MPs demand credit rate caps - but will they work?

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107 MPs from all of the major political parties signing an Early Day Motion calling for a limit on the UK's most expensive form of credit after a campaign by the political pressure group Compass.

Lisa Nandy, Labour MP for Wigan, who tabled the motion, said: "This is the first major test of the coalition Government's commitment to protecting the vulnerable from immoral and excessive profiteering.

"The strength of feeling in the Commons and amongst the public is clear - action is long overdue."

But critics, particularly but not exclusively short-term lenders themselves, argue that Government measures will do exactly the opposite of what MPs intend: send consumers straight into the arms of other high-cost lenders, particularly illegal loan sharks - which is another issue being fought in the industry.

Will interest rate caps work?

All of the major political parties promised to limit the excessive interest charged by some credit and store cards during the general election but, as yet, they haven't yet addressed the "much more pernicious" high cost credit sector.

Compass claims that there are millions of people on low and middle incomes that are refused help by High Street banks and are forced to seek credit away from mainstream lenders, often at crippling interest rates.

Doorstep lenders or home credit groups regularly charge yearly rates of around 272%, while the interest on payday loans can amount to a staggering 2,600% APR.

The group believes that more affordable short term credit, by which they mean capped interest rates, will better enable Brits to face the recession led rise in unemployment and cuts to working hours and wages. The poorest borrowers in the UK are subjected to the highest interest rates for credit anywhere in Europe, the body points out.

The general secretary of Compass, Gavin Hayes, said: "We're confident that the Government will do the right thing and protect our most vulnerable citizens. A cap on the cost of credit is supported by seven in 10 people and it now also has support from all sides of the House - it is clearly an idea whose time has come."

However, the Finance & Leasing Association (FLA) - whose members include Alliance & Leicester, Citigroup and MBNA as well as the three major credit reference agencies - said that restricting interest rates will "undermine responsible lending".

Fiona Hoyle, Head of Consumer Finance at the FLA, said: "Coming on top of all the recent new regulation, further restrictions will have the unintended consequence of forcing legitimate and responsible lenders to leave the market, or raise their prices, or both.

"We hope MPs will instead focus on the illegal loan sharks who prey on people who are in financial difficulty. The real risk now is a society polarised between the credit 'haves and 'have-nots'."

Stella Creasy, the Walthamstow MP who introduced the bill, dismissed FLA objections, however, tweeting that the comments were just, "the legal loan shark companies trying to spin the #vote4credregbill".

On her blog she added that Government, "cannot avoid being accountable for their actions on this issue."

Rising personal debt

According to Compass, UK citizens are some of the most indebted on the planet. In April 2010, they collectively owed more than £1,460bn in personal debt.

Nearly three million Brits currently use doorstep loans which charge them up to £83 in interest and additional collection charges for every £100 that they borrow.

The loan sharking and pawnbroker racket is consequently highly lucrative for the lenders - earning them around £2 billion every year.

More availability

In addition to limiting the rates of interest that are currently being used by lenders in the high cost credit sector, the Early Day Motion also calls for the Government to make affordable sources of credit available through community credit unions, mutuals, cooperatives and the Post Office network.

The Government has previously attempted to increase the availability of affordable credit to the UK's poorest borrowers through its Growth Fund.

Unfortunately, the £100 million allocated to it was woefully small compared to the £35 billion that it's estimated the high cost credit sector is worth.