Introduction To Banking, UK Bank Accounts
Since the dawn of time, in order to be profitable, the primary function of banks, including UK banks, has been two-fold: (a) to receive deposits; and (b) to advance credit. Over time, what has evolved is not a change in the fundamental nature of this two-fold function, but the manner in which such service is provided. As such, even today, typically UK banking services and products can be broken-down into these two principal functions.
The following is a brief explanation of how each of these works:
A. RECEIVING DEPOSITS
1. Current Accounts
In the not too recent past, the only type of “current” account you would have been able to open would have been a traditional cheque-book current account. However, as with most services in the banking sector, recently banks have started to offer their customers a wide range of current account services in the hopes of attracting (and, more importantly, keeping) their custom. Consequently, today (depending on whether or not you qualify) you could feasible open any one of the following types of current accounts:
1.1 Traditional Current Account
As the name suggests, the traditional current account offers customers the chance to deposit money on an account that allows them to withdraw the money by means of using a[n]:
(ii) cheque-book and cheque guarantee card (which, these days, can guarantee cheques for either 50 or 100 Pounds);
(iii) ATM card;
(iv) debit card (which is used in much the same way as a credit card, but takes the money off the account automatically, rather than sending you a monthly statement); and
(v) counter-cheque to withdraw money at the till in a branch of the bank where they bank.
Although it varies from bank-to-bank, most UK banks these days offer minimal payable interest on credit balances. Moreover, subject to approval from the bank, customers who have traditional current accounts can operate overdrafts on their accounts. A note of caution, however, maintaining an unauthorised overdraft on your current account will subject you to high interest rates and fee charges and should, therefore, be avoid.
1.2 High Interest Current Account
High interest current accounts are maintained by those who have healthy bank balances. Effectively the account works in very much the same way as a traditional current account. Where the account differs is with its payable and chargeable interest. In short, those who maintain balances on their high interest current account in excess of certain thresholds will be entitled to additional interest accruing to their account. On the other hand, if they fail to maintain these required balances, they’ll likely be forced to pay a penalty charge.
1.3 Student & Young Person’s Current Accounts
Student & young person’s current accounts are a means for students and young persons to become used to using a current account without any lending services necessarily being provided. Due to the UK’s laws regarding the creation of debt for those under 18 (which, very simply stated, specify those under 18 cannot be held accountable for the debt they create), traditionally UK banks did not permit those under 18 from opening current accounts – on which overdrafts can be created. Instead UK banks preferred students & young persons to open saving accounts to operate their banking business. However, realizing that there may be a need for students & young persons to operate a current account in this modern-age, UK banks are now more willing to open current accounts, with zero lending availability, in the hope of keeping the business of these potential profitable customers of the future.
1.4 Graduate Current Account
Graduate current accounts offer those who have recently graduated from university a range of financial products to try and ease their transition into working life. Included among these could be interest free overdrafts up to certain thresholds, loans, credit cards, etc. Essentially graduate current accounts have developed as a result of UK banks having undertaken market research that shows graduates have a far greater earning power by the time they are in their mid to late 30s than those who do not graduate from university. For this reason, banks want to keep these accountholders and so try to ease their financial responsibilities directly following their graduation in the hope of enticing them to remain long-term bank customers.
1.5 Foreign Currency Current Account
Foreign currency current accounts are still a rarity. This type of account occasionally pays interest on deposits denominated in foreign currencies with a cheque-book withdrawal system. More often than not, foreign currency current accounts are denominated in US Dollars.
2. Savings Accounts
As with current accounts, savings accounts have come along way since their general introduction as a banking product in the early 1970s. Today it is possible to open:
(i) a traditional savings account;
(ii) a high interest savings account;
(iii) an ISA; and
(iv) an offshore saving account.
Importantly, the essential difference between a current account and a savings account (beyond the fact that a customer is not allowed to have an overdraft on a savings account) is that a prudent saver tries to save as much as possible whilst limiting the tax on their savings to as little as possible. Fortunately, by using such instruments as ISAs and offshore savings accounts, customers can now do this. Nonetheless, standard prudent financial advice is that individuals always maintain - on easy to withdraw deposit - at minimum, enough to cover their next 90 days of expenditure (in case you suddenly lose your job!). Due to the structure of ISAs and offshore savings accounts, this may not be practical. For this reason savers also contemplate opening high interest savings accounts, which allow them to keep money readily available, and which pay less interest than other long-term savings accounts, but higher rates of interest return than standard deposit accounts.
B. ADVANCING CREDIT
Mortgage lending by UK banks accounts for one of the biggest growths in the industry in the last 20 years. Traditionally the domain of building societies, today UK bank are more than willing to provide their customers with mortgages to purchase proprieties. Ordinarily mortgages are obtained over a period of 25 years. The down-payment policy of banks varies. In some cases UK banks require their customers to pay a down-payment of up to 20% of the purchase price of the property. However, in this traditionally cut-throat business, UK banks have been known to provide 100% mortgages, and (in the mid 1980s) even 110% mortgages.
Those looking to take out a mortgage need to consider the monthly repayments they’ll be required to make. Underlying this decision will be whether to take out a variable or fixed interest mortgage. Fixed interest mortgage are where the interest rate is fixed over the term of the mortgage. Alternatively, variable interest mortgages are where the interest rate floats against a peg – usually the Minimum Lending Rate (or “MLR” as it is also know) or London Inter Bank Overnight Rate (“LIBOR”), if the mortgage is of sufficiently high enough amount.
Finally, generally banks lend amounts equivalent to two times the annual salary of the borrower, or three times the combined salary of the borrowers if the lending is a joint-mortgage.
