Payday loan customers are paying over the odds for loans and an independent price comparison website should be launched to help them choose the best deal, the Competition & Markets Authority (CMA) has stated.
The CMA said a "lack of price competition" could be adding £5 to £10 to the average cost of a payday loan (based on a typical loan of £260 taken out for around three weeks.
With customers taking out an average of six loans a year, this means a typical customer could be forking out up to £60 a year more than they should.
Research conducted by the CMA indicates that, while there are around 90 payday lenders offering loans in the UK, the three largest lenders (CashEuroNet, Dollar and Wonga) account for around 70% of total revenue generated from payday lending in the UK.
If the payday loans sector was subject to greater competition, consumers could save around £45 million a year, the CMA added.
Simon Polito, chairman of the Payday Lending Investigation Group and CMA deputy panel chair, warned that the resulting increased rates charged by payday lenders hits vulnerable borrowers the hardest.
He explained: "While the average income of payday lending customers is similar to that of the overall population, their access to other credit options is often limited when they are taking out a payday loan and in some cases those borrowers paying the extra costs are the ones who can afford it the least. This can particularly apply to late payment fees, which can be difficult to predict and which many customers don't anticipate.
"We believe that the creation of an independent price comparison website is a particularly important option - as those that exist at the moment suffer from a number of limitations and are only used by a small proportion of borrowers.
Mike O'Connor, Chief Executive of StepChange Debt Charity, said: "Today's findings show that the payday lending market consistently fails consumers. Payday loans are supposed to serve as one-off short term loans, but with customers taking out an average of six per year, it is clear that this is a market that traps people in unsustainable cycles of unaffordable repeat borrowing.
"The failure of the payday loans companies to compete for customers adds insult to the injury of people paying extortionate prices."
Richard Lloyd, Which? executive director, added: "The Competition and Markets Authority is right that a lack of competition is leading to consumers paying over the odds for payday loans.
"Forcing lenders to be clear and upfront about costs would help consumers to compare the price of different loans. But this is not sufficient to clean up the payday market and stop the spiral of debt into which so many people fall.
"We also need to see tougher action by the regulators to clamp down on the excessive charges that borrowers get hit with when they're in financial difficulty."
CMA research indicates that in 2012 there were around 1.8 million payday loan customers in the UK, taking out approximately 10.2 million loans, worth £2.8 billion.