMW applies to most types of employed workers aged 22 and under, including
full-time, part-time, casual workers and apprentices. It is expressed as a ‘per hour’
rate that varies according to the employee’s age and applies from 1 April in one
calendar year to 31 March in the following year.
People must be of school leaving age to get the minimum wage. This is defined as
the last Friday of June in the school year when they had their sixteenth birthday.
Apprentices under the age of 19 or who are in their first year are entitled to the
apprentice rate. People aged 23 and over must be paid at least the national living
wage, which was introduced in April 2016.
Table 12.1 National minimum and living wage brackets
Age
23 and over (living wage) – highest rate
21 to 22
18 to 20
Under 18
The hourly
rates increase
with age and are
confirmed annually
in the Budget
Apprentices under 19 or in their
first year – lowest rate
Source: GOV.UK (no date a)
Note! National minimum wage and national living wage rates change every year.
Check GOV.UK for the current rates: https://www.gov.uk/national-minimumwage-rates.
For example, Pat Martin works part-time in a bakery and is paid
£9.50 per hour. As she is 43 years old, her employer is paying
her a bit more per hour more than the national living wage.
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Her daughter Kathy is in the first year of an apprenticeship
with a hairdresser. This year she is being paid the minimum
wage for apprentices but next year she will be paid the
minimum wage for workers aged 20. As Kathy works 38 hours
a week, her income will rise by more than £300 per month.
As soon as she is fully trained, Kathy expects to earn £17,000
a year which works out at around £8.60 per hour.
Employment contracts that specify a wage lower than the minimum are not binding.
There are some exceptions to the NMW, however, including voluntary workers,
people on work experience who are not trainees such as interns, trainees on some
government schemes, prisoners and members of the armed forces. Workers who are
entitled to the minimum wage but do not receive it have rights under the Act to
examine their employer’s records and claim missing wages. They can also take their
employer to an industrial tribunal. The government offers a confidential helpline for
workers who are in dispute with their employer.
Some employers, especially in the retail and hospitality industries, offer ‘zero hours’
contracts which mean people agree to be available for work as and when required
but do not have any guarantee of hours or times of work. Workers who have these
contracts are entitled to the NMW when they are ‘on-call’ at the employer’s premises.
It is illegal for employers to insist these workers are on site and then not use them
and refuse to pay them.
12.2 Maximum working hours
The Working Time Regulations were introduced in 1998 and specify the following:
◆ An employee can work a maximum of 48 hours work per week, averaged over 17
weeks, unless they choose to work longer.
◆ An employee who works five days a week is entitled to at least 5.6 weeks' paid
holiday per year. Employers can choose to include bank holidays in this figure.
People who work less than five days a week are entitled to the pro rata equivalent,
for example if they work three days a week, 3 x 5.6 = 16.8 days per annum.
◆ An employee is entitled to at least 11 consecutive hours' rest in any 24-hour
period.
◆ If the working day is longer than six hours, they are entitled to a minimum
20-minute rest or lunch break.
◆ An employee is entitled to at least one day off each week.
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Table 12.2 Summary of employees’ entitlements under the Working Time
Regulations 1998
Weekly hours
Paid holiday
Rest hours
Rest break
48 hours,
averaged
over 17
weeks (unless
the employee
chooses to
work longer)
5.6 weeks'
paid holiday
per year for
workers who
work five
days a week.
Employers
can choose to
include bank
holidays in
this figure.∗
11 consecutive
hours' rest in
any 24-hour
period
20-minute
rest or lunch
break if the
working day
is longer than
six hours
Time off per
week
One day
∗ People who work less than five days a week are entitled to the pro rata equivalent,
for example if they work three days a week, 3 x 5.6 = 16.8 days per annum
Source: ACAS (no date)
The regulations do not apply to all types of employment. For example, they do not
apply to the armed forces, emergency services, domestic workers in private
households (such as nannies) or where 24-hour staffing is required. An employee’s
working hours, annual leave (holidays) and rest periods should be set out in the
employee’s contract of employment.
12.3 Income tax and NI
Everyone who receives an earned or unearned income must pay income tax and NI
contributions once they earn more than a minimum amount called a personal
allowance. There are no age limits for paying income tax: the amount people earn
determines whether they pay it or not. Income tax is one of the oldest taxes in the
UK, having been introduced in 1799 to raise money to fight Napoleon. The Income
Tax Act 2007 is the most recent legislation. The amount of income tax and NI people
must pay is set out every year by the Chancellor in the Budget.
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12.3.1 Income tax
Most people get a personal allowance – that is, a certain amount of money that they
can earn before they pay income tax. The exceptions are people who were born
before 6 April 1938, blind people, and married couples where one partner was born
before 6 April 1935.
People calculate how much income tax they owe by:
◆ subtracting their personal allowance from their gross annual income to find their
taxable income;
◆ working out which tax bands apply to their taxable income; and
◆ calculating the amount of tax using the tax rates for each band.
Table 12.3 Income tax rates
Tax rate
Basic rate 20% – on lowest band of
taxable income
Higher rate 40%
The taxable income
bands, corresponding to each
tax rate, are set annually
in the Budget
Additional rate 45% – on highest band
of taxable income
Note! Income tax rates and bands may change on 6 April each year. Check
GOV.UK for the current rates and bands: https://www.gov.uk/income-tax-rates.
The following examples use illustrative amounts for the tax bands and personal
allowance to demonstrate how income tax is calculated. Knowledge of the
specific personal allowance and tax band amounts are not required for the
assessments.
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Wendy Chen’s earnings
Wendy Chen earns £22,000 gross per year.
Her personal allowance is £12,570 so her taxable
income is:
£22,000 – £12,570 = £9,430
All £9,430 falls into the basic rate tax band of
taxable income. This band is taxed at 20%, so
Wendy owes:
£9,430 x 20% = £1,886 of income tax.
Kurt Ford’s earnings
Kurt Ford earns £50,500 per year. His personal
allowance is also £12,570 so his taxable income is:
£50,500 – £12,570 = £37,930
He pays 20% on the first £37,700 of that amount,
which is:
£37,700 x 20% = £7,540 of income tax.
Some of Kurt’s income falls into the next tax band:
£37,930 taxable income – £37,700 which falls into
the basic rate tax band = £230 in the higher rate
tax band.
Kurt pays 40% on £230:
£230 x 40% = £92 of income tax.
In total Kurt pays £7,540 + £92 = £7,632 in
income tax.
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12.3.2 Income tax on savings interest
Income tax on savings has changed significantly since April 2016.
The income tax you pay on savings interest depends on what you earn, as it has
always done, but new allowances apply (GOV.UK, 2017). Taxpayers can earn a certain
amount in savings interest tax free, known as the personal savings allowance (see
Table 12.4).
Table 12.4 Personal savings allowance
Tax band
Personal savings
allowance (PSA)
Tax rate payable on
savings interest above
Basic
£1,000
20%
Higher
£500
40%
Additional
None
45%
Let’s look at this in more depth.
People who have a taxable income of less than £5,000 after other allowances have
been deducted pay no income tax on savings interest. This is the starting-rate band.
Taki Singh and the starting-rate band
Taki earns £15,800 per annum. He has a personal
allowance of £12,570. This means his taxable
income is £3,230, which falls within the £5,000
starting-rate band for savings income for the tax
year.
As the starting rate is 0%, Taki will owe no income
tax on his savings interest.
Basic-rate taxpayers have a personal savings allowance of £1,000 before they start
to pay income tax on their savings interest.
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Wendy Chen’s £1,000 personal savings
allowance
Wendy earns £22,000 per annum and so is a basicrate taxpayer. In the current tax year she has savings
interest of £350, which is below her personal savings
allowance of £1,000. So Wendy owes no income tax
on her savings.
Higher-rate taxpayers have a personal savings allowance of £500.
Cynthia French’s £500 personal savings
allowance
Cynthia earns £65,000 per annum. She has also
earned £420 in savings interest in the current tax
year. As this interest is less than her £500 personal
allowance, she owes no income tax on her savings
income.
However, if Cynthia earned £520 in savings interest,
she would owe income tax on the savings that are
above her allowance, ie on £20 at the higher rate of
income tax (40%).
A reason for these changes is to encourage people to save and to rely less on the
state. With so few savers paying income tax on their savings, since 6 April 2016
providers no longer deduct basic income tax at source. This means savings interest
is now paid gross (ie before tax).
Individual savings accounts (ISAs) are tax-free, so the interest earned on a cash ISA
does not count towards a saver’s personal savings allowance and they do not owe
any income tax on it, regardless of how much they earn elsewhere (GOV.UK, 2017).
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12.3.3 National Insurance
People who work pay NI contributions if they are:
◆ aged between 16 and the state pension age; and
◆ an employee earning more than a specified amount per week; or
◆ self-employed and making a profit over a specified amount each year.
Since April 2016, NI contributions are not payable for young apprentices.
People are issued with an NI number in the months before they reach the age of 16
and all the contributions they make during their working life are recorded against
this number.