One note of interest, most borrowers assume that they are being given a mortgage by the lending bank. In fact, as a mortgage is a security interest in law, it is actually the borrower who is giving the bank a mortgage.
For many years UK banks offered their customers a personal loan – and that was that! Today if you ask your bank for a loan, you’ll need to be a little more specific. To say the loan market in the UK has expanded exponentially would be understatement. Some of the more common types of loans you may come across include:
2.1 Home Improvement Loan
As the name suggests, the proceeds of this type of loan are used to improve the value of your home. In certain cases the lender may ask to “secure” the loan against the home.
2.2 Auto Loan
This is the type of loan you’ll need to apply for if you want to buy a car. Again, in certain cases the lender may ask that you secure the loan against the car. Also, you will likely be required to take out fully comprehensive insurance for the duration of the loan – in case anything should happen to the car.
2.3 Student Loan
These days student loans come in various forms. It is possible to get a student loan from the government to help pay towards the tuition costs of your university fees. It is also possible to get a student loan to help you with your day-to-day expenses whilst studying at university. It is the second of these two types of “student loans” that UK banks are generally willing to provide.
2.4 Holiday Loan
A newer entrant into the loan field is what is called the “holiday” loan. As its name suggests, the proceeds of this type of loan are used in order to go on holiday. Although the repayment period can vary, many suggest that you should not create a repayment period exceeding one year, otherwise you may not be able to afford to go on holiday next year!
2.5 Consolidated Loan
With credit becoming easier and easier to obtain in the UK, one of the biggest growth areas for UK banks lending to their customers is the consolidated loan. A consolidated loan allows you to use the proceeds of the loan to pay off other debt that you may have where the interest rate is higher than that incurred on the consolidated loan – for example, to pay off your credit card debt. It is also a useful means of consolidating lots of small debts, with lots of different creditors to repay, into one large debt.
2.6 Personal Loan
These days it is still possible to apply for the traditional personal loan. Normally this type of loan is applied for where no other form of loan applies – for example, if you want to buy a new television and don’t want to pay high interest rates on hire purchase borrowing.
Although not strictly a loan-type product, provided you are earning a salary, most UK banks these days are willing to let their long-term customers run a small overdraft on their current account to help them tide over their day-to-day living expenses.
3. Credit Cards
Today the UK is one of the biggest consumers on credit cards in the world. A statistic recently being pushed around by consumer watchdog groups was that there were now more credit cards in the UK than people! As you can see then, credit cards are big business. They’re also, likely to be, the most expensive way to borrow! So, be carefully. Most major banks and financial institutions issue credit cards under the Master Card and Visa Card name.
Essentially what happens is you apply for a credit card, it is authorised, you then go to a store and purchase an item on the credit card, and you will then get a statement asking you to make either a minimum repayment (of 5%) or full payment, or somewhere between the two. If you fail to make repayment in full, you’ll be charged a monthly interest rate on the outstanding credit. Conversely, and rather nicely, if you make repayment in full you’ve found a way to get 28 days interest free credit (the statement period). As you can see then, credit cards have their uses, provided they are used sensibly. Importantly, if you only make minimum monthly repayments, you’ll need to compare credit card offers to see if you can find a cheaper way (i.e. less interest and fee charges) of funding your credit card purchases.
Finally, keep in mind that a credit card is neither a debit card, a charge card, or a store card. All of these work on similar but different basis – notably that you cannot usually maintain a credit balance at the end of any statement period in the case of these last three types of cards.
C. OTHER BANKING SERVICES
Beside those services outlined above that have traditionally been offered by UK banks, recently UK banks have also been offering their customers the following additional services:
1. Foreign Exchange
Prior to end of the Second World War the UK did not effectively have in place any form of foreign currency control regulations. It didn’t need to – it was a major exporter of foreign exchange (“FX”). However, after the Second World War this all changed, the United States had taken over the UK’s place as being the premier foreign currency exporter and strict currency control regulations were needed for a period of almost 35 years (1945 – 1980). During this period UK banks either could not transacted in FX, or it simply wasn’t profitable to do so. Consequently, FX trading by UK banks was minimal.
However, all this was to change with the introduction of Thatcherism monetary policies in the early 1980s and suddenly it became extremely profitable for UK banks to be involved in FX transactions. Consequently branches of UK banks began to offer FX services as wide and varied as simply changing money and notes to far more complex bills of exchange and bills of lading. Although still comparatively small, FX is now considered a major revenue earner for domestic UK banks; with different banks offering different services to its customers, some more comprehensive and complex than others. That said, most high street banks in the UK tend to offer straightforward currency exchange services.
Insurance products being offered by UK banks today probably accounts for the biggest profit growth in UK banking in the last 25 years (outside of possibly mortgage lending)! Nearly all UK banks today either offer their own insurance products or have aligned themselves with a major insurance provider – an example: Royal Bank of Scotland and Direct Line.
The types of insurance products offered by UK banks include (i) car insurance; (ii) life insurance; (iii) accident insurance; (iv) holiday insurance; (v) home contents insurance; (vi) home insurance (note, this is not the same as a home contents insurance. In the case of the later, you are insuring the home and its fixtures. In the case of the former you are insuring the valuables inside the home); and (vii) credit insurance – a sort of insurance policy you take out when you have outstanding borrowings in case you become unemployed or sick, in which case the insurance company pays your premiums until such time as you find a new job or get better.
One final note, with regard to all of the above products, worth pointing out is that most, if not all of these services, are offered to both individual accountholders and business accountholders. It is also possible to open a hybrid personal / business bank account, which is commonly known as a “trading as” or “T/A” account. In the event that you are interested in operating a personal, business, or T/A account, and would like more information on any of the above products, please feel free to select the relevant page on this site.