In (another) abrupt u-turn, it now seems likely that the government will accept the substance of the Labour peer Lord Mitchell’s amendment to the Financial Services Bill, which calls for a cap on the interest rates charged by payday loan companies such as Wonga and Provident.
Finally, the day has come when you will be able to read your statutorily regulated newspaper, drink your minimally-priced lager, and pay for both of these with a payday loan the price of which is set by the government. Oh, and whilst doing all of this you’ll be kept warm by an energy tariff which an energy company has been forced by law to offer you. I caricature, but you don’t have to be Old Holborn to feel uneasy.
It is very difficult to defend payday loans. They are symptomatic of the sort of financial desperation that we all hope never to experience. But there are three important reasons why the government should resist a cap.
The first is that a cap lacks a convincing intellectual grounding. Its supporters want a cap because they believe that the cost of credit is unacceptably high given that it is being used to purchase life’s essentials. But if we accept that the cost of something should be capped because it is “too high”, then it is not clear why we are capping interest rates rather than the prices of essential goods themselves, such as food and petrol.
The answer is that we just don’t like the idea of payday loans – they evoke images of grubby, predatory loan sharks. In contrast, those of us cocooned in the comforts of suburban London seem far more comfortable with a 150% tax on every litre of petrol purchased by the “vulnerable poor”. Go figure.
The second reason to resist a cap is that it would not address the real reasons that people turn to payday loans. The most basic reason – that life’s essentials are too expensive – I have already mentioned. The flipside of that coin is that incomes are too low, and there is much that the government could do to help here. The target of a £10,000 tax free allowance is a start, but we should be moving much more quickly towards that goal. Too often though, it seems that two market distortions – in this case, income tax and interest rate caps – are seen to make a right. It is the same with income tax credits: take with one hand, give with the other.
The need for payday loans also arises from the absence of alternative sources of credit, such as overdrafts and credit cards, which require the borrower to hold a bank account. Those who cannot obtain bank accounts are effectively locked out of traditional credit markets. This is a problem which requires real policymaking effort to solve – and so a cap on payday loan interest rates is viewed as an attractive, effortless solution.
And that brings me to the third reason: an interest rate cap is just too easy. It is a populist reaction to a well-run campaign. Real political leadership would be refusing to endorse a cap, and committing instead to a comprehensive policy programme which addresses the real problems which cause people to take out payday loans.
But instead, intervening in a free market is seen as a quick, easy and harmless fix. Unfortunately, this is unlikely to be the case. When governments set a price cap, prices tend to gravitate towards that cap, as we saw with tuition fees. Some payday loans will probably become more expensive.
And there is a real danger that by setting a maximum interest rate, all loans at or below that interest rate become “respectable”, taking the urgency out of the need to deal with the underlying problems.
When governments set prices, unintended consequences follow, and payday loans will be no different. Financial desperation deserves to be taken seriously. A cap on interest rates is lazy, and represents a neglect of the political leadership which this issue requires.
Matthew Powell tweets @matthewpowell89