The number of years over which people have paid NI has an impact upon their
entitlement to certain state benefits, such as Jobseeker’s Allowance, Maternity
Allowance and bereavement benefits. In April 2016 the government introduced a new
state pension. People need to have made NI contributions to be eligible for the full
amount of the new state pension, and they need ten qualifying years to receive any
new state pension. People with no NI record before 6 April 2016 need 35 qualifying
years to get the full new state pension (GOV.UK, no date b).
The amount of National Insurance that an individual pays depends on their
employment status and their income.
Note! National Insurance contributions may change on 6 April each year. Check
GOV.UK for the current rates: https://www.gov.uk/national-insurance/howmuch-you-pay.
12.3.4 Paying income tax and NI
Employees’ income tax and NI contributions are paid by their employer direct to Her
Majesty’s Revenue and Customs (HMRC) through the Pay As You Earn (PAYE) scheme.
The employer pays the employee net of these payments.
People who are self-employed receive gross income from their clients – in other
words, without tax and NI being deducted. Self-employed people must pay the
correct income tax and Class 4 NI contributions themselves through a system called
self-assessment. This involves completing income tax forms called tax returns. They
pay the flat rate Class 2 contributions throughout the year, often by monthly direct
debit. Section 12.5 provides further information on filling in a tax return for selfassessment.
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Employees who owe additional
income tax on their savings
interest can pay this amount in
monthly instalments through
their employer’s PAYE system
by an adjustment made to
their tax code, or they can pay
it in a single payment direct to
HMRC. Self- employed people
pay any additional tax on
savings interest as part of
their self-assessment.
Self-employed people must complete tax returns to declare their income and pay their tax.
12.4 PAYE documents
Under the Employment Rights Act 1996, employers must provide employees with
details about the income tax and NI paid on their wages. There are three different
documents involved:
◆ a payslip, which is produced every time someone is paid, such as once a month;
◆ a P60, which is prepared at the end of every tax year to show all the income tax
and NI contributions paid during the preceding 12 months;
◆ a P45 that is prepared when an employee leaves an employer. It summarises the
employee’s tax and NI details for their next employer.
You can see a sample P60 and a sample P45 on the HMRC website (see the references
at the end of this topic).
12.4.1 Payslips
A payslip must show earnings before and after deductions, explain deductions and
show how the wage is paid. Employers can provide payslips on paper or
electronically. Most employers use payroll software to generate payslips and make
salary payments into employees’ current accounts.
Employers use the employee’s tax code to work out how much tax to deduct from
their earnings. These tax codes show the individual’s personal allowance and are
provided by HMRC. The format for a tax code is three or four numbers and one letter;
for instance, 1257L is a common tax code for the tax year 2022/23, as most people
have a personal allowance of £12,570. People who have more than one employer are
given two tax codes so that HMRC can ensure they get the correct personal
allowance.
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Kurt Ford’s payslip
Kite and Raglan plc has issued Kurt with the payslip
shown in Figure 12.1 for his earnings in September
202X. It shows:
◆ his tax code and his NI number;
◆ the employee number that identifies Kurt in the
company’s payroll records;
◆ that the salary is paid by automated credit into
his current account;
◆ his gross pay and the income tax and NI that Kite
and Raglan plc has paid to HMRC on his behalf
for this month;
◆ his net pay, which is the amount credited to his bank account; and
◆ the amount of gross pay, tax and NI paid so far this tax year (the six months
from April to September).
Figure 12.1 Kurt Ford’s pay slip
Kite and Raglan plc
Date: 01/10/202X
Payment period
Payment method
01/09/202X to 30/09/202X
Credit transfer
Tax Code
Employee no.
Employee name
N.I. number
1257L
20849
Kurt Ford
NM937592P
PAYMENTS
DEDUCTIONS
Description
Amount
Description
Amount
Basic salary
4,208.33
PAYE Tax Paid
636.00
N. I.
407.40
Gross pay
4,208.33
Net pay
3,164.93
Taxable pay to date
18,965.00
© The London Institute of Banking & Finance 2022
Total deductions
1,043.40
Tax paid to date
3,816.00
N. I. paid to date
2,444.42
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12.4.2 P45
By law, an employer must issue a P45 to an employee who stops working for them.
The employee gives the P45 to their new employer so that their new employer can
calculate how much income tax and NI they need to deduct. If people do not have a
new job to go to, they give the P45 to Jobcentre Plus for use in benefit calculations.
Sometimes people have more than one job at the same time – for instance, someone
might work part-time in a shop during the daytime and then take another part-time
job in a restaurant in the evenings. In this situation the person would not have a P45
to give to the restaurant; the second employer would have to calculate the tax and
NI payable based on information provided by the employee.
A P45 shows the employee’s:
◆ tax code and PAYE (Pay As You Earn) reference number;
◆ National Insurance number;
◆ leaving date;
◆ earnings in the tax year so far; and
◆ income tax paid in the tax year so far.
It comes in four parts:
◆ the old employer sends part 1 to HMRC;
◆ the employee keeps part 1A for their records; and
◆ the employee gives parts 2 and 3 to their new employer or Jobcentre Plus.
Figure 12.2 Sample P45
Source: HMRC (no date). Contains public
sector information licensed under the
Open Government Licence v1.0.
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12.4.3 P60
An employer must issue a P60 at the end of every
tax year to any employee who is working for them
on 5 April. A P60 summarises the tax paid by the
employer for the tax year that has just ended. It
can be provided on paper or electronically.
Employees use P60s to prove how much they
have earned and how much income tax and NI
contributions have been deducted from their
salary. They might need this information to:
◆ complete a self-assessment tax return;
◆ claim back overpaid income tax or NI
contributions;
◆ apply for tax credits; or
◆ apply for a loan or a mortgage.
Figure 12.3 Sample P60 (GOV.UK, 2021)
12.5 Filling in an income tax return
In the March 2015 Budget, Chancellor George
Osborne announced plans to abolish tax returns
and replace them with digital tax accounts during
the next Parliament (GOV.UK, 2015).
As it stands, however, some people need to
complete a tax return to tell HMRC about their
earned and unearned income – for example,
people who need to pay extra income tax on
their savings interest or who are self-employed.
A tax return covers income received in one tax
year, that is from 6 April in one calendar year to
5 April in the following calendar year. A tax
return can be completed on paper or online at
the HMRC Online Services website.
HMRC provides guidance for completing tax
returns on paper and online; for example, there
is detailed guidance on how to complete the
section on interest received from UK banks and
building societies.
You can find a sample tax return on the HMRC
website (see references at the end of this topic).
Figure 12.4 Example of a
paper tax return
Sources: GOV.UK (2020). Contains public sector information licensed under the Open
Government Licence v1.0.
© The London Institute of Banking & Finance 2022
205
The tax return requires just one total figure in whole pounds. Taxpayers round down
all figures to do with income. For example, Kurt Ford looks at the information
received about his savings interest:
Gross interest credited to your account
£74.23
He enters 74 in the relevant box on the tax form.
People who complete tax returns do not calculate the tax owed. HMRC will calculate
it based on the figures entered on the tax return.
There are strict deadlines for when HMRC must receive a completed tax return and
for when people must pay the money they owe. The tax year ends on 5 April and the
deadlines are as follows:
◆ Paper tax returns must be received by midnight on the following 31 October.
◆ Online tax returns must be received by midnight on the following 31 January.
◆ The final payment of tax due must be received by midnight on 31 January.
There are penalties for missing the deadline for submitting a completed tax return:
◆ From one day to three months late: a fixed penalty of £100.
◆ Three months late: £10 for each following day up to a 90-day maximum of £900.
This is as well as the fixed penalty above.
◆ Six to twelve months late: £300 or 5% of the tax due, whichever is the higher.
This is as well as the penalties above.
◆ Twelve months late: in serious cases up to 100% of the tax due instead of the
£300 or 5% penalty, as well as the £1,000 in penalties above.
HMRC calculates the tax people owe based on the information in their tax return so
people are required to declare that the information on it is accurate and complete.
If people complete their tax return online the calculation is done immediately. If
people submit on paper after the deadline of the 31 October, HMRC cannot guarantee
that the tax calculation will be completed before the payment deadline of 31 January.
This is one of the reasons why many people choose to complete their tax return
online. People need an activation code before they can set up an account to complete
tax returns online. It takes time for HMRC to send this code to them by post so
people need to plan ahead if they are to meet the online return deadline.
12.5.1 Self-employed income
People should keep all records that relate to their tax return, such as their P60s, for
at least 22 months after the end of the tax year that the tax return covers. This is in
case HMRC needs to check them or she wishes to appeal against her tax calculation.
Note! The following examples use illustrative amounts for the tax bands and
personal allowance to demonstrate how NI and income tax are calculated.
Knowledge of the specific personal allowance and tax band amounts are not
required for the assessments.
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Paying tax and NI using self-assessment
Li is a self-employed painter and decorator. He pays
his Class 2 NI contributions by monthly direct debit
and completes his self-assessment tax return online.
Here are his figures.
Li earns £24,000 taxable profit after allowable
expenses in the current tax year.
His personal allowance is £12,570 so after this
allowance is deducted his taxable income is:
£24,000 – £12,570 = £11,430.
