New measures introduced to combat fraud and protect consumers have significant implications for the UK’s financial services industry, and could even prompt questions about banks’ business models.

Three recent developments in particular – mandatory reimbursement of authorised push payment (APP) scam victims, enhanced powers for banks to delay suspicious payments, and a record fine for Starling Bank’s know-your-customer (KYC) failings – highlight the rapidly shifting dynamics of fraud prevention and payment systems.

APP fraud happens when you’re tricked into sending money to a fraudster via bank transfer. New protections mean that banks will reimburse APP scam victims within five days, up to a maximum of £85k for payments made on or after 7 October 2024. All types of APP fraud are covered by the new measures, including investment scams (including some crypto scams), purchase scams, romance scams and impersonation scams.

At the same time, the government has given banks increased powers to delay payments by up to four business days, where there are reasonable grounds to suspect that a payment is fraudulent and more time is needed for the bank to investigate. 

Meanwhile the regulator, the Financial Conduct Authority (FCA), has fined Starling Bank £29m following repeated breaches of a ban on opening accounts for high-risk customers (those at risk of being under sanctions or anti-money laundering concerns). Although Starling grew from approximately 43,000 customers in 2017 to 3.6 million in 2023, measures to tackle financial crime did not keep pace with its growth, the FCA says.

Bearing in mind the increasing trend for banks to rely upon accountants to assist in conducting KYC checks on clients, the Starling fine certainly brings this area into sharp focus.

Potential trade-offs

For consumers, the changes bring much-needed protection from fraud, but they are not without potential trade-offs – including slower payment processing, particularly for suspicious transactions. And in the longer term they could prompt possible changes to the business model for retail banking, in particular around the ‘free’ current account.

In addition to increased payment protection, the moves provide incentives for both sending and receiving banks to reduce fraud and encourage better coordination between sending and receiving banks. The result should be improved reporting of APP scams and better measurement of the problem. It could also prompt wider fraud prevention initiatives and information sharing between banks and online platforms/tech companies and others in the wider payment ecosystem.

The impact on businesses will vary depending on their reliance on consumer payments. Businesses making payments themselves lie outside the scope of these protections (except some SMEs, microbusinesses and small charities.) However, if their business model depends on receiving interbank payments from consumers, they may potentially be impacted by the slowing of payments.

However, these developments are not without their risks. This will increase the costs of free banking, with cross-subsidisation from the base of current account holders to the victims of fraud. At the same time, ‘indemnifying’ victims risks effectively funding fraudsters – albeit indirectly and unintentionally.

Retail banking/payments developments

For banks, these changes risk having more profound ramifications and could prompt deeper questions about the long-term evolution of retail banking in the UK. 

In particular, the present model includes ‘free’ current accounts – providing the full suite of banking services to consumers, along with interest-bearing deposit/savings accounts (with a more restricted set of services). For current accounts in credit, banks receive no revenue relating to the banking services that they provide, although they can effectively ‘earn interest’ on these small credit balances. Because there is a cost to providing services such as payments, banks are incentivised to minimise the cost of providing these payment services. (In the case of card payments, banks receive some revenue through interchange fees, but in the case of interbank transfers via Faster Payments, they receive no income.)

Conversely, current accounts that are overdrawn (in debit) generate interest revenue and overdraft fees for banks. This revenue is then used to fund the ‘free’ current accounts for those in credit. Effectively there is a cross-subsidy from those in society who are overdrawn, to those who are in credit.

The UK is an outlier in Europe with this model. In most other European countries, consumers routinely expect to pay a monthly ‘subscription’ (possibly also with ‘per transaction’ fees too), to cover the cost of providing the bank services that come along with their current account.

Fraud losses and cross-subsidy

In the context of the Payment Systems Regulator’s (PSR) APP scams reimbursement policy, some argue that cross-subsidies are relevant, too. When banks reimburse the victims of APP fraud, this cost is effectively spread across all existing current account holders. 

Debates about whether this is fair or socially advantageous aside, it’s like an insurance policy. While the ability of an individual to withstand such a catastrophic loss is limited, such a loss shared across the large current account customer base is easily bearable.

While the concept of cross-subsidy within banking and current accounts is not new, a harder question is, which forms of cross-subsidy are good for society and should be encouraged? And which sub-groups within society should be favoured? This is a policy question.

Could business models for banks change?

There’s no doubt that APP reimbursement represents a cost for banks. The result may be that banks look to start charging for certain payments and move away from the current ‘free banking’ model. Another possible outcome is that banks could withdraw the provision of certain payment services from the suite of current account services. Metro’s decision in September to withdraw the provision of credit cards may be a taste of things to come. 

APP reimbursement alone is unlikely to change the banking business model. However, it is one cost that, if combined with other cost pressures on retail banking, could potentially lead to changes in the future.

• ICAEW’s Financial Services Faculty is hosting a free webinar on 28 March on APP scams – What are they? How to avoid them? How to get reimbursed? Find out more and book your place.
•  This article has been produced by the ICAEW Financial Services Faculty. Find out more about joining the Financial Services Faculty