The government is to introduce a new law to cap the cost of payday loans.
The level of the cap, which has not yet been announced, will be decided by the new industry regulator, the Financial Conduct Authority (FCA).
The Treasury says there is “growing evidence” in support of the move, including the effects of a cap already in place in Australia.
But the industry said the move could restrict credit, and encourage more illegal lending.
The cap will be included in the Banking Reform Bill, which is already going through Parliament.
Speaking to the BBC, the Chancellor, George Osborne, said there would be controls on charges, including arrangement and penalty fees, as well as on interest rates.
“It will not just be an interest rate cap,” he told BBC Radio 4’s Today programme.
“You’ve got to cap the overall cost of credit.”
‘Duty on regulator’
Previously the government had said such a cap was not needed.
But the chancellor denied the government had a made a U-turn on the issue, saying he was not pre-judging the outcome of a Competition Commission inquiry into payday lending.
“These things can go along in parallel,” he said.
Some payday lenders have been criticised for charging more than 5,000% annual interest – though the lenders say these loans are meant to be short-term, so the annual rate can make charges appear worse than they are.
Australia has an interest rate limit of 4% per month, after a maximum up-front fee of 20%.
However, even in Australia, borrowers can still face hefty charges.
Penalties for late payment are allowed to be as much as twice the loan amount.
In the UK, the FCA has already been given the power to cap the costs of payday loans.
But under the new law, the FCA will now have a duty to go ahead and introduce price controls.
“Now the regulator will go away and decide what is the best form of cap,” said Mr Osborne.
The FCA takes over as the industry regulator in April 2014, so no changes are expected before 2015.
The FCA has also proposed a series of measures to clamp down on the industry, including limiting loan roll-overs to just two, and restricting the use of continuous payment authorities (CPAs).
But the Consumer Finance Association (CFA), which represents some of the payday lending firms, was sceptical about whether price controls would work in consumers’ interests.
It said the move could encourage more illegal lending.
“Research from other countries where a cap has been introduced, suggests price controls would lead to a reduction in access to credit, and open up a larger market for illegal lenders,” a spokesman said.
The FCA itself has also expressed reservations about a cap on charges, fearing that some lenders might increase fees to the legal maximum.
Labour leader Ed Miliband has already said his party would cap the cost of payday loans.
Mr Miliband has also pledged to give councils new powers to limit the spread of payday lending shops in town centres.
The shadow minister for competition and consumer affairs, Stella Creasy, told the Today programme that “the devil really is in the detail”.
“This industry’s a bit like an inflated balloon and if you don’t crack down on the whole cost of credit, then wherever they can recoup their costs by expanding the prices at other points, they will.”