Li has no other taxable income as all his savings are in a cash ISA. His taxable
income of £11,500 falls into the 20% income tax band so he owes income tax
of:
£11,430 x 20% = £2,286.
He also needs to pay Class 4 NI contributions. Let’s assume these are payable
at 9% of his taxable profits above £9,568 for the current tax year. The calculation
would be:
£24,000 – £9,568 = £14,432
£14,432 x 9% = £1,298.88
For the tax year he therefore owes income tax plus Class 4 NI contributions:
£2,286 + £1,298.88 = £3,584.88
He also needs to make a payment on account for his tax bill for the following
tax year. This is calculated as half his current bill, so the online self-assessment
calculator adds £3,584.88 ÷ 2 = £1,792.44, giving Li a total of:
£3,584.88 + £1,792.44 = £5,377.32.
Li uses the online self-assessment system because the website does all the
calculations for him. He just needs to deduct the payment on account he has
already made towards this tax bill. Then he pays the tax he owes using HMRC’s
online bill paying service and his debit card.
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Key ideas in this topic
◆ Employers’ and employees’ obligations under legislation and regulations
related to earnings.
◆ The national minimum wage.
◆ Regulations on maximum working hours.
◆ Income tax and National Insurance contributions.
◆ Employers’ PAYE systems and the forms they need to provide for employees:
payslip, P60 and P45.
◆ Self-assessment.
◆ Completing a tax return on paper and online.
References
ACAS (no date) Working hours [online]. Available at: https://www.acas.org.uk/working-hours
GOV.UK (no date a) Low Pay Commission, The National Minimum Wage [online]. Available at:
https://www.gov.uk/government/organisations/low-pay-commission
GOV.UK (no date b) The new state pension [online]. Available at:
https://www.gov.uk/new-state-pension
GOV.UK (2015) HMRC overview [online]. Available at:
https://www.gov.uk/government/publications/budget-2015-hm-revenue-and-customsoverview/hmrc-overview
GOV.UK (2017) Annex A: rates and allowances [online]. Available at:
https://www.gov.uk/government/publications/autumn-budget-2017-overview-of-tax-legislationand-rates-ootlar/annex-a-rates-and-allowances
GOV.UK (2020) Tax return 2021 [pdf], 21 November. Available at:
https://www.gov.uk/government/publications/self-assessment-tax-return-sa100
GOV.UK (2021) PAYE draft forms: P60 [online]. Available at:
https://www.gov.uk/government/publications/paye-draft-forms-p60
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HMRC (no date) P45 Details of employee leaving work [pdf]. Available at:
https://webarchive.nationalarchives.gov.uk/20140206151534/http://www.hmrc.gov.uk/forms/
p45.pdf
Picture acknowledgements
All images © iStock and posed by models.
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Glossary
Acceptable
One of the key features of money – to be widely accepted.
Administration order
A repayment plan arranged by county courts in England,
Wales and Northern Ireland for people with less than
£5,000 in unsecured debt and at least one county court
judgment (CCJ) against them. They apply to the court to
have an administration order issued, then pay what the
court decides they can afford directly to the court each
month, and the court makes repayments to their creditors.
AER
Annual equivalent rate is the interest that will be earned on
the money in one year and takes into account how often
the provider pays the interest (for example, monthly or
annually), the effect of compounding the interest and any
fees and charges.
APR
Annual percentage rate – the total cost of borrowing over
one year, including the interest charged and any fees.
Aspirations
Things or experiences that people would like to have in the
future, for example owning a home instead of renting,
having a luxury holiday or buying a sports car.
Assets
Things that a person or a business owns. For a person their
assets might include property, jewellery or financial
products such as company shares.
ATM
Automated teller machine, also known as a cash machine.
Bacs
The central payment system used to process different types
of electronic payment.
Balance
Income minus expenses.
Balance transfer
Moving the balance (total amount owed) on a card from one
card provider to another.
Banker’s draft
A banker’s draft is similar to a cheque but the payment is
signed and guaranteed by the financial services provider
that issues it, rather than by an individual. Banker’s drafts
are used for paying large sums of money but are falling out
of fashion for being old fashioned and not particularly
secure.
Bank rate
The interest rate that the Bank of England uses when it
lends money to other banks. Financial services providers
take account of the Bank rate when they decide how to set
interest rates on their own products.
Bankruptcy
A situation in which a person cannot pay their debts and is
the subject of a court order that shares out their assets
between their creditors.
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Barter
To exchange goods and services for other goods and
services without using money.
Basic bank account
A current account that allows people to store their money
as an electronic balance and make payments by direct
debit, standing order, prepaid cash card or by withdrawing
cash. There is no debit card, cheque book or overdraft
facility on this type of account.
Benefit
A government payment made to individuals who meet
specific conditions to help them meet their living expenses.
For example, people who are unemployed, unable to work
because they care for a disabled person, or have a disability
themselves may be entitled to benefits if they meet the
criteria.
Budget
A plan of expected incomings and outgoings over a set
time period such as a month. The Budget is also the term
given to the government’s spending plan, which the
Chancellor (see below) sets out in the House of Commons.
Budget balance
Total income minus total expenditure: a person’s net
financial situation.
Budget deficit
A situation in which outgoings exceed income.
Budget surplus
A sum of money available once all the essential expenditure
in a given period, eg a month, has been made.
Capital
The money or other assets owned by an individual or a
business. In the case of a financial services provider, it
refers to the funds provided by the shareholders, not
deposits from customers.
Card verification
Three numbers on the back of a credit or debit card. This
is a security measure designed to prevent fraudulent use
of the card by someone other than the cardholder.
Cashback
A service offered by some retailers when customers pay by
card. The retailer gives the customer cash and debits the
amount of cash handed over from the customer’s payment
card.
Cashback card
A type of card that gives back to the cardholder a
percentage of the value of transactions made with the card,
in the form of cash.
Cash flow forecast
A plan of expected incomings and outgoings over several
time periods, such as the next three months.
Cash card
A card used to withdraw cash from ATMs or branch
counters.
Cash ISA (individual
savings account)
An account that pays interest tax-free on cash savings up
to a certain level.
© The London Institute of Banking & Finance 2022
Chancellor of the
Exchequer
The British Cabinet minister responsible for financial and
economic matters and in charge of the Treasury.
CHAPS
Clearing House Automated Payment System, a same-day
payment system for high-value transactions, such as a
house purchase.
Charge card
A credit card that must be repaid in full every month.
Cheque
A written instruction to the provider (eg the bank or
building society) to pay a specified amount to a specified
person or organisation. (The law relating to cheques is
quite complex so this is a simplified explanation for the
purpose of these study materials.)
Child Trust Fund (CTF)
A long-term savings account only available to children born
between 1 September 2002 and 2 January 2011. CTFs were
set up by the government to encourage people to build up
savings for their children. They have been replaced by
junior ISAs.
Citizens Advice
A charity providing free, independent, confidential and
impartial advice on citizens’ and consumers’ rights and
responsibilities.
Common bond
An interest or circumstance shared by a group of people,
for example working for the same employer or living in a
certain area.
Communication channel
The medium through which information is transferred to
its intended recipient, eg email or telephone. In financial
services, it refers to the way a customer can contact their
provider and manage their account. It is also referred to as
a distribution channel.
Competition and
Markets Authority (CMA)
An independent, non-ministerial government department,
which works to promote competition between providers so
that customers benefit.
Consolidation loan
A loan used to pay off a number of different debts, meaning
that there is then only one payment to make each month,
to the loan company.
Consumer credit
This is another term used for borrowing. It is important to
understand that ‘taking credit’ or ‘buying on credit’ refers
to borrowing. However, a credit into a bank account means
paying money in.
Consumer Prices
Index (CPI)
One of the means the government uses to measure
inflation. It is calculated by checking the price of a
representative sample of goods on a monthly basis – this
enables statisticians to measure how much prices are rising
or falling. See also Retail Prices Index (below).
Consumer Rights Act 2015 Sets out the basic rules that govern how consumers buy
and businesses sell to them in the UK.
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Contactless card
A card that can be read simply by holding it in front of a
card reader. It is used for low-value payments.
Coronavirus
Coronavirus disease, known as Covid-19, is a respiratory
illness that causes mild to moderate symptoms in a
majority of cases but proves debilitating or fatal for a
significant minority. It caused a global pandemic with wideranging economic effects.
Cost of borrowing
Also called ‘cost of credit’. This is the total amount that the
borrower will be charged including interest and any fees.
For personal loans and credit card borrowing the cost over
a 12-month period must be quoted – the annual percentage
rate (APR).
County court
judgment (CCJ)
In England and Wales, a judgment issued by a county court
to a person who does not respond to court action from a
person or organisation to which they owe money. The CCJ
affirms that the money is owed.
Credit agreement
The formal agreement between a provider and a borrower
setting out the amount borrowed, the interest charged, the
arrangements for repayment and any other terms and
conditions.
Credit card
A card that allows the holder to make purchases face to
face, online or over the phone, and to withdraw cash from
an ATM. Unlike a debit card, where the money is taken from
the holder’s own account, transactions are paid by the card
provider. The card holder repays the amount owed to the
provider either in one payment or in instalments. The
provider charges interest on cash withdrawals from the
time the withdrawal is made and on purchases after a
certain period.
