LONDON (Reuters) - Britain's financial watchdog has begun a review to discover whether capped interest rates on payday lending have driven vulnerable consumers into borrowing from illegal loan sharks.
The introduction of the rate cap in January 2015 was in response to concern among lawmakers and the Church of England about the impact very high interest rates were having on people taking out short-term loans to tide them over until payday.
The cap, which ensures that no one ends up paying more than twice the amount borrowed, has resulted in significant improvements for consumers, the Financial Conduct Authority (FCA) said on Tuesday, adding that borrowers are now less prone to falling into arrears.
However, the number of loans has plunged from a rate of 800,000 a month before 2014, when stricter rules were first introduced, to about 300,000 a month in 2015, when the rate cap took effect.
The 2014 rules included tighter supervision, restrictions on how often loans can be rolled over and on the ability of payday lenders to take money direct from customers' bank accounts.
Instead of taking out payday loans, more people are getting into debt with local councils and utility companies or taking out longer-term instalment loans, the FCA said.
The examination of the cap, the findings of which will be published next summer, is part of a broader review of high-cost credit to see if any changes are needed in the way products are designed, bought or sold.
The watchdog's definition of high-cost credit includes payday loans, home-collected credit, catalogue credit, some instances of "rent-to-own" lending for consumer goods, guarantor loans and pawn-broking.
Motor finance, credit cards, overdrafts and some instalment lending could also be included, the FCA said.
FCA Chief Executive Andrew Bailey said the watchdog needed to be conscious of possible side-effects of restrictions to stop people being ripped off.
"We have to be careful that we do not create a market which encourages illegal lending," Bailey said in a blog for MoneySavingExpert.com, a consumer campaign body.
"Going to illegal money lenders, or loan sharks, means that you are not protected if you find yourself unable to pay."
Banks have also come under the microscope after Britain's Competition and Markets Authority was heavily criticised by lawmakers for what they saw as a failure to tackle high fees on unarranged overdrafts.
"The FCA will look in more detail at overdrafts from a consumer protection as well as a competition perspective, using its full range of powers," the FCA said.
StepChange, a debt charity, said that further FCA action is necessary to tackle the shift by traditional payday lenders to instalment loans and welcomed the watchdog's acknowledgement that overdrafts can act as a form of high-cost credit.
"The need for caps in other markets has already been accepted, as with payday loans and credit cards," said StepChange CEO Mike O'Connor.
"There is ongoing consumer detriment from overdraft fees. Unnecessary delays in action risks further harm to financially vulnerable consumers."
Editing by Mark Potter and David Goodman