Millions of customers hoping for refunds of unauthorised overdraft charges were disappointed yesterday after a surprise decision in the Supreme Court.

In a landmark ruling, the five judges of the court unanimously decided that the Office of Fair Trading (OFT) did not have the authority to determine the fairness of the charges — which can be as much as £35 for a single slip into the red.

The decision, which overturned rulings by the High Court and the Court of Appeal, means that an estimated one million customers who have lodged demands for the return of their money are likely to be turned down unless they can prove that they are suffering financial hardship.

Politicians and consumer groups expressed surprise and dismay at the ruling, amid calls for a change in the law.

Nick Clegg, the leader of the Liberal Democrats, said: “The decision will be a bitter blow to the millions of people who’ve had to pay extortionate fees to their banks just because a cheque has bounced or they’ve unintentionally gone overdrawn.

“Regardless of the legal position, it simply isn’t right that someone on a low income should pay £25 or more to their bank just because they’re overdrawn by a pound or two. The only way to protect millions of customers from being ripped off is to change the law.”

Sarah McCarthy-Fry, Exchequer Secretary to the Treasury, said: “We would prefer to see the banks voluntarily agree a fairer system of charges for the future, but we don’t rule out further measures if this doesn’t deliver the kind of change we need.

“We are examining options for a compulsory system alongside discussions with the banks. The bottom line is that we need a system of charges that is more proportionate and more transparent, so that the fees are fair and people are clear about what they are signing up to.”

Customers who go into an unauthorised overdraft or breach their agreed limit can be charged for each payment while they are in the red, as well as additional monthly fees. Campaigners say that the actual cost to the banks of processing the transactions could be as little as £2.50.

Peter Vicary-Smith, the chief executive of Which?, said: “The ruling effectively allows the banks to charge whatever they like, irrespective of whether it is fair or reasonable, and that cannot be right. The banks ought to remember that taxpayers have handed them a big cheque to bail them out.”

The Office of Fair Trading said it would consider the detail of the judgment before making a decision on whether to continue to investigate the charges. A further announcement is expected next month.

In response to the Supreme Court’s decision, the Financial Services Authority (FSA) lifted the waiver on processing customer complaints that has been in place since July 2007, when the test case began. The FSA, the banks and the OFT decided on the test case and waiver after the county courts and the Financial Ombudsman Service became overwhelmed with customers’ applications for refunds after an organised consumer campaign against the charges.

The removal of the waiver means that the majority of customers who complained will receive letters over the coming weeks explaining that they will not receive a refund. Only those customers who can show that they are in financial difficulty may get their money back.

Lloyds, the banking group that is 43 per cent owned by the taxpayer, confirmed that customers suffering financial hardship might still receive a refund, but would not elaborate on the exact criteria that would be used to judge who qualifies.

Some consumer groups argued that bank customers should not accept defeat. Martin Lewis, of moneysavingexpert.com, the consumer website that helped to spearhead the campaign against such bank charges, said that the OFT could yet bring a second legal challenge against the banks, although he conceded that the chances of success were slim.

He said: “In Justice Walker’s summing-up, he said that the OFT may be able to look at fairness by another route. The fact that this was deemed important enough to be said in his very short statement is of great significance. Analysis of the full report reveals the court’s coded message to the OFT was, ‘You took this case on too narrow a legal basis’.”

A spokesman for the British Bankers Association said: “We shall examine the new case that Martin Lewis presents but we maintain that fees for unarranged overdrafts are fair.”

Despite widespread opposition to overdraft charges, the millions of bank customers who do not incur any charges and therefore receive their current account services at no cost, or even receive interest, will welcome the Supreme Court’s decision.

If the banks had lost, it could have cost the industry up to £3 billion a year in lost revenue and led to refund payments of up to £10 billion. The likely outcome would have been the introduction of monthly account charges and increases in other fees, such as cash machine withdrawals, as the banks looked to recoup the lost revenue.

Calculations by moneynet.co.uk, the financial website, suggest that the banks would have had to charge current account customers between £2.50 and £3 a month to replace the lost revenue if the OFT had capped charges at £12, as it has done with credit card fees. However, the fees would have probably been much higher to recoup the money paid in refunds of charges. But as the ruling has gone in favour of the banks, this expected transformation in the way we bank is unlikely to materialise — for the time being.

Most experts agree that there will be a cooling-off period as the banks assess their options. Many in the industry would still like to introduce regular account fees, as is already the norm in much of continental Europe, because they provide a regular and reliable income. Over the past few months, in expectation of defeat in the court case, most banks have been restructuring and even cutting overdraft charges but that process is likely to stop now.

Consumer groups have called on the banks not to introduce new charges or increase existing ones, but this is unlikely. With banks determined to boost profits, and restore their decimated balance sheets, new charges are inevitable.