Money Advice Scotland and Citizens Advice Scotland both confirmed to The Herald that they have seen a considerable rise in the number of their clients being left in extreme financial hardship as a result of set-off. This little known practice gives banks the right to take money without warning from a customer’s account if they fall behind with repayments elsewhere within the same banking group, such as those on a credit card or loan account.

Yvonne MacDermid, chief executive of Money Advice Scotland, said: “We have seen an increase in this [practice] and I think we will see more of this, especially as banks can’t bring in so much money through [bank] charges etc.”

The only way to stop a bank using set-off is to ensure that current account, savings account, credit card and personal loans are all held with separate institutions. However, it is often not possible for indebted consumers to switch banks. Indeed a CAS bureau in the North of Scotland had one client who was threatened with court action by her bank for attempting to move her current account to another bank. This threat was issued after the bank had taken £400 from her account without warning, leaving her with no money to live on.

Kaliani Lyle, chief executive of Citizens Advice Scotland, said: “While setting-off is legal, it can place severe hardship on a client if their bank uses all the wages or benefits that are put into an account to pay towards other commitments. And, as ever, the people who are most vulnerable to this are those who are struggling on the lowest incomes to begin with.

“If someone is struggling with debt, it’s not in anyone’s interest -- including the bank’s - to put the client into even deeper financial trouble. We would ask all banks to look very closely at their procedures in relation to setting-off, and to be as flexible as possible -- taking clients’ individual circumstances into consideration.”

However, questions have now been raised, by consumer groups, as to whether banks using set-off are in fact breaching their own voluntary code of practice. In many cases money is been snatched from accounts by banks, less than two weeks after a payment has been missed and just days before direct debits for mortgage, council tax and utilities bills are set to come out of a customer’s account. The guidance on the Banking Code, to which all UK banks are supposed to adhere, appears to forbid this.

It says that banks “should acknowledge that income should only be used to repay ‘non-priority’ debts once provision has been made for any ‘priority’ debts. The subscriber [bank] should leave the customer with sufficient money for reasonable day-to-day expenses”.

A missed payment on a credit card or unsecured personal loan is not a “priority debt”. The Banking Code Standards Board is currently investigating 12 UK banks over their approach to set-off, after a catalogue of suspected breaches was sent to it by consumer groups. One such case involved a client at an East of Scotland CAB whose bank moved all his part-time wages and benefits from his account to go towards arrears on a personal loan. This action left the client in financial hardship, with no access to funds for himself or his family. On the face of it this appears to be a cut and dried breach of the Banking Code.

However, the issue of how and when set-off is applied has yet to be resolved and the Banking Code Board will cease to exist at the end of this month when responsibility for bank accounts passes to the Financial Services Authority. The FSA told The Herald it had not written a specific rule which would prevent banks taking money from customer accounts via set-off without prior written notice as it insists they must do in the case of bank charges. However, a spokesperson said that they believed notifying customers about set-off would be covered under its more general “appropriate information“ rule.

“From 1 November the appropriate information rule will apply covering pre-sale, to the sale itself and post-sale. This means that even if a customer has an existing contract, the firm must continue to provide information to enable that customer to make ongoing decisions on an informed basis.”

In addition the regulator said any bank taking money which left a customer unable to meet priority debts or buy food could be held accountable under its treating customers fairly principle, pointing out that it expected banks to be every bit as thorough in identifying financial hardship cases with regard to set-off as it was with regard to the bank charge waiver.