The FCA cap on payday loans: acting where the market has failed

The proposed cap means that if someone pays back a £100 loan within 30 days they would pay a maximum of £24 in charges.

The proposed cap means that if someone pays back a £100 loan within 30 days they would pay a maximum of £24 in charges

Today the Financial Conduct Authority (FCA), the regulator that takes care of the payday lending industry, has set out its proposals for a total cap on how much a payday loan will cost.

In short the price cap, which is up for consultation until September 1, 2014 (get sending those consultation documents) is composed of three components: a cap on the cost of how much a loan will cost at the initial point of sale, a cap on how much a lender can charge for default fees, and the maximum amount that a borrower will end up paying for a payday loan.

The initial cost cap will be set at a daily rate of 0.8 per cent of the amount borrowed. This is in comparison to the median average of 1.4 per cent per day, which 11 firms already charge. To put that into pounds and pence, someone borrowing £100 for 30 days will not pay more than £24 for it.

A cap will be set at £15 which is a fixed rate of how much a lender can charge in fees if that borrower defaults, and finally a total cost cap will be set at 100 per cent of the total amount borrowed which will apply to all interest, fees, and charges.

The FCA has said that they conclude by setting a daily rate of 0.8 per cent that a substantial amount of consumers will lose access to short-term high cost credit, in this instance payday loans, but also conclude that their initial cost cap will benefit those borrowers who currently only just qualify for this type of credit, for they are the ones who have the greatest risk of late or non-payment (and are thus the very borrowers payday loan firms profit the most from).

Consumers losing access to this form of credit is predicated on the risk, noted by the FCA, that a cap on the cost of credit will increase the chances of payday lenders leaving the market.

This was always going to be a risk, but this ought not to worry us too much: given that lenders make most of their money on the extra charges and fees they can throw into a loan, it was inevitable that an industry with historic light touch regulation was going to abuse this.

The upshot of this was lenders selling loans to people they knew were unable to afford them. While on paper losing access to payday loans for consumers sounds alarming, this is only because previously lenders were able to stay in the market by lending irresponsibly and putting borrowers in precarious debt cycles. Ask yourself this: do we want these firms in the market?

Lenders themselves have already taken this opportunity to suggest the rise of illegal lending is inevitable. But the FCA today has said different. Instead they have found in their consumer analysis of around 2,000 borrowers that those who otherwise sought payday loans will now rely more on family and friends, dip into savings, or not borrow at all.

International evidence has shown consistently that illegal lending has not risen where prices on the cost of credit have been capped. In fact in many countries, the UK included, illegal lending rose at the same time as liberalisation of consumer credit.

In other words, a rise in illegal lending would be unprecedented.

From international evidence we also find that, where the price of credit has been capped, the cost of credit by lenders tends towards the stipulated maximum cost. Put simply, lenders don’t tend to compete with each other on price but find a way of organising their loan prices to neatly reflect the maximum they can charge.

Again, the FCA has said that some firms will exit as a consequence of the cap, but that has to do with the way in which companies have previously arranged their business (profit from poverty in other words). But not all firms will leave the market. This makes sense when looking abroad. But it does beg the question: if that is true then why not make the cap lower?

The point of a cap on the cost of credit is to act where the market has failed: to say lower prices where they have failed to be lowered in a full market place. A cap in this sense would benefit the consumer. But if the cap on the cost of credit is too low the consumer will not necessarily benefit at all. That’s the case with these changes proposed today: the price for a short term loan is still very high.

The FCA has pointed out that in other countries with price caps, such as Australia and Canada for example, lenders have been obliged to find means of profit in other ways than ripping off low income households – for the top three firms in the UK, who the FCA has said will still be able to operate as usual after the cap is put in place in January 2015, I worry this incentive won’t disappear.

In conclusion, while this is a very significant move that will almost certainly see firms disappear (for good reason), the cap could be set lower without the risk of unforeseen circumstances (like illegal lending). Further, access to affordable credit from places such as credit unions should receive another renewed focus during the time from now until the cap is introduced.

Carl Packman is a contributing editor to Left Foot Forward and the author of Loansharks: The Rise and Rise of Payday Lending

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6 Responses to “The FCA cap on payday loans: acting where the market has failed”

  1. Julian Gibb

    Who opened the door for pay day lenders to enter the UK – Labour

  2. Peem Birrell

    This is deeply silly – in what sense has the ‘market failed’? Price controls (and this is just another variation of price control) destroy markets and result in shortages. Look at Venezuela…

  3. treborc1

    I’m disabled I cannot now get a loan with my bank the Halifax due to the Lloyd’s banking group putting a carpet ban on people with benefits.

    I need a loan the pay day lenders are the only ones I can get a short term loan. It’s either that or go to the local loan shark.

    The issue is a simple one the banks have failed us and the politician are a bunch of morons who cannot see the banks or the financial sector messing up or rather they did not want to.

  4. Leon Wolfeson

    You’re thinking that there’s a market in the first place.

  5. Leon Wolfeson

    Another example of the Tories trying to kill the poor. Payday lenders are the only way we can get credit and the Tories want to stop it!

  6. Ed Turlti

    It’s good that the FCA is taking the steps to place caps on payday lending in the UK. As stated in the article, payday loans in Canada have put caps on the amount lenders can charge in fees to help protect the consumer. However that being said if you put too large or a cap on the amount that can be charged it will be very difficult for places to stay in business as they have things such as rent, bills, and staff wages to worry about, not to mention the default rate on these kinds of loans. People always seem to want to chase these kinds of business’ away but there are people out there that have no where else to turn and would rather pay the fees than face the alternative, whatever that may be.

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