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Capping the Costs of Legal Loan Sharks is a Step in the Right Direction

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It was very encouraging news last week that a House of Lords amendment to the Financial Services Bill set out giving the new Financial Conduct Authority (which begins operating on 1 April 2013) the powers to cap the cost of payday loans.

But it hasn't been met with all round enthusiasm. Russell Hamblin-Boone, Chief Executive of the Consumer Finance Association - a trade body for some payday lenders - said in a press release that the "CFA welcomes any move which promotes responsible lending and drives out rogue lenders", but told the BBC in a report that setting a cap will drive lenders out and reduce choice in the market.

In actual fact, despite Hamblin-Boone's pessimism, the cap is a good thing and it can work.

Many critics believe that if you set caps on the cost of credit, which will directly impact upon extrortionate charges raised by payday lenders and legal loan sharks, the illegal loan sharks will indirectly gain.

But the evidence suggests otherwise. France and Germany, like the UK, have very large consumer credit markets, however the UK also has a very large payday lending market, with only the Netherlands and Latvia closely behind it. Countries like France and Germany cap their interest rates from anywhere between 15 to 200 per cent. Moreover, research by the European Commission shows that France and Germany had no rise in illegal lending after it introduced caps on credit.

Other critics say that caps on credit will hurt economic growth. There is no evidence for this either. In fact the opposite may be true, given that a decrease in over-indebtedness will influence the building up of savings and investment.

The truth is a cap on the cost of credit will drastically reduce the amount that a loan will cost from an expensive high street lender. Councillor Mike Harris, from Lewisham, told the BBC recently that when he took out a payday loan he paid the £100 he borrowed back in a single week and was still charged £20 for the pleasure.

Credit unions in the UK, rather ironically the only financial institution to have an interest rate set for it (26.8%), charge a lot less. In addition to the funding that it will receive from the government, more money should be spent on the industry in order to ensure it can extend more loans, as a responsible lender, to people who would otherwise be taking out payday loans - particularly around Christmas (researchers at R3 estimate that 500,000 people will take out loans before Christmas this year).

The UK, unique in Europe, has not had any interest rate caps since 1974 when the 1948 Moneylenders Act (which capped interest at 48 per cent) was succeeded by the Consumer Credit Act. But what the government have decided to carry from an amendment to the Financial Services Bill is allow the FCA to prohibit the charging of costs above an amount which it specifies as extortionate and the charging of certain types of fees which it considers to be unacceptable.

This is welcome news and a step in the right direction. For those who say it won't work or that it will hurt the economy are simply not looking at the facts.