Is a price cap a good thing for financial products?

finance confidence

A price cap is a popular way for government regulators to safeguard an industry that might be overcharging consumers.

Whilst every financial product is different in its own way, there are only a handful of products in the UK that have been subject to a price cap in recent years – but are they always in the best interests of the consumer?

The FCA introduced a price cap for the payday loans industry in 2015, moving away from the 1% daily interest that was charged by most lenders to a cap of 0.8% per day, equal to £24 per £100 borrowed.

More recently, there has been a price cap on the unauthorised overdrafts charged by banks and credit providers, where some banks charged exorbitantly high fees at around £100 per £100 borrowed. Other industries likely to undergo a price cap include rent to own, logbook loans and buy now, pay later.

But the impact of a price cap is not always straightforward . On the one hand, it protects consumers who now benefit from a lower price and they can have peace of mind that they should not be overcharged by inflated fees or late penalties.

On the other hand, lower rates charged means less profit margins for lenders – so now they have to become increasingly stricter with who they lend to. Or equally, they must go out of business.

What was the outcome of the price cap?

In the payday industry in the UK, the price cap in 2015 had profound implications. Notably, there was a huge exodus of lenders and brokers who left the market, unable to make it affordable. With over 200 lenders trading in 2014, there are now less than 40 trading today.

In addition, the number of approved customers also declined quite dramatically. With more than 10 million payday loans approved in 2012, there were less than 3 million approved in 2020.

Some people will be happy that less payday products are being consumed. However, there is a large proportion of customers who this helps to get by each month and if they cannot get approved for a loan which they used to get approved for, what are their options? Does this encourage loan sharking? Or does it put some people in poverty?

How is America preparing for price caps?

America has addressed price caps for the payday industry already, by creating a price capp of 36% in 16 states already, including New York.

For the remaining 31 states where there is no price cap and lenders charge around 500% APR, there have been talks amongst officials in government to introduce a similar cap.

Dan Kettle, of US lender Pheabs, commented: “The issue is that the lenders require around 200% APR in order to make their business profitable. A price cap could be devastating on the industry and the general population. Not just for the customers who need to borrow each month to tide them over, but also the tens of thousands of employees working for lenders in-store or online in the hotspots of California, Texas and Nevada.”

“There is certainly a good incentive to charge lower rates to benefit consumers, but we need to look at the economic implications as a whole and strongly limit the growth of illegal lending and loan sharking.”