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Big banks are raking in up to £3.5 billion a year from punishing overdraft charges with more than half believed to be pure profit.

The income estimates come from the Office of Fair Trading(OFT) which believes millions of customers have been ripped off through unfair penalty fees.

The figures suggest the bank's profits from the fees are likely to range from £1.5billion to £2 billion a year.

The OFT is locked in a legal battle with banks in an effort to have the charges, which can be as high as £39 for busting an overdraft limit, brought down.

The banks are fighting the OFT and have issued dark threats that any clampdown will see the introduction of monthly fees on current accounts, so ending free banking as we know it.

The court case is due to start in January, however there are fears that beligerent banks could drag out any resolution of the case for many years.

The OFT first signalled that it believed high overdraft charges were likely to be an unfair penalty, because they are way above the bank's real costs, in April last year.

Since then, tens of thousands of people have lodged complaints and claims for the refund of penalties, plus interest, going back over a six year period.

The big banks have so far paid out more than £400 million to these customers, despite insisting that their fees are legally applied and perfectly fair.

The banks have been swamped by complaints and refund claims bringing suggestions the final bill could well top £1 billion.

The court case involving the OFT and the banks is supposed to produce a final resolution to the question of whether the charges are unfair and can be reclaimed.

The OFT's handling of the case is being led by Cavendish Elithorn who put an official estimate on the bank income from the charges for the first time.

He suggested it would be up to £3.5 billion a year. Mr Elithorn would not say how much of this is profit however it is thoughtly likely to be more than 50per cent.

The real cost of sending a customer an overdraft charges letter is thought to be less than £3, however the bank will generally charge more than £25 in those circumstances.

Mr Elithorn rejected industry threats that a crackdown on the overdraft fees would bring the end of free banking and annual account fees of up to £300.

He said there would be 'no excuse' to impose such new account fees.

He suggested the banks, which have posted record profits for two years in a row, could easily swallow any loss of income without the need to impose new charges.

"I would say there is no excuse at all for banks to introduce charges on the vast majority of customers in relation to the work that we are doing," he said.

"We have no control over the core pricing of banks, nor should we... But we believe that a lot of banks will continue to offer free services to those in credit.

"Personally, I don't see the need for new monthly account charges."

Mr Elithorn say the banks have rejected the OFT's case. They insist the charges are fair and that the OFT has no jurisdiction over what the banks should charge.

The court case is due to begin in January and could run for up to five months. If the banks lose, they could appeal the case, dragging out any conclusion into 2009 and beyond.

That would be disastrous for the thousands of people seeking refunds. Currently the banks have frozen offering any payments pending the outcome of the case.

Mr Elithorn admitted:

"It could be more than one year. There are strategic reasons why some banks would want to drag it out, but there are also strategic reasons why some banks would want to see a quick resolution to this."

The British Bankers Association(BBA) insisted the charges are legal.

A spokesman said:

"These payments are not charges, they are fees for a service, which is the overdraft facility.

"It is perfectly simple for customers to avoid having to pay them, either by arranging an overdraft first of keeping within an agreed limit.

"The banks maintain that these fees are fair in that people know they exist and they know what they are. They also notify people in advance before they are levied.

"Clearly, if the OFT is correct then we are into a different ball game."

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