At eccount money, we have preached the gospel of ‘no overdrafts’ for a very long time and for very good reasons: Overdrafts are expensive and they tend to confuse your income and expenditure to a dangerous degree. As a result, you may be paying entirely unnecessary interest on the debt you’ve made and loosing control of your finances. At the same time, as with so many financial products, overdrafts were originally created with the best intentions and have, as a look back will readily testify, been highly instrumental in supporting the entrepreneurial spirit and turning the entire world of business and finances upside down. As if that alone wasn’t a reason to delve into the history of overdrafts, then perhaps the fact, that they were invented right here in the UK – or, to be more precise, in Scotland – certainly is.
It was in May of 1728, that Edinburgh-based merchant William Hog discovered that he had some financial problems at his hands. These had nothing to do with his business, which was rock-solid and doing well. Rather, it had to do with the payments of his customers, which were never quite as prompt and reliable as his own payments to his suppliers. Which meant that his account would regularly drop to zero, making it impossible for him to pay some of his bills and leading to pre-collection letters and additional costs. No wonder Hog was displeased. He approached his bank, the Royal Bank of Scotland, about this to brainstorm on a possible solution for his issue. After many hours of intensive debate, they came up with an idea: Couldn’t the bank allow him to go into the red for just a few days, so Hog could pay his creditors? After all, his account would soon enough be in balance again. Overdrafts were born – and shortly after, the world of banking would never be the same again.
What made overdrafts such an ingenious principle was that it ingrained a fundamentally human principle into the otherwise somewhat cool world of money and finance. By offering their customers overdraft facilities, banks were showing a great deal of trust for their clients and taking their problems into consideration. Of course, the principle had advantages for themselves, too, since they no longer had to renegotiate a new loan each and every time an account holder ran out of money on a short-term basis. But mainly, the idea caught on with other merchants like William Hog as well as entrepreneurs, who all relied fundamentally on upholding their liquidity. To them, overdrafts were a lifesaver – and they in turn readily made use of them to keep their companies running.
It wouldn’t take long until the Royal Bank of Scotland had turned from a young and aspiring financial institution into one of the leading banks. It was then that its competitors realised that if they wanted to stay in business, they would have to follow suite. And so, within no more than a few years, overdrafts became part of the basic services of most of the major banks in the UK – and it wouldn’t take long, until they’d caught on in the rest of the world. Today, overdrafts have become a core component of every current account in the Western world.
At the same time, it was obvious right from the start that overdrafts weren’t for everybody. If a merchant was successful and provided he was serious about his business, overdrafts were a great tool for him to bridge short-term cash deficiencies. If things were going bad, however, overdrafts could quickly turn into massive debts. In any case, overdrafts were always intended solely for business purposes, never for private persons and this is where things started going wrong. For many households, overdrafts would turn into a more convenient and hassle-free way of taking up credit, even on a long-term basis. As goes without saying, however, these debts would eventually have to be paid back. Gradually, it emerged that overdrafts were confusing many customers, who didn’t see them for what they really were – an exception, not the rule. Due to this confusion and combined with the spread of credit cards, the debt spiral has accordingly only gotten worse over the past decades.
Account holders themselves are certainly to blame for many of the problems associated with overdrafts. And yet, banks have undeniably made it far too easy for customers to go into overdrafts and lured them into paying high interest rates. To counterpoint this tendency, a variety of protection measures were introduced to reduce fees and fines for customers. Although these have somewhat improved the legal situation for UK households, overdrafts can still not be recommended to private individuals; simply put, because that’s not what they were originally created for. One of the essential bookkeeping principles, after all, is to always keep incoming and outgoings in balance – and overdrafts may frequently serve to make that harder rather than easier.
Which is why your best choice is still an eccount. By eliminating overdrafts, you can finally turn towards what’s really important: Smart budgeting and getting rid of debt. William Hog, we’re sure, would have agreed.