Payday lenders will face a probe from the Competition Commission after being referred to the regulator this morning by the Office of Fair Trading.
The Watchdog warned of “deep-rooted problems” and that “features of the payday lending market prevent, restrict or distort competition”.
It said that many firms’ business models are based on making loans which are unaffordable, leading to borrowers paying far more than expected through rollovers and additional interest and charges.
Lenders appear to make up to half of their revenue from such practices.
The OFT’s investigation of 50 of the top payday lenders has revealed that they appear to target borrowers with poor credit histories, limited access to other forms of credit and an urgent need to borrow.
It means that lenders are competing primarily on the availability and speed of loan approval, rather than price. That is weakening competition in price among lenders, the OFT said.
Clive Maxell, OFT chief executive, said: Competition appears not to be working properly in the payday lending market, allowing firms to profit from making loans that cannot be paid back on time.”
The move comes ahead of a Westminster summit on the sector planned for Monday. Consumer Minister Jo Swinson has called together payday lenders, charities, consumer groups and other minister to a Department of Business meeting to discus the problems.
The campaign is growing to curb the worst practices of a £2.2bn sector that has been accused of preying on vulnerable people.
Yesterday north London council Haringay banned payday lender websites from its public computers, in libraries and other places, following a similar move by Cheshire East council on Monday.
Meanwhile a number of universities have now banned payday loan advertising from their campuses.
Last week London club Millwall became the third Championside side – following Sheffield Wednesday and Bolton - to turn down sponsorship from leading lender Quick Quid.
Meanwhile Sheffield Labour MP Paul Blomfield has introduced a Private Member’s Bill to crack down on payday lenders.
Responding to today’s move, Which? Executive director Richard Lloyd, said: “Referring payday lenders to the Competition Commission doesn’t mean the OFT can now stand down. It must get tough and enforce existing rules.”
The OFT has promised to continue “to crack down on payday lenders that breach the law” but passes over responsibility to regulate the sector to the Financial Conduct Authority next April.
It said that by referring the market now the work of the Competition Commission will be able to provide the FCA with evidence on which to develop its rules and new powers from April 2014. The City Watchdog will have the ability to place a cap on interest rates and limit the number of rollovers lenders can make.