Credit crunch
A reduction in the availability of loans or a tightening of the
conditions needed to obtain one. The global financial crisis
of 2007–08 began when financial institutions became
reluctant to lend funds to one another.
Credit history
A record of money borrowed and repaid by an individual.
These records are held by credit reference agencies and
providers will check the individual’s credit history when a
prospective customer applies for a borrowing product.
Creditor
A person or organisation to which someone owes money.
Credit union
A mutual organisation (that is, owned by its members) that
provides a range of financial products, eg savings accounts
and personal loans to members. Members of a credit union
must share a common bond, eg all work for the same
employer or all work in the same district.
Current account
Bank or building society accounts where people can store
their money in the form of electronic balances and
withdraw it to make payments.
© The London Institute of Banking & Finance 2022
Debit card
A card that can be used to withdraw cash, to make face-toface transactions in, for example, shops, and to make
payments online or over the phone.
Debt Arrangement Scheme A Scottish government-run programme similar to a debt
management plan. It involves arranging to make payments
via a debt payment programme.
Debt management
company (DMC)
An organisation to which a person in debt (debtor) pays
what they can afford each month. The DMC then deals with
the organisations (creditors) owed money.
Debt management plan
A detailed plan drawn up by a debt management company
(DMC) and sent to an individual’s creditors (entities they
owe money). It sets out an affordable monthly payment
shared between the creditors.
Debt relief order (DRO)
An order a person in specific conditions can apply for if
they cannot afford to pay off their debts. It generally lasts
one year, during which time none of the people owed
money can take action, and after which the listed debts are
cleared. Granted by the Insolvency Service, a DRO works out
cheaper than going bankrupt.
Debtor
A person in debt to an individual or organisation (creditor).
Demographic changes
Changes to the size and structure of the population (for
example an increase in the number of people over the age
of 65, or a rise in children of school age).
Demutualisation
The process whereby a mutual organisation (eg building
society) legally becomes a shareholder-owned joint stock
company (eg a bank).
Denomination
A group of coins or notes that share the same face value.
Deposit
A sum of money placed by a customer with a financial
services provider.
Direct credit
An electronic payment into an account, for example a salary
or benefit payment.
Direct debit
An electronic payment out of an account. The amount and
frequency of a direct debit payment can vary.
Discretionary expenditure Voluntary spending on products and services that people
want now, and savings towards items they aspire to buy in
the future.
Dividend
A payment of profits from a company to its shareholders,
often at twice-yearly intervals, either as cash or (depending
on the plan) as further shares or reacquisition of shares.
Divisible
A key feature of money – to be easily divided into amounts
of different value.
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Double coincidence
of wants
A situation in which two people have goods or services to
trade and each wants what the other person can provide.
Durable
A key feature of money – to be strong enough to be reused
in many transactions.
Duty
The tax paid on certain items, including fuel, cigarettes and
alcohol.
EAR
Equivalent annual rate – traditionally the cost of borrowing
using an overdraft.
Economic boom
A period when the country is producing and selling an
increasing amount of goods and services.
Essential expenditure
Spending on items required to live, eg rent or mortgage
repayments, food and drink, water supplier, gas and
electricity.
Face value
The value marked on a coin or note (eg 1p, 2p, 5p, £5,
£10).
Faster Payments
An electronic payment service that enables payments to be
made within two hours.
Fiduciary value
Value based on trust in the banking system.
Financial Conduct
Authority (FCA)
One of the two main regulators of financial services in the
UK (the other is the Prudential Regulation Authority).
Financial Ombudsman
Service (FOS)
An independent body set up by Parliament that settles
customer complaints about providers at no charge to
consumers.
Financial Policy
Committee (FPC)
A part of the Bank of England that monitors and responds
to risk posed to the entire financial services market. Its
focus on the whole market makes it a macro-prudential
authority.
Financial Services
Compensation Scheme
(FSCS)
A compensation scheme that pays compensation to
account holders of up to a certain amount per provider if
the provider goes into default (in other words cannot pay
account holders the money they have in their accounts).
Fronting
A fraudulent method of lowering car insurance costs by
naming a person as the main driver on a policy when they
are not.
General insurance
A broad category of insurance that provides protection
against financial losses associated with events such as car
accidents (motor insurance), loss of or damage to a home
or its contents (buildings and home contents insurance),
problems with a holiday (travel insurance) and vet bills (pet
insurance).
Gross interest
Interest paid without tax deducted.
© The London Institute of Banking & Finance 2022
Guarantor
Someone who undertakes to repay a financial obligation if
the person who took on the obligation in the first place
cannot or does not repay it. For instance, a guarantor might
agree to pay rent or make repayments on a loan on
someone else’s behalf.
Health insurance
Products used to protect against the financial loss of being
too unwell to work or being diagnosed with a critical illness.
HMRC
Her Majesty’s Revenue and Customs – the organisation that
collects taxes on behalf of the government.
Homogeneous
A key feature of money – to look and feel the same as other
coins and notes of the same denomination.
Income
Earnings, savings and interest payments received within a
certain time frame.
Income tax
Tax paid on earnings from employment, self-employment
and interest on savings.
Independent Commission A committee formed in June 2010, as a response to the
on Banking (ICB)
global financial crisis. It considered reforms to the UK
banking sector to promote both financial stability and
competition.
Independent financial
adviser (IFA)
A professional who makes financial recommendations to
clients, based on available products across a wide range of
providers.
Individual savings
account (ISA)
An account that pays interest tax-free on savings up to a
certain level. There are two types of ISA: cash ISAs and
stocks and shares ISAs. Junior ISAs are available for people
under 18.
Individual voluntary
arrangement (IVA)
A formal alternative to bankruptcy comprising a contractual
arrangement with those owed money.
Inflation
A rise in prices, which means that the purchasing power of
money falls.
Inheritance
The property, money, etc, passed from one person to
another upon death.
Insolvency
A situation in which a person cannot repay what they owe
because their debts are greater than their assets.
Insurance certificate
A document issued by an insurance provider that verifies
the existence of coverage for the policyholder, and offers a
summary of the cover given.
Instant access account
An account from which the holder can withdraw their
money at any time without losing any interest.
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Insurance
Products that give financial protection against certain
events. For example, someone who has travel insurance
might be able to claim back the cost of a holiday if they
have to cancel through illness.
Interest
Money either paid to an account holder by the provider, or
charged to the account holder by the provider. Interest is
paid on savings accounts and some current accounts and
charged on borrowing, eg an overdraft. Each provider
decides the rate of interest it will pay or charge, depending
on the type of account and, in some cases, the credit
history of the individual account holder.
Interest rate
The amount, expressed as percentage, that a financial
services provider charges a borrower when it lends money,
or pays to a saver.
Interest rate margin
The difference between the interest rate that a bank
charges on borrowing products and the interest rate that it
pays on savings.
Intrinsic value
The value that an item has in itself, eg a bag of rice has
intrinsic value because it is a staple food; a solid gold coin
has intrinsic value because it is made of a precious metal;
a banknote does not have intrinsic value because it is a
piece of paper or polymer.
Investments
Money paid into financial products; the aim is that the value
of the product will grow over time and so the person will
eventually receive back more money than they paid in.
Investments are a way of saving over the medium or long
term.
Investment banks
Banks that are involved in trading financial assets such as
shares, underwriting issues of shares by other institutions
and advising on mergers and acquisitions. Investment
banks do not provide services such as current accounts, etc
– these are provided by retail banks.
Junior ISA
Long-term savings accounts set up by a parent or guardian
specifically for the child’s future. The child can only access
the money once they turn 18 years old.
Legal tender
Coins or banknotes that must be accepted if offered in
payment of a debt.
Life assurance
A type of insurance policy that pays out a sum of money if
the insured person dies.
Life cover
See life assurance.
Life cycle
The stages through which people pass between birth and
death, including childhood, teenage years, young adult,
mature adult and old age. Not everyone passes through all
stages (for instance they might die at an early stage) and
not everyone passes through the stages at the same age.
© The London Institute of Banking & Finance 2022
Life expectancy
The number of years that people are expected, on average,
to live, based on the year in which they are born.
Liquidity
The assets that a business holds in the form of cash, that
can be used to meet immediate demands for payment.
(Many assets cannot be used in this way – for example a
company that owns a building or machinery would have to
sell them in order to make a payment.)
Mandatory expenditure
Compulsory outgoings; they do not necessarily apply to
everyone but if they do apply, they must be paid.
Mandate
A paper or online instruction to a provider (eg bank or
building society) to make a payment from an account.
Means of exchange
A function of money – to allow people to make payments.
Minimal asset process
(MAP)
Available in Scotland and similar to a DRO. The MAP is the
route into bankruptcy for people with less than £2,000 in
assets.
Money
Anything widely accepted as a means of making payments.
Money Advice Service
A consumer information service set up by the government
to help people make informed financial decisions. It is now
part of the Money and Pensions Service along with Pension
Wise and the Pensions Advisory Service.
MoneyHelper
An independent organisation set up by the government to
support people to make the most of their money and
pensions.
