Government to legislate to cap the cost of payday loans

George Osborne said that amendments to the Banking Reform Bill, which is currently before Parliament, would place a duty on the Financial Conduct Authority (FCA) to introduce a suitable cap. The announcement builds on the FCA's own proposals for how it will regulate the consumer credit sector when it takes over responsibility from the Office of Fair Trading (OFT) next year.

"We have created a powerful new consumer regulator to regulate the payday lending industry and now we're asking them to set a cap on the cost of credit," Osborne said.

The cap would be based on the total cost of credit to borrowers, including arrangement fees and penalty fees as well as interest, he said. The level and design of the cap would be set by the FCA.

However, consumer credit expert Ian Roberts of Pinsent Masons, the law firm behind Out-Law.com, warned that the introduction of a cap on "lawful regulated lenders" could risk some borrowers becoming "unable to access such credit at all, leaving them at the mercy of criminal gangs".

Payday lenders are companies that offer high interest, unsecured loans, that are intended to be repaid when borrowers receive their next regular income payment. The market for these loans was worth between £2 and £2.2 billion, or between 7.4 and 8.2 million new loans, in 2011/12, according to OFT estimates.

Setting out its proposals for regulation of the consumer credit sector last month, the FCA said that it was putting lenders "on notice" that tougher rules were on the way. It has proposed limiting to two the number of times that lenders can 'roll over' unpaid customer loans or use automatic continuous payment authorities (CPAs) to take repayments directly from bank accounts. The FCA already has the power to introduce a cap if deemed necessary, although it has previously ruled out doing so.

In a statement, the Treasury said that it had "always kept the case for a cap under review as the market has evolved".

"With growing evidence in support of a cap and emerging lessons from other countries – especially the cap on costs introduced in Australia this year – the Government believes it is right to use the opportunity of [the Banking Reform Bill] for Parliament to be clear on its intention," it said.

"The Government has discussed and agreed this with the FCA. To ensure that there is an evidence-based approach to designing the cap, the Government is asking the FCA as regulator to use its existing planned work to report on its proposed approach," it said.

Australia introduced some payday loan charge caps earlier this year. Interest rates are capped at 4% per month after a maximum up-front fee of 20%, according to the BBC. However, penalties for late repayment can be as much as twice the loan amount.