Payday loan interest rates to be capped

Interest rates charged by payday lenders will be capped for the first time in order to protect low income borrowers from taking on unaffordable levels of debts.

On Wednesday, the government announced that it would amend the Financial Services Bill next week in order to allow the new financial regulator power to limit loan charges.

The same amendment was rejected by the House of Commons in May, and the government’s decision came hours before that decision was expected to be defeated by the House of Lords.

Labour peer Parry Mitchell, who put forward the amendment to the House of Lords along with Lord Welby, the incoming Archbishop of Canterbury, said the government had “conceded in a constructive way”.

“They [the government] told us we will have right of veto on the wording of the amendment so I am sure we will come to a good agreement.”

Lord Parry said that the cap would apply to all lenders, and would be decided by the Financial Conduct Authority.

Public opinion has been building against the payday loans industry, which charge annual interest rates of over 4,000 per cent to borrowers.

Rate caps are already in use in other countries including Germany, Canada and parts of Australia and the US. An FT investigation last year found US payday lenders were targeting the UK as a growth market, in part because of a regulatory crackdown in many US states.

Credit unions, organisations championed by the government as an alternative to payday lenders and loan sharks, are also subject to a cap and cannot charge interest of more than 2 per cent a month, or 26 per cent a year.

Payday lenders argue that annual rates of interest are not a fair way to judge the cost of short term loans.

Writing in the FT, Errol Damelin, chief executive of Wonga, argued: “Our customers do not borrow from us out of economic hardship. They do so because we offer a fast and transparent means of obtaining a short-term loan.”

However, research by consumer groups has found that many borrowers are forced to roll over their loans, incurring higher levels of debt, as they cannot meet interest rate repayments. Which? reported that more than one-third of payday loans are used to pay household bills.

The financial ombudsman has reported a rise in the number of individuals who made complaints about payday lending companies this year.

The Office of Fair Trading, which is undertaking a review of the sector, said last week that it was concerned about poor practices within the industry, including failure to assess whether borrowers could repay loans.

It has opened formal investigations into a number of lenders and has written to the entire industry detailing its findings.

The Consumer Finance Association, which represents a number of payday loan companies, said that the industry had already agreed to a voluntary code of practice to improve industry behaviour.