Money laundering
The process of making ‘dirty’ money (money gained from
criminal activities) ‘clean’ – in other words making it look
as though it has been acquired legitimately.
Mortgage
A loan taken out to pay for a property, usually over a long
term such as 25 years.
Mutual organisation
An organisation owned by its customers, who are also its
members, rather than by shareholders.
National Insurance
contributions
Money deducted from the pay of people who are employed
or self-employed and used by the government to fund state
pensions and other benefits.
National living wage
The minimum that people aged 23 and over must be paid
per hour by law. The national minimum wage applies to
workers aged under 23.
National minimum wage The minimum pay per hour to which workers are entitled
by law. The rate depends on a worker’s age and whether
they are an apprentice. It applies to workers aged under 23.
Workers aged 23 and over are entitled to the national living
wage.
© The London Institute of Banking & Finance 2022
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National Savings and
Investment (NS&I)
A provider that is backed by the Treasury (the government
department that manages the UK’s finances).
Needs
Things that people need to survive, such as food, basic
clothing and a place to live.
No claims discount
A discount on the insurance premium that builds up for
each year a person does not make a claim.
Notice account
An account for which the holder has to tell the provider in
advance if they want to withdraw their money. If they do
not give the provider the required amount of notice, they
lose interest on their savings.
Office for National
Statistics
The independent organisation that produces statistics on
many aspects of life in the UK such as employment, health,
how long people live for in different areas of the country,
housing, etc.
Office of Fair Trading
The government department that monitored how
businesses compete with each other. It was abolished in
April 2014 and its responsibilities shared between the
Financial Conduct Authority and the Competition and
Markets Authority.
Overdraft (authorised
and unauthorised)
A facility that allows an account holder to withdraw more
money than they actually have in their account. An
authorised overdraft is agreed with the bank in advance
within certain limits. Exceeding those limits or going
overdrawn without permission is an unauthorised overdraft,
and attempted withdrawals may not be honoured.
P45
A document legally required from an employer when an
employee stops working for them. It summarises the
employee’s tax and National Insurance details for their next
employer.
P60
A document prepared at the end of every tax year to show
all the income tax and National Insurance contributions
paid by an individual during the preceding 12 months.
Packaged account
A current account that offers extra benefits such as travel
insurance, for which the account holder pays a monthly fee.
Payday loan
A loan designed to be taken out for only a very short
period, which charges a very high APR.
Payment allocation
The order in which a card provider uses money paid into
an account to pay off the amount outstanding.
Payment mechanism
A means of transferring money from one account to
another, eg debit card, cheque.
Payment protection
insurance (PPI)
An insurance product intended to ensure repayment of
loans should a borrower face unexpected events that
prevent them from repaying the debt.
© The London Institute of Banking & Finance 2022
Pension
An income that people receive after retiring from work. In
the UK people receive a pension from the state; some
people also receive pension payments from schemes run
by their former employers or arrangements that they have
made for themselves.
Personal allowance
The amount that an individual can earn before they have to
pay income tax.
Personal loan
A product that allows someone to borrow a fixed amount
over a fixed period at a fixed rate of interest.
Personal savings
allowance
The amount of savings interest that can be earned before
the saver pays tax. The amount of the allowance varies
according to how much other income the saver has earned
in the tax year.
Portable
A key feature of money – to be small and light enough to
carry around easily.
Premier account
A current account that offers additional benefits, such as a
personal banker, for wealthy customers with an income or
savings above a certain level.
Premium
The price of an insurance policy, based on factors including
how likely an event is to occur, the amount of money
needed to rectify the situation should the event happen, the
length of time the policy will be in force, and how the
premium is paid.
Premium Bond
A lottery bond, issued by NS&I, entered into a monthly prize
draw with tax-free prizes or ‘premiums’. Bonds must be
held for a full calendar month after the month in which they
were purchased, and retain an equal chance of winning
until cashed in.
PIN
A secret personal identification number that verifies a
user’s identity to a system, eg at a point of sale for debit
and credit cards.
Prepaid cards
A card that has to have money credited to it before the card
holder can use it to pay for goods. Once the initial sum of
money on the card runs out, it can be topped up again.
Some prepaid cards can be loaded with foreign currency
and used abroad.
Prudential Regulation
Authority (PRA)
One of the two main regulators of financial services in the
UK (the other is the Financial Conduct Authority).
Public limited
company (plc)
A large company whose shares are sold and traded to the
general public. The shareholders have limited liability, up
to the value of their investment, for the company’s debts.
Purchasing power
The quantity of goods or services that money can buy.
© The London Institute of Banking & Finance 2022
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Rate of exchange
How much one item is worth in terms of a different item,
eg one bag of flour is worth four nails, one British pound is
worth 1.5 euros, etc.
Rate of return
The amount a saver gains in interest on their savings. For
instance an account paying 0.2% AER offers a lower rate of
return than one paying 0.4% AER.
Real terms
A value adjusted to account for changes in prices. For
example, although someone may receive a nominal pay
increase of 5%, if inflation (ie rise in general prices) is 3%
then in real terms the pay increase is approximately 5% –
3% = 2%.
Recession
A period of at least six months when the amount of goods
and services the country is producing is shrinking.
Recognisable
A key feature of money – to be easily identified as genuine
money.
Redundancy
Losing a job because the business no longer needs, wants
or can afford that job to be done; it is related to the needs
of the business and not to how well or badly an individual
does their job.
Representational value
The value that an item represents rather than the value it
has in itself: a banknote is just a piece of paper or polymer
but it represents the value that is printed on it.
Retail banks
Banks that deal directly with consumers, for example
providing current accounts and mortgages.
Retail Prices Index (RPI)
One of the ways the government measures inflation. It is
calculated by checking the price of a representative sample
of goods on a monthly basis but unlike CPI (see above), it
also takes into account mortgage interest payments and
other costs associated with home ownership.
Risk averse
Reluctant to take any kind of risk.
Risk tolerant
Willing to take risks.
Savings bonds
A savings product held for a fixed period, eg two years. The
holder can only make a limited number of withdrawals, or
none at all, during that period without incurring a penalty.
Scarce but sufficient
A key feature of money – to be available in sufficient
quantities to meet people’s needs but not in such quantities
that the value of money falls.
Self-assessment
A method used, often by self-employed people, to calculate
the amount of tax and National Insurance they need to pay.
Self-employment
Earning an income by selling your goods or services directly
to a consumer, rather than being employed by somebody
else and being paid a wage or salary.
© The London Institute of Banking & Finance 2022
Sequestration
The term for bankruptcy in Scotland, which applies to
people who owe more than a specified amount, have not
been bankrupt in the last five years and have had court
judgments for payment made against them.
Shares
Investments that represent part-ownership of a company.
Standards of Lending
Practice
A voluntary code of conduct that sets out good practice for
the provision of advice about loans, credit cards, charge
cards and current account overdrafts. It assures customers
that subscribed providers follow the Standards and gives
information on the service they should expect.
Standing order
An electronic payment out of an account. Standing orders
are used to make regular payments of the same amount.
Starting-rate band
An amount of savings that an individual can earn tax-free
if their total income is less than the personal allowance.
Statement
A record of the transactions on an account, issued at
regular intervals such as monthly or quarterly. The
statement indicates whether a debit or credit to the account
was made by cheque, withdrawal from an ATM, direct debit,
etc.
Stocks and shares
Stocks, shares and equities are all words used to describe
an investment that gives the holder part ownership of a
company. If the company’s value increases, so does the
value of your share; if its value falls, so does the value of
your investment. Shares are bought and sold on stock
exchanges.
Store card
A card issued by a retailer that the holder can use to make
purchases within that store or group of stores. As with a
credit card, the amount owing is paid off at a later date,
either in one payment or in instalments, and interest is
charged on the amount owed.
Store of value
An attribute of money that allows people to store money
now and spend it later.
Student account
A current account designed for students in higher
education that charges low interest or no interest on
overdrafts, and offers other benefits such as low-cost
contents or travel insurance.
Sub-prime market
Lending to and borrowing by consumers with untested or
poor credit histories.
Sum insured
The maximum amount an insurance provider will pay out.
Taxable income
Income on which tax must be paid – that is, after deducting
allowances and any permitted expenses from the total
income earned.
Tax band
A category of income on which a specific rate of tax is
payable.
© The London Institute of Banking & Finance 2022
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Tax code
A code used by a person’s employer or pension provider to
calculate the tax to deduct from pay or pension.
Tax paid at source
Tax deducted by the provider (on behalf of the government)
from interest earned on savings. Since April 2016,
providers no longer deduct income tax from savings
interest at source.
Tax return
A tax form completed annually by people in certain
situations (eg self-employed people or employed people
who receive money in addition to their salary). It sets out
details of income and expenditure and allows the taxpayer
or HMRC to calculate the amount of tax and NI
contributions owed.
Tax year
Also known as the financial year, the tax year runs from 6
April to 5 April in the following year. The tax people owe is
calculated according to how much they have earned April
to April rather than January to December.
Third-party insurance
Insurance that covers damage that the policyholder causes
to someone else (the ‘third party’) or to their property but
does not cover the policyholder for any injury or loss that
they suffer themselves.
