A national database of payday loans should be established and laws tightened to ensure payday lenders more carefully assess vulnerable borrowers, a timely report from the Australian Centre for Financial Studies has said.

But with a review of the maligned sector due to be delivered to Assistant Treasurer Kelly O'Dwyer by the end of the year, the ACFS warned that stronger regulation in the form of tighter interest rate caps risks suffocating a market used by a significant proportion of the Australian population to fund their day-to-day living expenses.

More than 1 million Australian borrow through payday lenders each year to fund basic living expenses. Credit:iStock

"Lower caps on fees, for example, may have the unintended consequence of encouraging illegal lending activity – and so other policy initiatives should be trialled," the report by RMIT University academics Marcus Banks, Ashton de Silva and Roslyn Russell said.

The market for "small amount credit contracts" (SACC) – loans of up to $2000 for periods of between 16 days and 12 months, made at relatively high interest rates, colloquially known as payday loans – has grown dramatically in recent decades, the report said, driven by a 20-fold increase in demand.