Capping payday loan interest rates might make things worse

The new regulator has warned that introducing an interest rate cap on payday loans would actually make things worse for borrowers.

Many critics of payday loans have suggested that one way to restrict the damage they can do is to impose an interest rate cap, limiting just how much they can charge borrowers.

However, the newly-created Financial Conduct Authority (FCA) has made the claim that “caps on APRs or restrictions on how often [consumers] can borrow” might make their financial situation worse.

This comes at the same time as an investigation carried out by the Office for Fair Trading (OFT) on the payday lending industry, and alongside a separate document published by the FCA which concluded that “at present a variable total cost of credit cap is not the way to address consumer detriment in the payday lending market in the short term”.

In a section of the paper concerning consumer choice and reasonable decision-making, the authors of the report for the FCA say that consumers often use payday loans as the only source available to them, and any further restrictions on their supply could do unintended damage.

Progress reversed?

In December 2012, Labour peer Lord (Parry) Mitchell forced through an amendment to the Financial Services Bill, now the Financial Services Act 2012, that gave the FCA the power to cap the cost of credit.

However after the publication of a piece of research carried out by the Personal Finance Research Centre at the University of Bristol, for the Department of Business, Industry and Skills (BIS), looking at the operability of a cap, the official Government position now says that despite having that power it would not be in the interest of borrowers for the FCA to use it.

Possible changes in the future

BIS has said that a consultation will take place looking at whether there is any more evidence to suggest a cap on the total cost of credit will be beneficial, which will take place before April 2014, when the FCA takes over the regulation of payday lending. But this new report shows that as things stand there is no desire to install a cap.

Critics will argue that in not committing to a price cap the FCA is allowing payday lending firms to rip off borrowers when they are at their most financially vulnerable. Because lenders compete on speed, and not price, there is no incentive to bring prices down and make payday loans more affordable. This means that customers with the fewest options are the least able to save money, invest and spend on food and other basics.

Other significant changes should be more forthcoming though, as a result of the OFT's investifation into bad practice in the payday loans market. As we explained in Payday lenders told to shape up or lose licences 50 leading lenders have been told to make changes or else face closure.The areas that the OFT want payday lenders to modify are:

-        better decision making on assessing whether the borrower can afford the loan;

-        providing detailed explanations on how payments will be collected;

-        cutting out aggressive debt collection practices; and

-        issuing forbearance measures to help struggling borrowers.

What do you think? Should the FCA introduce an interest rate cap on payday loans? What should it be? Let us know your thoughts in the comment box below.

More on payday loans:

Payday lenders told to shape up or lose licences

How to survive until payday!

The best alternatives to payday loans

Easy Finance Club: the payday lender with an APR of 68,300%

The dangers of multiple payday loans

How payday loans can scupper your chances of a mortgage

One million Brits use payday loans every month