Transaction
Buying or selling something.
Transaction need
The reason why someone needs to make a payment, eg
needing to top up your phone credit so that you can use
your phone is a transaction need.
Travel insurance
A product providing coverage for unexpected events such
as trip cancellation, medical expenses, travel delays and
other losses incurred while travelling.
Traveller’s cheque
A pre-printed cheque for a set amount of currency eg 50 or
100 US dollars or euros. A traveller’s cheque can be
exchanged for local currency or used to make payments
while abroad.
Treasury
Her Majesty’s (HM) Treasury, the government department
responsible for development and implementation of
financial and economic policy.
Trust deed
Available in Scotland and similar to an individual voluntary
arrangement (IVA). An insolvency practitioner helps people
who are insolvent to make affordable repayments, and after
four years any outstanding debt is written off.
Unit of account
A function of money – to allow people to compare prices
and to measure the value of money in a bank account, etc.
Utility
An essential public service, such as electricity, gas, water
and sewerage.
© The London Institute of Banking & Finance 2022
Voluntary excess
The excess is the amount paid on any claim by the
policyholder before the insurance company will pay
anything. A compulsory excess is usually set by the
insurance company, but consumers can opt for a higher
voluntary excess in exchange for a lower premium.
Wants
Things that people would like to have but can survive
without, such as entertainment, fashionable clothes, etc.
Will
A legal document setting out what a person wants to
happen to their belongings (assets) after their death.
Youth account
A current account designed for people under 18; no
overdraft facility is provided as banks do not usually allow
under-18s to borrow.
Zero-hour contract
A type of employment contract that does not set out a fixed
number of hours that an employee must work and be paid
for. The employer is not obliged to provide work nor the
employee to take work offered.
© The London Institute of Banking & Finance 2022
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226
© The London Institute of Banking & Finance 2022
Index
A
administration orders 11.1.3
annual equivalent rate (AER) 5.1
annual percentage rate (APR) 6.1, 6.3.2
aspirations 2.2, Topic 5 introduction,
Topic 9 introduction
Association of British Credit Unions Limited
(Abcul) 7.3
B
bank accounts see also savings
balances 1.5
basic current accounts 4.2.1
closing procedures 4.5
current accounts 1.5, 4.1, 4.2.2, 4.2.3,
4.2.4
joint accounts 4.2.6
monitoring 4.4
opening procedure 4.3
overdrafts 1.5, 6.1, 6.2, fig.6.1
packaged current accounts 4.2.7
premier accounts 4.2.8
statements 1.5
supermarket banks 4.1
switching 4.5, 7.7
Bank of England
Bank rate 2.5, 5.1, fig. 5.3
Financial Policy Committee (FPC) 8.2.1,
8.2.2, fig. 8.2
inflation management 5.2
Prudential Regulation Authority (PRA)
8.2.1, 8.2.2, fig. 8.2
Bank of Scotland Topic 7 introduction
Bank rate 2.5, 5.1, fig. 5.3
banker’s drafts 3.4
Banking Reform Bill 8.1.2
banknotes see paper notes
bankruptcy 11.2.3, 11.3.3
banks
advantages and disadvantages 7.1.2
assets 7.2.1, 7.2.2, fig. 7.2
Barclays Group 7.1.1
the ‘Big Five’ 7.6
branch networks 7.6.1
communication channels 7.6
First Direct 7.1.2
history Topic 7 introduction
Lloyds Banking Group 7.1.1
mobile banking 7.6.4
online banking 7.6.2
payment systems 1.1.5
products and services 7.1
telephone banking 7.6.3
Barclays Group 7.1.1, 7.6
barter 1.1, 1.1.3, 1.1.5
benefits 10.8, 12.3.3
bitcoin 1.3.2
bonds 5.1.3
branch networks 7.6.1
Bristol Credit Union 7.3.1
British Bankers’ Association 7.1.1, 8.6
budgets
balance 9.4
deficit 9.4.1
drawing up a plan 9.4.2
expenditure 9.3
income 9.2
monitoring and checking 9.5
objectives 9.1
overview Topic 9 introduction
revision 10.5
building societies
advantages and disadvantages 7.2.1
assets 7.2.1, 7.2.2, fig. 7.2
demutualisation 7.2.3
local focus 7.2.2
products and services 7.2
Building Societies Association 7.2.3, 8.6
buildings and contents insurance 10.3
C
Callcredit 6.5
card verification value (CVV) 6.3.1
cash
advantages 3.1.1
disadvantages 3.1.2
use Topic 1 introduction, 3.1
cash cards 3.5.1
cash flow 9.6, Topic 9 introduction
cashback 3.5.2, 6.3.3
certificate of insurance 10.1.3
CHAPS (Clearing House Automated Payment
System) 3.2.5
charge cards 6.3.5
charity credit cards 6.3.3
Cheque and Credit Clearing Company
(CCCC) 3.3.3
cheques
advantages 3.3.1
decline in use 3.3.3, fig. 3.2
disadvantages 3.3.2
overview 3.3
children 2.1, Table 2.1
chip and PIN 6.3.1
Citizens Advice Topic 11 introduction
civil partnerships 2.5.4
codes of conduct 8.6, Topic 8 introduction
coins 1.1.3, 1.2.6, 1.2.8, 1.3.2, Topic 1
introduction
communication channels
branch networks 7.6.1
mobile banking 7.6.4
online banking 7.6.2
overview 7.6
post 7.6.5
telephone banking 7.6.3
© The London Institute of Banking & Finance 2022
227
compensation 5.4.1, 7.1.2, 7.5, Topic 7
introduction, 8.2.1, 8.4, fig. 8.4
competition 8.5, Topic 8 introduction
Competition and Markets Authority (CMA)
8.5, Topic 8 introduction
complaints 8.2.1, 8.2.2, 8.3, fig. 8.3
comprehensive insurance 10.2.1
consolidation loans 11.1.1
consumer credit see loans
Consumer Credit Directive (2008) 6.1
Consumer Insurance (Disclosure and
Representations) Act (2012) 10.1.2
Consumer Prices Index (CPI) 5.2, 9.7
consumer protection
background 8.1
organisations Topic 7 introduction,
Topic 8 introduction
overview Topic 7 introduction
contactless cards 3.5.4
contracts
cooling-off period Topic 6 introduction
loans Topic 11 introduction
cooling-off period Topic 6 introduction
cost of living
food 9.7.3
fuel 9.7.2, fig. 9.1
housing 9.7.1
overview 9.7
reducing expenditure 10.9.4
council tax 9.3.1
county court judgment (CCJ) 11.1.3
Covid-19 (coronavirus) 5.1
credit agreements see contracts
credit cards
balance transfers 11.1.1
charge cards 6.3.5
fees 6.3.2
functions 6.3, 6.3.1
interest rates 6.3.2
statements 6.3.2
store cards 6.3.4
transaction cycle 6.3.1, fig. 6.3
types 6.3.3
credit crunch
causes 8.1.1
global impact 7.1.2
regulatory responses to 8.1.2
credit reference agencies 6.5
credit status 6.2.2, 6.5
credit unions
advantages and disadvantages 7.3.3
background Topic 7 introduction
membership 7.2.1, 7.3.1
products and services 7.3, 7.3.2
regulation 7.3.1
creditworthiness 6.2.2, 6.5, 9.3.2
currencies 1.3.2
currency
foreign exchange 1.4.2
local currencies 1.3.2
current accounts
basic current accounts 4.2.1
228
choice and convenience 4.1
electronic payments 3.2
fees 4.1
functions 1.5
interest on credit balances 4.2.5
joint accounts 4.2.5
monitoring 4.4
overdrafts 1.5, 6.1, 6.2
packaged accounts 4.1, 4.2.7
premier accounts 4.2.8
standard accounts 4.2.3
students and graduates 4.2.4
supermarket banks 4.1
types 4.2
customers
credit status 6.2.2, 6.5, 9.3.2
financial lifecycle 1.6, Topic 2
introduction
needs, wants and aspirations 2.2, Topic 5
introduction, Topic 9 introduction
D
debit cards 1.2.6, 3.5.2, 3.6.1, fig. 3.3
debt
administration orders 11.1.3
advice and counselling Topic 11
introduction
bankruptcy 11.2.3, 11.3.3
debt management plans 11.1.2
debt relief orders (DROs) 11.2.2
good v bad debt 10.7
individual voluntary arrangements (IVAs)
