Payday lenders have been given 12 weeks to change their business practices or risk losing their licences after irresponsible lending and non compliance with standards were uncovered by the Office of Fair Trading.

The OFT’s review found inadequate assessments of affordability, a failure to adequately explain how payments were collected, aggressive debt collection practices and not using forbearance for customers in financial difficulty.

Clive Maxwell, OFT chief executive, said: “We have found fundamental problems with the way the payday market works and widespread breaches of the law and regulations, causing misery and hardship for many borrowers. Payday lenders are earning up to half their revenue not from one-off loans but from rolled over or re-financed deals where unexpected costs can rapidly mount up.”

The action was announced in the final report on the OFT’s compliance review of the £2bn payday lending sector.

The review found evidence of problems throughout the lifecycle of payday loans from advertising to debt collection and across the sector including by leading lenders that are members of established trade associations.

The 50 leading lenders, each of which was inspected, will have to take rapid action to address the specific concerns the OFT identified with each of their businesses.

Failure to cooperate with this process will trigger enforcement action.

Lenders were found to compete by emphasising the speed and easy access to loans rather than the price and also to be relying too heavily on rolling over or refinancing loans.

The regulator believes that both these factors distort lenders’ incentives to carry out proper affordability assessments as to do so would risk losing business to competitors.

Too many people are granted loans they cannot afford to repay and it would appear that payday lenders’ revenues are heavily reliant on those customers who fail to repay their original loan in full on time.

Despite payday loans being described as one-off short term loans, costing an average of £25 per £100 for 30 days, up to half of payday lenders’ revenue comes from loans that last longer and cost more because they are rolled over or refinanced.

The OFT also found that payday lenders are not competing with each other for this large source of revenue because by this time they have a captive market.

The OFT believes that these fundamental problems with the operation of the payday market go beyond non-compliance with the law and regulations.

Maxwell said: “’We are proposing to refer this market to the Competition Commission, which has wider powers to get to heart of the problems in this market and to identify and impose lasting solutions that protect consumers.”

The Financial Conduct Authority will regulate consumer credit from April 2014 and it will be able to use the analysis and conclusions of the Competition Commission in developing its rules and applying its powers.

The FCA will have significant powers and resources beyond those available to the OFT, including powers to cap interest rates and to impose a ban or a limit on the number of rollovers lenders may offer.

are proposing to refer this market to the Competition Commission, which has wider powers to get to heart of the problems in this market and to identify and impose lasting solutions that protect consumers.

Maxwell added: “Irresponsible lending is not confined to a few rogue payday lenders – it is a problem across the sector. If we do not see rapid, significant improvements by the 50 lenders we inspected they risk their licences being removed. Payday lending is a top enforcement priority for the OFT.”