LONDON (Reuters) - Britain is to cap the cost of payday loans, stepping up its controls over the industry only a month after the regulator said that enforced price controls would be "a very intrusive proposition".
Short-term lenders such as Wonga, QuickQuid and Lending Stream have flourished as high street banks have pulled back from riskier lending. But the industry has become a focal point in the political debate around how some households are struggling to cope with rising prices and stagnant wages.
Chancellor George Osborne said capping charges was "the next logical step" to take and called some of the fees charged by lenders "outrageous".
"We're going to have a cap on the total cost of credit - we're looking at the whole package, not just the interest fee, but also the arrangement fees as well as the penalty fees," Osborne said in a statement.
The finance ministry said the level of the cap will be decided by the new regulator, the Financial Conduct Authority (FCA). The new rules will be added to the Banking Reform Bill, which is already going through parliament.
Britain's financial watchdog was criticised last month for not imposing a cap on interest rates imposed by payday lenders as part of proposals to discipline the industry, which provides short-term loans intended to tide borrowers over until payday.
The FCA at that time said a price cap had been looked at, but it was a "very intrusive proposition" that could make it harder for people to borrow and push them into the hands of loan sharks. The FCA will start regulating the industry in April 2014.
Government ministers had previously been reluctant to commit to a cap on the cost of credit while the opposition Labour party has actively campaigned for such a limit.
"The government is today admitting it got it wrong in opposing these measures," said Labour's business spokeswoman Stella Creasy.
Wonga, one of the biggest payday lenders in Britain, has seen profits surge and charges an annual interest rate of 5,853 percent, according to its website.
Australia has capped payday loan interest rates and many EU countries and U.S. states have price controls.
The Consumer Finance Association (CFA), which represents the major short-term lenders operating in Britain, said it was surprised at the cap.
"If the objective of the proposed cap is to drive out rogue lenders, the Australian experience has had some success, however it has not reduced household debt or the need for credit," said Russell Hamblin-Boone, Chief Executive of the CFA.
UK regulators are widening their scrutiny across the credit industry after spending the last few years clearing up mis-selling by banks and trying to improve their behaviour.
Consumer Group Which? welcomed the latest move, saying high charges "drag people down in a spiral of debt", and said it needed to be part of a wider cleanup of the credit market.
Britain's competition authority is also investigating payday lenders after the consumer watchdog said there were deep-rooted problems in the way the 2 billion pound ($3.1 billion) a year industry treats vulnerable customers.
The watchdog said firms were profiting from loans that could not be paid back on time after finding about half of revenues came from fees charged for customers extending loans and a fifth came from loans that were extended four times or more.
(Reporting by Steve Slater, Paul Sandle, Kate Holton and William James; Editing by Simon Jessop and Louise Heavens and David Evans)