11.2.1
insolvency 11.2, fig. 11.1
repayments 10.9.2, 11.1
solutions overview Topic 11 introduction
switching to cheaper products 11.1.1
debt management companies (DMCs) 11.1.2
Debt Arrangement Scheme 11.3.1
debt relief orders (DROs) 11.2.2
demographics see also financial lifecycle
definition 2.5
family units 2.5.4
life expectancy 2.5.1
migration 2.5.2
demutualisation 7.2.3
direct debits 3.2.2
discretionary expenditure 9.3.3
distribution channels see communication
channels
double coincidence of wants 1.1
Driver and Vehicle Licensing Agency
(DVLA) 10.1.3
E
earned income
National Insurance contributions (NICs)
9.3.1, 12.3, 12.3.3, 12.3.4
national living wage 12.1, Topic 12
introduction
national minimum wage 12.1
overview 9.2.1, Topic 12 introduction
© The London Institute of Banking & Finance 2022
P45 12.4.2, fig. 12.2
payslips 12.4.1, fig. 12.1
taxation 12.3, 12.3.4, Topic 12
introduction
eBay 3.2.7
economics
boom and bust 2.5
the cost of living 9.7
inflation 1.2.3, 5.2
interest rates 2.5
trends 2.5
unemployment 2.3, 2.5
education 2.3, 2.5.3
electronic payments
advantages 3.2.8
CHAPS (Clearing House Automated
Payment System) 3.2.5
direct debits 3.2.2
disadvantages 3.2.8
mobile banking 3.2.6
online banking 3.2.3
overview 3.2
PayPal 3.2.7
standing orders 3.2.1
emergency funds
loans 10.7
savings 10.6, 10.9.1
state benefits 10.8
emotional risk 2.4.2
employment see also earned income
earned income 9.2.1, Topic 12
introduction
legislation Topic 12 introduction
and location 2.3
and migration 2.5.2
national living wage 12.1, Topic 12
introduction
national minimum wage 12.1, Table 12.1
working hours 12.2, Table 12.2
Equifax 6.5
equivalent annual rate (EAR) 6.1
essential expenditure 9.3.2, Table 9.2
euro, the 1.4.2
European Union
unemployment rates (2013) 2.3, fig. 2.1
exchange rates 1.4.2
expenditure
and budget deficit 9.4.1
and budget planning Topic 9 introduction
cost of living 9.7, 10.9.4
discretionary 9.3.3
essential 9.3.2, Table 9.2
mandatory 9.3.1
needs, wants and aspirations 2.2, Topic 5
introduction, Topic 9 introduction
Experian 6.5
F
families 2.5.4
Faster Payments 3.2.4, fig. 3.1
fei stones 1.1.2
Financial Conduct Authority (FCA) Topic 7
introduction, 8.2.1, 8.2.2, fig. 8.2, Topic 8
introduction
financial crime
money laundering 4.3
financial crisis (2007–08)
bank bailouts 7.1.2, 8.1.1
credit crunch 7.1.2, 8.1.1, 8.1.2
timeline 8.1.1
financial inclusion
financial services provision 4.2.1
financial life cycle 1.6, 2.1, Table 2.1,
Topic 2 introduction, Topic 9 introduction
and attitudes to risk 2.4.5
external influences 2.5
interest rate impact 2.5
life events 2.3, Table 2.2
Financial Ombudsman Service 8.2.1, 8.3,
Topic 8 introduction, 10.1
financial planning see also savings
balance 9.4
budgets 9.1, Topic 9 introduction
cash flow forecasts 9.6, Topic 9
introduction
and the cost of living 9.7
expenditure 9.3, Topic 9 introduction
and the financial lifecycle 2.1, 2.3,
Table 2.1, Table 2.2, Topic 2
introduction, Topic 9 introduction
income 9.2, Topic 9 introduction
monitoring and checking 9.5
needs, wants and aspirations 2.2, Topic 5
introduction, Topic 9 introduction
revision 10.5
unexpected events 10.6, Topic 10
introduction
Financial Policy Committee (FPC) 8.2.1,
8.2.2, fig. 8.2
financial risk 2.4.4
financial services
banks 7.1
building societies 7.2
choosing a provider 7.7
codes of conduct 8.6, Topic 8
introduction
communication channels 7.6, Topic 7
introduction
credit unions 7.3
fees Topic 7 introduction
global business 7.1.2
National Savings and Investments
(NS&I) 7.4
Post Office 1.5, 7.5
providers fig. 7.1, Topic 7 introduction
regulation Topic 7 introduction
sub-prime market 8.1.1
Financial Services Act (2012) 8.1.2, 8.2.1
Financial Services Authority (FSA) 8.2.1
Financial Services (Banking Reform) Bill
8.1.2
© The London Institute of Banking & Finance 2022
229
Financial Services Compensation Scheme
(FSCS) 5.4.1, 7.1.2, 7.5, Topic 7
introduction, 8.2.1, 8.4, fig. 8.4, Topic 8
introduction
financial stability 8.2.1
First Direct 7.1.2
fixed interest rates 6.1
fixed period accounts 5.1.3
food prices 9.7.3
fuel prices 9.7.2, fig. 9.1
G
general insurance fig. 10.1, Topic 10
introduction
globalisation 7.1.1
gold
as payment system 1.1.2
prices 1.1.3, fig. 1.1
graduates 4.2.4
guarantors 11.1.1
H
health 2.3.3
health insurance fig. 10.1, Topic 10
introduction
Help to Buy ISAs 5.3.3
higher education 2.5.3, fig. 2.2
higher rate of interest 5.1.2
HM Revenue and Customs (HMRC) 9.3.1
HM Treasury 8.2.1
housing costs 9.7.1
HSBC Bank plc 7.1.1, 7.6
I
identity checks 4.3
income
and budget planning Topic 9 introduction
from employment see earned income
and life stages 2.3.2
net income 9.3.1
pensions 2.5.1
taxation 9.3.1
unearned income 9.2.2
unexpected funds 10.9, fig. 10.2
income tax 5.3, 9.3.1, 12.3, 12.3.4, Table
12.3, Topic 12 introduction
P45 12.4.2, fig. 12.2
P60 12.4.3, fig. 12.3
returns 12.5
self-assessment 12.5.1
Independent Commission on Banking 8.1.2,
fig. 8.1
individual savings accounts (ISAs) 5.3.1,
12.3.2
Help to Buy ISAs 5.3.3
Junior ISAs 5.3.2
Lifetime ISAs 5.3.4
tax 5.3.1
individual voluntary arrangements
(IVAs) 11.2.1
230
inflation
measurement 5.2, 9.7
and purchasing power 1.4.1, 5.2, Table 5.1
and savings 5.5, Table 5.2
insolvency 11.2, fig. 11.1
instant access accounts 5.1.3, 5.1.4
insurance
buildings and contents 10.3
claims 10.1.4
costs 10.2.3
documents 10.1.3
general insurance fig. 10.1, Topic 10
introduction
information disclosure 10.1.2
legal requirements 9.3.1, 10.2
life assurance fig. 10.1, Topic 10
introduction
mobile phones 10.4
motor insurance 10.1.1, 10.2
no-claims discount 10.1.1
pay-as-you-go 10.2.2
pet insurance 10.4
premium tax 10.1.1
premiums 10.1.1
sum insured 10.1.3
terms and conditions 10.2.1
travel insurance 10.1.2, 10.4
interest rates
annual equivalent rate (AER) 5.1
annual percentage rate (APR) 6.1, 6.3.2
Bank rate 2.5, 5.1, fig. 5.3
credit cards 6.3.2
economic impact 2.5
equivalent annual rate (EAR) 6.1
fixed 6.1
higher rate 5.1.1
loans 6.1
overdrafts 6.2.2
personal loans 6.4
regular savers 5.1.2
saving term 5.1.2
savings 2.5, 5.1, 5.5, Table 5.2
variable 6.1
intrinsic value 1.1.2
investments
stocks and shares 5.4.3
Irish Deposit Protection Scheme 7.5
J
Junior ISAs 5.3.2
L
legal tender 1.3.2
life assurance fig. 10.1, Topic 10
introduction
life events
education 2.3.1, 2.5.3, fig. 2.2
employment 2.3
health 2.3.3
and income 2.3.2
retirement 2.5.1
© The London Institute of Banking & Finance 2022
and social status 2.3.4
unforeseen circumstances 2.3.5
life expectancy 2.5.1
life cycle see financial life cycle
lifelong learning 2.5.3
Lifetime ISAs 5.3.4
living wage 12.1, Topic 12 introduction
Lloyds Banking Group 7.1.1, 7.6
loans
and borrower needs Topic 6 introduction
choosing a product 6.6
consolidation loans 11.1.1
contracts Topic 11 introduction
credit cards 6.3
customer credit history 6.5
fees 6.1
guarantors 11.1.1
interest rates 2.5, 6.1
measure of deferred payments 1.3.4
overdrafts 1.5, 6.1, 6.2, fig.6.1
overview Topic 6 introduction
payday lenders 8.2.2
personal loans 6.4, Table 6.2
regulation 6.1
repayments 11.1.1
secured Topic 6 introduction
and unexpected events 10.7
unsecured Topic 6 introduction
local exchange trading systems or schemes
(LETS) 1.1.5
M
mandatory expenditure 9.3.1
