New law to cap payday loan costs

A new law will compel the financial regulator to use its powers to cap the costs of payday loans. But is that really the way to tackle the issue?

The cost of payday loans will be capped as a result of an amendment to the Banking Reform Bill, Chancellor George Osborne has announced.

The cap will be determined by the Financial Conduct Authority (FCA), the financial regulator. George Osborne said the cap will cover not only the interest rates charged, but also additional charges like arrangement and penalty fees.

However, exact details on what the cap will come into effect are yet to be announced.

The Banking Reform Bill is currently going through the House of Lords ahead of being enshrined in law.

Getting tough on payday loans

The authorities are falling over themselves to show that they are taking payday loans seriously and want to clean them up.

Back in June the Office of Fair Trading (OFT) referred the payday lending market to the Competition Commission for investigation. The OFT also contacted 50 leading payday lenders to give them 12 weeks to address issues with their business practices it had already identified. Nineteen of those lenders have since announced they are to quit the market entirely.

Meanwhile the FCA has published new rules which payday lenders will have to follow once it takes over regulation of the sector in April next year.

These include:

• limiting the number of times an unpaid loan can be ‘rolled over’ for another month to just two occasions;
• limiting the number of times lenders can use continuous payment authorities to collect the repayments to two occasions;
• introducing a ‘risk warning’ to all payday loan advertising.

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What about interest rates?

The regulator already has the power to cap payday loan costs, thanks to the Financial Services Act 2012. However, it is understood that this new law will oblige the FCA to make use of those powers.

And that makes me rather uneasy, as up to now the FCA has been very open about the risks of such action.

Back in April the FCA said that caps on APRs may actually leave borrowers worse off, suggesting that, for all the faults of the payday loan market, a cost of credit cap was not the way to address it. The thinking goes that introducing such a cap may result in fewer options for borrowers, as lenders leave the market. And while supply may disappear, demand won't, leaving borrowers potentially turning to black market lenders.

And last month when it announced its payday loan rules, it had this to say:

“We considered whether it would be appropriate to introduce a limit on how much interest firms can charge on a loan – so how much it costs a customer to have credit. However, at this stage we don’t believe we have enough evidence or information to fully understand the implications of doing this.

“From April 2014, we will have the power to gather information from consumer credit firms and we will work closely with the other competition authorities to develop comprehensive evidence so we can consider whether structural changes, like price capping or setting maximum loan amounts, are necessary to ensure a competitive market that delivers better outcomes for consumers.”

So in October the regulator admitted it didn’t know enough about whether a price cap could help at all and would not be in a position to know more until after it had begun full regulation of the sector.

Yet here we are, a month later, with the FCA now being compelled to introduce just such a price cap by the Government.

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A better way to borrow

Payday loans can be incredibly expensive. There are plenty of better ways to borrow, whether it’s from family or friends, a local credit union or even a budgeting loan from the Government.

Read The best alternatives to payday loans for more.

What do you think? Is the Government right to force the FCA to introduce a payday loan cost cap? What cap would you set? Let us know your thoughts in the Comments box below.

More on payday loans:

The best alternatives to payday loans

How to tackle payday loans

The dangers of multiple payday loans