The Office of Fair Trading has referred the UK payday loans market to the Competition Commission.
After a public consultation, the OFT said it, "continues to suspect that features of the payday lending market prevent, restrict or distort competition" and believes existing laws don't go far enough to tackle the root causes.
Particular areas of concern include:
- Murky pricing: The difficulty borrowers face in identifying the full cost of loans, making it hard to compare providers and find the cheapest deal
- Fixation on speed: Lenders compete primarily on the availability and speed of loan approval, rather than price. This may also encourage them to overlook the affordability test designed to prevent irresponsible lending.
- Barriers to switching: When loans are rolled over after the end of the initial loan duration this stops other lenders competing for their custom and as a result offering borrowers a better rate.
- Lender of last resort: Borrowers' typical poor credit history prevents them accessing alternative types of loan and so payday lenders aren't forced to keep rates low.
- It pays to bend the rules: Responsible lenders who invest time and money in following the rules put themselves at a competitive disadvantage to firms that don't.
- Unaffordable loans: Borrowers are often forced to rollover their initial loan because they can't afford the repayments. They are then charged additional interest and other fees for the privilege.
The OFT said lenders could be making up to 50% of their revenue from such practices.
By calling in the Competition Commision, the market will be investigated and the findings passed to the Financial Conduct Authority, which will put in place measures to help resolve the problems when it takes over responsibility for regulating payday lenders next April.
The FCA will be able to cap interest rates and ban or limit the number of rollovers lenders may offer.
In March 2013, the OFT wrote to 50 payday lenders giving them 12 weeks to prove they were complying with existing rules or risk losing their licence to trade. While the lenders still have until the end of July to shape up, so far five lenders have exited the market.
Clive Maxwell, OFT chief executive, said: "Competition appears not to be working properly in the payday lending market, allowing firms to profit from making loans that cannot be paid back on time. We have seen evidence of financial loss and personal distress to many people.
"The Competition Commission can now conduct a detailed investigation to get to the root causes and, if necessary, use its far reaching powers to fix the payday lending market. In the meantime, we are using the powers available to us to crack down on payday lenders that breach the law or OFT guidance."
Joanna Elson, chief executive of the Money Advice Trust, welcomed the OFT's referral. She said: "Payday loans have come from nowhere to be one of the most common debt problems people face. In 2007 as the financial crisis began National Debtline took just 465 calls for help with payday loans, but last year that figure had grown to 20,013."
Which? executive director Richard Lloyd added: "Payday lending is rife with poor practice yet people are increasingly turning to this very high cost credit to cover essentials or pay off existing debts. This is a market where lenders are not competing fairly with each other on price but instead use speed and ease of access to entice customers into deals they cannot afford."
But Lloyd said the OFT still had to take a tougher stance with the industry: "This referral doesn't mean the OFT can now stand down, it needs to stay tough with lenders and continue to take early enforcement action against any company found to be lending irresponsibly."