January 8, 2013, by Peter Cartwright
Interest Rates Ceilings…..again!
Few topics in the area of consumer finance have received as much attention as interest rate ceilings on (in particular short term) consumer debt products. Entering the term “interest rates ceilings” into Google produces about 775,000 results. Among the contributions to the subject are a very large number of academic studies. Most of these studies are sceptical about the value of caps, although many are sympathetic to some of their stated aims. The Coalition Government had also made clear its doubts about ceilings. It is against this background that the Government’s U-turn, in the form of a decision to allow the Financial Conduct Authority (FCA) to set such ceilings, took many observers by surprise.
The arguments for and against ceilings are so well-rehearsed and well-developed that I cannot do justice to them, let along add to them, here. There are ideological arguments against restrictions of choice. There are also claims that the charges levied on short term loans are not excessive given (a) the small amounts borrowed; (b) the short term nature of the loan; and (c) the fact that consumers are choosing such loans, even if the suggestion in the Financial Times by the Chief Executive of Wonga that its customers “do not borrow from us out of economic hardship” might raise a few eyebrows. But the most compelling argument against ceilings is that they are liable to produce unintended consequences. Such consequences may involve in particular (a) the removal of the supply of legal short-term loans (described typically as “payday loans”) and (b) the replacement of these with credit from illegal loan sharks. So the argument goes, the (legal) supply may go away, but the demand will not. The literature on ceilings adds some weight to these arguments. For example, the Review of High Cost Credit published by the Office of Fair Trading in 2010 concluded that price controls “would not be an appropriate solution to the particular problems found in these high-cost credit markets”.
Yet despite these arguments the Government has changed course, albeit not quite in the way it is sometimes presented. “Payday loan interest rates to be capped” said the FT’s headline in November. Well, probably, is the reply. The Financial Services Act 2012 does not place a cap on rates. The Act instead gives the FCA the power to set a cap on rates. Lord Mitchell, whose amendment might well have led to defeat for the Coalition, recognised this, stating that the amendment “puts the responsibility squarely into the hands of the FCA”. But the Government’s comments could be taken as an indication that it expects the Authority to act. Lord Sassoon stated that “the Government is, like all of us, concerned about the appalling behaviour of some firms in this sector and the harm vulnerable consumers suffer as a result.” High profile campaigning by the likes of MP Stella Creasy and the intervention of incoming Archbishop of Canterbury Justin Welby (who described some rates as “usurious”) may further compel the Government to push for action. In addition, given the enormous public pressure on the FCA to show that it has “teeth” (something its predecessor, the Financial Services Authority, was perceived by many to lack) it would be surprising if it did not feel some pressure to take advantage of its new powers.
One interesting development is that the Government is expected imminently to take delivery of yet another report (this time from the University of Bristol) on the impact of interest rate ceilings. If this follows the trend of previous works and raises questions about the utility of such ceilings, the Coalition may find itself in a difficult position indeed.
Peter Cartwright (Professor of Consumer Protection Law, School of Law and Integrating Global Society Research Lead for Finance and Society)