Loans cap wrestles with complex problem of lending

Research suggests major lenders are not as scrupulous with their pre-loan customer checks as they claim to be. Photo: Rui Vieira/PA Archive

The Government decided back in November that it wanted to impose limits on the prices payday lenders are able to charge to borrow money. The Financial Conduct Authority was tasked with setting the cap.

The FCA has trawled through the details of 20 million loans issued by 33 firms in the UK in 2012 and 2013. It has looked at how similar caps have worked in Australia and Florida.

It has decided to limit both the interest a company can charge for a payday loan and the penalty fees it can impose for late payment.

The Competition and Markets Authority found that currently the average price of a payday loan of £100 for one month was £30. The FCA proposes to lower this to £24 and limit default fees to £15. Wonga was charging £30 but recently lowered this to £20.

From 2015, the FCA says, the overall cost of a payday loan will never exceed 100 per cent of the amount borrowed. The FCA says its reform will lead to "significant savings" for customers, it will also drive some payday lenders out of business; the assumption, I'm told, is that around 30 per cent of the market will disappear.

It's a tricky balance to strike. In theory, the lower the cap, the lower the profits for a payday lender. But the lower the cap, the higher the risk that lenders restrict credit or withdraw altogether from a market that already has competition problems.

This matters in as much as there is a clear need for short-term credit. According to the Competition and Markets Authority, 1.8 million customers take out a payday loan every year.

The FCA's challenge is to ensure that they are adequately protected while limiting the number of people who suddenly find themselves unable to borrow as the market shifts.

You may argue that anyone who loses access to short-term credit at annualised rates of interest of 5000 per cent is a lot better off, but to take such a view rather ignores the complexities of the problem.

Wonga, Dollar and CashEuroNet account for 70 per cent of the loans issued to UK customers.

If you are willing to pay an eye-popping price for the convenience of borrowing money for a short period and (here's the important bit) you can afford to pay that price, then is it really the regulator's job to say "no"?

The likes of Wonga have always maintained they are scrupulous about who they lend to, though the research suggests otherwise. In June the CMA found that in 2012 one in five payday loans was "rolled over", on average more than twice and often incurring late charges on the way. One in six loans issued in 2012 had still not been repaid in full by October 2013. Those are pretty compelling signs of significant distress.

There is plenty that is wrong with payday lending but it isn't quite as lucrative as it once was. The FCA has already capped the number of times a loan can be rolled over, restricted the ability of firms to dip into a borrower's bank account to recover debts (Continuous Payment Authority, sounds sinister but gyms use it too) and enforced tighter affordability checks.

Compliance comes at a cost. In the last 12 months Cash Generator, Albemarle and Bond, Cheque Centre and Cash & Cheque Express are some of the names that have decided that short-term lending is no longer profitable enough and ceased lending.

There are still plenty of lenders out there although most of them are online and 70 per cent of loans are issued by just three: Wonga, Dollar and CashEuroNet. The CMA found evidence that the growth in payday loans has "slowed substantially" as regulation has tightened but there's still money to be made. The same report concluded that average return of capital ranged from 28 per cent to 44 per cent - that's one hell of a profit margin.

The FCA says its proposals will deprive the industry of £420 million of revenue. "Poorer players will be forced to withdraw," says Martin Wheatley. He also concedes that the number of people borrowing from loan sharks will in all likelihood rise.