marriage 2.5.4
Mastercard 6.3.1
means of exchange 1.3.2
Metro Bank Topic 7 introduction
migration 2.5.2
Minimal asset process (MAP) bankruptcy
11.3.3
minimum wage 12.1, Table 12.1, Topic 12
introduction
mis-selling 8.2.1, 8.2.2
mobile banking 3.2.6, 7.6.4
mobile phones 10.4
money
and changing needs 1.6
coins 1.2.8, 1.3.2
durability 1.2.5
features 1.2
functions 1.3, Topic 1 introduction
homogeneity 1.2.8
local currencies 1.3.2
measure of deferred payments 1.3.4 see
also loans
origins and development 1.1
paper notes 1.2.8, 1.3.2
payment transfer 1.2.1
portability 1.2.6
purchasing power 1.4.1, 1.4.2
security features 1.2.2
stable value 1.2.3
store of value 1.3.3
supply 1.2.7
units of account 1.3.1
MoneyHelper 8.2.1, 10.6, Topic 11
introduction
money laundering 4.3
mortgages Topic 6 introduction, 7.2.2, 9.7.1
motor insurance 10.1.1, 10.1.3, 10.2
mutual organisations
building societies 7.2
credit unions 7.2.1, 7.3, Topic 7
introduction
N
National Debtline Topic 11 introduction
National Insurance contributions (NICs)
9.3.1, 12.3, 12.3.3, 12.3.4, Topic 12
introduction
national living wage 12.1, Topic 12
introduction
national minimum wage 12.1, Table 12.1,
Topic 12 introduction
National Savings and Investments (NS&I)
5.4.2, 7.4
needs 2.2, Topic 5 introduction, Topic 9
introduction
net income 9.3.1
No1 CopperPot Credit Union Ltd 7.3.1
no-claims discount 10.1.1
Northern Rock 8.1.1
notice accounts 5.1.3
O
occupational pensions 2.5.1
oil prices 9.7.2, fig. 9.1
online banking 7.6.2 see also electronic
payments
overview 3.2.3
overdrafts 1.5, 6.1, 6.2, fig.6.1
authorised and unauthorised 6.2.2
costs 6.2.2
function 6.2.1
overview 6.2, fig.6.1
Oyster cards 3.5.3
P
P45 12.4.2, fig. 12.2
P60 fig. 12.3
packaged accounts 4.1, 4.2.7
paper notes 1.1.4, 1.2.6, 1.2.8, 1.3.2, Topic 1
introduction
Pay As You Earn (PAYE) 12.3.4, 12.4
Pay Your Way 3.1
payday loans 8.2.2
payment cards 3.5
payment protection insurance (PPI) 8.2.1,
8.2.2
payment systems see also bank accounts
bank system 1.1.5
banker’s drafts 3.4
barter 1.1.2, 1.1.3, 1.1.5
© The London Institute of Banking & Finance 2022
231
cash 3.1
cash cards 3.5.1
CHAPS (Clearing House Automated
Payment System) 3.2.5
cheques 1.2.6, 3.3, 3.3.1, 3.3.2, 3.3.3,
fig. 3.2
choice and convenience 3.7, fig. 3.4
contactless cards 3.5.4
debit cards 1.2.6, 3.5.2, fig. 3.3
direct debits 3.2.2
Faster Payments 3.2.4, fig. 3.1
gold 1.1.3, fig. 1.1
intrinsic value 1.1.2
mobile banking 3.2.6
money 1.1, 1.2
online banking 3.2.3
overview Topic 1 introduction, Topic 3
introduction
payment cards 3.5
PayPal 3.2.7
pre-payment cards 3.5.3, 3.6.2
representative value 1.1.3
standing orders 3.2.1
travellers’ cheques 3.6.3
when abroad 3.6
payslips 12.4.1, fig. 12.1
pensions
eligibility 2.5.1
policies fig. 10.1, Topic 10 introduction
personal loans
features 6.4, Table 6.2
functions 6.4
interest rates 6.4
personal tax allowance 12.3.1, Table 12.3
pet insurance 10.4
petrol prices 9.7.2, fig. 9.1
physical risk 2.4
population change see demographics
Post Office 1.5, 7.4
products and services 1.5, 7.5
premier accounts 4.2.8
Premium Bonds 7.4
pre-payment cards 3.5.3, 3.6.2
Prudential Regulation Authority (PRA)
Topic 7 introduction, 8.2.1, 8.2.2, fig. 8.2,
Topic 8 introduction
purchasing power 1.4.1, 1.4.2
and inflation 5.2, Table 5.1
R
recession 2.5
regular savers 5.1.2, 5.5, Table 5.2
regulation 6.1
compensation 8.2.1, 8.4, fig. 8.4
competition 8.5, Topic 8 introduction
complaints 8.2.1, 8.2.2, 8.3
consumer protection Topic 8 introduction
credit unions 7.3.1
definition and purpose 8.2
financial services providers Topic 7
introduction
ring-fencing 8.1.2
232
system overview 8.2.1, fig. 8.2
rent 9.7.1
representative value 1.1.3
reputation risk 2.4.3
Retail Prices Index (RPI) 5.2, 9.7
retirement 2.5.1
reward cards 6.3.3
ring-fencing 8.1.2
risk see also insurance
attitudes to 2.4, 2.4.5
emotional risk 2.4.2
financial risk 2.4.4
and insurance Topic 10 introduction
physical risk 2.4.1
reputation risk 2.4.3
savings 5.4, 5.5, Table 5.2
Road Traffic Act (1988) 10.2
Royal Bank of Scotland Group 7.6
S
salary see earned income
Santander UK plc 7.1.1
saving term 5.1.2
savings fig. 5.2, Table 5.2
access 5.1.3, 5.5, 10.9.3
account application and operation
channels 5.1.5
account features 5.5, Table 5.2
advertising 5.1, fig. 5.2
cash v stocks and shares 5.4.3
choosing a product 5.5, fig. 5.1, Table 5.2,
Topic 5 introduction
compensation scheme 5.4.1
fixed period accounts 5.1.3
functions Topic 5 introduction
individual savings accounts (ISAs) 5.3.1,
12.3.2
and inflation 1.4.1, 5.5, Table 5.2
instant access accounts 5.1.4
interest rates 2.5, 5.1, 5.5, Table 5.2
introductory bonuses 5.1.7
National Savings and Investments
(NS&I) 5.4.2
notice accounts 5.1.3
operation of account 5.5, Table 5.2
product advertising 5.1, fig. 5.2
product eligibility 5.5, Table 5.2
providers 5.5, Table 5.2
regular savers 5.5, Table 5.2
and risk 5.4, 5.5, Table 5.2
and tax 5.1.6, 5.3, 5.5, Table 5.2, 12.3.2,
Table 12.4
for unexpected events 10.6
withdrawals 5.1.4
Scotland
insolvency solutions 11.3
secured loans Topic 6 introduction
self-assessment 12.5.1
self-employment 9.2.1, 12.3.4, 12.5.1
shares 5.4.3
social status 2.3.4
social trends 2.5
© The London Institute of Banking & Finance 2022
spending see expenditure
Standards of Lending Practice 8.6
standing orders 3.2.1
state benefits 10.8, 12.3.3
state pensions 2.5.1
statements, bank 1.5
StepChange Debt Charity Topic 11
introduction
stock markets 5.4.3
stocks 5.4.3
store cards 6.3.4
store of value 1.3.3
students 2.5.3, 4.2.4
sub-prime market 8.1.1
Suffolk Credit Union 7.3.1
supermarket banks 4.1, Topic 7 introduction
surrogacy 2.5.4
switching, bank accounts 4.5, 7.7
T
tax
council tax 9.3.1
income tax 5.3, 9.3.1, 12.3, Topic 12
introduction
individual savings accounts (ISAs) 5.3.1,
12.3.2
Help to Buy ISAs 5.3.3
insurance premium tax 10.1.1
Junior ISAs 5.3.2
Lifetime ISAs 5.3.4
National Insurance contributions
(NICs) 9.3.1, 12.3, 12.3.3
P45 12.4.2, fig. 12.2
P60 12.4.3, fig. 12.3
Pay As You Earn (PAYE) 12.3.4, 12.4
personal allowance 12.3.1, Table 12.3
and savings 5.1.6, 5.3, 5.5, Table 5.2,
12.3.2, Table 12.4
self-assessment 12.3.4, 12.5.1
teenagers 2.1, Table 2.1
telephone banking 7.6.3
Tesco Bank Topic 7 introduction
third-party insurance 10.2.1
Totnes Pound 1.3.2
travel cards 3.5.3, 3.6.2
travel insurance 10.4
travellers’ cheques 3.6.3
trust deeds 11.3.2
tuition fees 2.5.3
TV licences 9.3.1
U
UK Cards Association 8.6
UK Payments Council 3.3.3
unemployment
EU rates (2013) 2.3, fig. 2.1
and location 2.3
unexpected events Topic 10 introduction see
also insurance
loans 10.7
savings 10.6
state benefits 10.8
unexpected income 10.9, fig. 10.2
units of account 1.3.1
unsecured loans Topic 6 introduction
utilities 9.7
V
value
intrinsic 1.1.2
representative 1.1.3
store of value 1.3.3
variable interest rates 6.1
Visa 6.3.1
W
wages see earned income
wants 2.2, Topic 5 introduction, Topic 9
introduction
welfare benefits 10.8, 12.3.3
Working Time Regulations (1998) 12.2,
Table 12.2
Y
Yorkshire Building Society Topic 7
introduction
young people 2.1, Table 2.1
bank accounts 4.2.2
© The London Institute of Banking & Finance 2022
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234
© The London Institute of Banking & Finance 2022