Short term lending rates to be capped by regulator

The government has announced it is getting the financial regulator to put a cap on what short term loan lenders can charge.  This is a change from the position only a matter of weeks back when the regulator wouldn't have any truck with the idea because it considered it 'very intrusive'. People who have been stung by so-called payday loans who often pay interest of 365% or so may be relieved.

If you borrow a tenner from Wonga now, then next month you'll pay back £20.31. You'll pay interest at 365% - more than fifty times the price of other loans - but that hasn't been enough to put off more than two million payday loan customers hungry for instant credit.

Worst symbols of the cost of living crisis

Labour leader Ed Milliband recently said "the Wonga economy is one of the worst symbols we have of the cost of living crisis.'

Labour has campaigned hard on payday loans. In May 2012 a private member's bill to cap their cost won cross-party support, but government whips ensured it was voted down. Now, every party wants to be seen as the consumer champion. The coalition has told the Financial Conduct Authority to intervene in the market and regulate costs.

Evidence suggests a cap is practical

In an interview on BBC Newsnight, Vince Cable MP, Business Secretary said: "this move has been planned for two years. We introduced all the measures to regulate the industry and it's a cross-governmental agreement. I made it very clear that we needed to listen to some of the backbenchers who were putting down amendments in parliament, engage with them and get more evidence and as a result of the evidence that has recently come forward from the United States and Australia that having a cap on interest rates is practical.

We considered that there was a balance of risks. We commissioned a study from the University of Bristol that warned of some of the unintended consequences. George Osborne has acted on behalf of both of us because we were concerned that the balance of evidence now suggests the merit of a cap. I'm less concerned about who is responsible than getting the right policy. There is a lot of argument in parliament about the merits of the cap and various people like the Archbishop of Canterbury are making this case. We commissioned a study from Bristol which said advantages and disadvantages in an interest rate cap. We were worried about the risks and we've looked at further evidence. A state like Florida, for example, has now found a way of looking not just at interest rates but at the various fees. The evidence that we were concerned about that this might encourage what I call the baseball bat brigade I think doesn't have to happen if it's properly managed, and looking at all the evidence we're decided that there is merit in having a cap.

The Archbishop of Canterbury certainly had an influence and we have all listened. I was very much involved in the decision, I've been involved all the way through with Jo Swinson who is a minister in my department. We've done a great deal and when I was in charge we had already taken all the key steps to regulate the industry - there was the competition investigation, the move to regulate advertising and the move to prevent companies abusing the payment system."

George Osborne MP, Chancellor of the Exchequer commented: "We're going to have a cap on the total cost of credit. We're looking at the whole package to look not just at the interest fee, but also at the arrangement fees and the penalty fees. This is all about having a banking system that works for hardworking people, making sure that some of the outrageous fees you see and some of the absolutely unacceptable practices are dealt with and it's all about the government being on the side of hardworking people."

Industry response

The announcement has surprised the industry because the Competition Commission and the Financial Conduct Authority were supposedly in the process of looking into whether a cap was needed or not. By introducing a cap as they have in Australia, the government's made up its mind to intervene in a market without waiting for official advice.

Richard Griffiths from Consumer Finance Association, which represents a number of payday loan lenders, said: "If the objective is to drive out some rogue lenders then that's certainly had some success in Australia, but what they've also seen there is that it hasn't driven down demand for loans and so therefore people are looking for other forms of credit and being driven towards illegal lenders and so that's something which the government obviously wants to be very wary of."

Capping the interest and the fees on payday loans should help some borrowers, but cost isn't the only way that payday loans can affect your financial future. There are indications that taking out a payday loan can harm your chances of getting a mortgage.