Payday lending: fixing a broken market

This report analyses online payday lending business models and outlines a proposed framework to be used to determine the level for the cap on the cost of credit, which both allows lenders to cover their costs and results in affordable loans for borrowers.


The purpose of this report is to develop a detailed understanding of the business models driving UK payday lending in order to inform the debate about the level and structure of the new interest rate cap and to examine which other regulatory interventions may be necessary to create a small-sum lending market which allows lenders to innovate and also delivers good outcomes for borrowers.

This report is designed to support the ongoing work of the Competition Commission and the FCA, but it may also be of interest to consumer groups and, ultimately, to investors.

Main Conclusions

Payday lending is currently causing enormous consumer detriment and harm, often to people who are among the most beleaguered and vulnerable in our society. The UK has the most sophisticated financial services sector ever to exist, yet the OFT found evidence of a borrower who been so poorly served by that sector that they had rolled the same loan over 36 times.

That borrower is not alone. In 2012 borrowers spent over £900m on payday loans, with £450m spent on loans which were subsequently ‘rolled over’.

The evidence presented in this report suggests that existing online payday lending business models are reliant on repeat borrowing for their profitability. Consumer detriment, in the forms of default, repeat borrowing and the taking of multiple loans from different lenders, appears to play a highly profitable role in existing business models. It seems that many payday loans serve only to increase the likelihood of future indebtedness.

Money spent on rollovers flowed out of the hands of people with a high marginal propensity to consume and into the hands of shareholders, company directors and venture capitalists, all with a much lower propensity to consume. Not only would many payday borrowers have been better off without these loans but our economy would also have been boosted had that money been left in their pockets.

Allowing capital to flow into the development of products which cause consumer detriment also carries a high opportunity cost. True innovation is stifled and products capable of answering consumers’ needs cannot be developed. This issue is of increasing importance and relevance to all of us; unless an economic miracle occurs, a growing proportion of our population will need to seek recourse to the high-cost credit sector.

Appropriate regulation has the potential to fix the payday lending market, which is currently failing due to asymmetric information and poor product design. The new cap on the total cost of credit, in particular, could transform this industry.

The FCA now has a unique opportunity to enable the high-cost credit sector to evolve into a sector which is genuinely ‘fit for purpose’.