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Economics

Study Notes

Regulation of Payday Loans (Financial Economics)

Level:
AS, A Level
Board:
AQA, Edexcel, OCR, IB

The UK Competition and Markets Authority (CMA) has intervened directly in the market for payday loans. The result will be a sharp fall in the rate of profit for payday lenders and it is likely that all but a few of the major loan providers will be forced out of the market.

What are payday loans?

Payday lenders such as Wonga offer short-term, high interest loans to consumers, with the suggestion that the money is paid back within a month, when they receive their next pay cheque. Unlike standard secured or unsecured loans, payday loans are short-term borrowing solutions aimed at those facing immediate financial difficulty.

The payday loans industry has come under increasing criticism in recent years and this helped bring about an investigation by the Competition and Markets Authority (CMA) into the practices of the main lenders. as a result, the CMA has chosen to act with a direct cap (ceiling) on the daily interest rate that can be charged.

Payday lenders have been criticised by some bodies (such as Citizens Advice) for making it too easy for a vulnerable person to „over borrow‟ at high interest, thereby creating long term financial hardship.

Regulation

The CMA has taken action to:

  • Introduce a cap on interest rates charged on loans - this price cap came into effect in January 2015 - read this article
  • Borrowers must never have to pay back more in fees and interest than the value of the loan, representing a total cost cap of 100 per cent
  • Reduced the fees that payday lenders can charge for arranging a loan
  • Introduce a cap on the fee that can be charged if a borrower defaults - that fee will be £15
  • Ruled that payday lenders must list their loan rates on at least one price comparison site in order to improve competition and price transparency in the industry - read this article

These interventions will have the effect of lowering the revenue from operating in the market. Given the high fixed costs that many of the lenders have, a fall in revenue directly reduces the profits from lending and the forecast is that low returns will cause the exit of many businesses from the market and a big round of cost-cutting (including job losses) for those firms that remain.

Statistic: Those who have taken out a payday loan in the past six months, which of the following apply to you? |<img src=
Find more statistics at Statista

Statistic: Types of financial struggles between paydays in Great Britain (UK) in 2014 |<img src=
Find more statistics at Statista

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