The coalition government has announced a cap on the cost of a payday loan.

The Labour opposition has been proposing such measures for a number of months, but the government had until today resisted such moves, arguing they were unnecessary.

An amendment to the banking bill will impose a duty on the Financial Conduct Authority (FCA) to impose the cap.

Citizens Advice has welcomed the move, but wants further reforms in the market and for banks to offer an alternative, such as a short-term micro-loan.

Citizens Advice Chief Executive Gillian Guy said: “This is a cap on the exploitation of people struggling with the rising cost of living. Payday lenders have failed to stick to their own promises to treat customers fairly. The Government’s plan to cap the cost of loans only goes to show how out of control the industry is.

“The extortionate interest rates, hidden charges and lack of financial checks have pushed many payday loan customers into serious financial hardship. As our new figures out today show, three in four people who take out payday loans get into difficulties.

“Citizens Advice has always been clear that any cap on payday loans must be a cap on the total cost of credit. Limiting interest rates alone would allow lenders to pile on excessive costs elsewhere, so the Government is spot on in deciding to tackle the overall cost. Ministers also need to look at opening up the market so there is more choice for consumers.

“To truly tackle the cost of payday loans, there needs to be more competition in the payday loan industry. As it stands lenders are competing on the speed of loans as opposed to actual costs. Banks are still shunning their responsibilities to offer their customers alternatives to payday loans. The Government needs to put pressure on traditional lenders to introduce responsible short-term micro-loans.

“Government must also tackle the underlying need for payday loans and ask – what is driving people to short term credit in the first place? The squeeze on living standards has caused a boom in payday lending as people turn to short-term loans to cover emergency costs and in some cases pay for everyday essentials. Rising energy prices, food costs and shrinking incomes means that more and more people will turn to short-term credit to help them get by.”