How regulators worldwide aim to rein in buy now/pay later

November 4, 2021 11:34 AM

The fast growth of the buy now/pay later market is attracting scrutiny from financial services regulators concerned about the lack of specific rules for point-of-sale credit and the potential risk to consumers.

This week's hearing of the House Financial Services Committee's task force is the latest in a series of moves bank regulators are taking in countries around the world to understand BNPL's impact on consumer debt, and how the product should be governed.

The political attention comes amid fast expansion for BNPL loans. The product is expected to grow from a $60 billion per quarter market in 2019 to $166 billion per quarter in 2023, according to RBC Capital Markets. Other estimates peg the potential BNPL market to grow higher. Bank of America, for example, expects the global BNPL market to pass $1 trillion in the next four years.

The appeal to investors and financial institutions is clear. BNPL increases conversion rates between 20% and 30% and boosts average ticket sales between 30% and 50%, according to RBC Capital Markets.

The incursion of fintechs like Affirm, Klarna and Afterpay has been accompanied by competitive moves from Goldman Sachs, Square, Capital One Financial Corporation, and investments and partnerships from the major U.S. card brands.

Fintech investors are also pouring funds into BNPL companies, anticipating more upside given the popularity of BNPL with younger consumers and the still relatively low penetration of the product. While BNPL payments have doubled globally over the past two years, the product still represents about 2% of the overall e-commerce market, according to WorldPay.

But there's also research that suggests BNPL poses a risk to consumers. Australia's Department of the Treasury found that 30% of the revenue from BNPL comes from "bad debt," which it defines as debt used for consumption rather than wealth creation. And considering late fees for BNPL lending, the APR for BNPL can be as high as 68%, according to the Australia's treasury.

A report from the Australian Parliament found BNPL funding is a factor in one out of five consumer insolvencies, compared to 3% for credit cards. In the U.S., about two thirds of BNPL users have a credit card balance that's 75% of their limit or more when making their first BNPL purchase, according to Research and Markets. Other data from Motley Fool's research arm found that 40% of consumers take out a BNPL loan to buy items they can't afford while avoiding credit card debt.

It's this risk that has regulators concerned. Here are examples of new regulations or government agencies that are planning or considering new rules for BNPL.

United States

The

Consumer Financial Protection Bureau

published a blog post on BNPL in July that said the product could be useful for some consumers, yet could also negatively impact a user's credit history.

At this week's hearing,

House Democrats

pushed the CFPB to closely examine BNPL ahead of potential regulations, while Republicans warned stronger regulations could curtail a product that provides financial flexibility for consumers.

There are very few, if any, U.S. regulations that deal specifically with BNPL. The loans often don't include interest if paid within the installment terms, normally four monthly payments. As such, BNPL lending

falls outside regulations

for longer-term credit that carries interest payments, such as the Truth in Lending Act.

At American Banker's recent

Card Forum

conference, Brian Tate, president and CEO of the Innovative Payments Association, and Eric Goldberg, a partner specializing in consumer financial services at the Washington, D.C.-based law firm Akerman, both predicted the CFPB would pursue stricter regulations on BNPL under Rohit Chopra's tenure.

In an email, a Klarna spokesperson said: “We understand and support reasonable regulation for buy now/pay later products, and in the U.S. are compliant with regulations enforced by the Consumer Financial Protection Bureau, Federal Trade Commission and numerous state regulators. We do not, however, believe no-interest products should be regulated in the same way as high-interest products, which could ultimately impact our ability to provide responsible credit alternatives to millions of Americans.”

Since fintechs are often outside the reach of the Federal Reserve and the Office of the Comptroller of the Currency, it would not be a surprise to have the CFPB weigh in, according to Brian Riley, director of Mercator Advisory Group's credit advisory service.

"The CFPB's broader powers enable it to take enforcement issues to any money lender," Riley said. "As was the case in Australia, some fintechs were criticized because loose lending generated excessive fees. The sentiment was that the lenders have a responsibility to ensure customers can actually pay as agreed."

In the U.S., an alignment between BNPL companies and regulators like the CFPB would be a step in the right direction for the industry as well as the consumers they serve, said Harris Qureshi, director of public policy and regulatory affairs in North America for Afterpay, in an email. "We would welcome the opportunity to set standards more formally through an agreed industry process," Qureshi said.

California

One of the first dustups between BNPL lenders and regulators in the U.S. took place in California, where Afterpay paid a

$1 million settlement

in 2020 over allegations it made illegal loans.

State regulators alleged that Afterpay required a license to lend. Afterpay, which is in the process of being acquired by Square, did not admit wrongdoing but agreed to operate under a state license.

Afterpay has lending licenses in

10 states

, including California, Qureshi said, adding BNPL companies are already regulated, as they are subject to consumer protection laws and regulations covering anti-money-laundering, privacy, fair treatment of customers, and electronic fund transfers.

Sezzle

had a similar dispute with California, which initially denied its application for a point-of-sale lending license in the state. It was granted a license in January 2020 after agreeing to pay $282,000 to refund fees collected when it made earlier unlicensed loans, on top of a $28,000 fine.

Sezzle had argued it was purchasing "credit sale contracts" from merchants, instead of offering loans, and thus did not require a lending license.

"Consumer protection in the fintech world has been an online issue for quite some time, and it's only heightened as the adoption of BNPL accelerates in the pandemic economy," said Sezzle CEO Charlie Youakim in an email.

In both the U.S. and U.K., concerns over consumers overextending themselves and missing opportunities to build credit are understandably mounting, Youakim said.

To address those concerns, Sezzle helps to analyze an individual's income and spending data, without reporting it to credit bureaus, and assigns a spending limit, Youakim said. "If they keep up a steady cadence of paying their installments on time, that limit can be increased. If not, they can't make a new purchase." Sezzle also offers

Sezzle Up

, a product that allows consumers to build their credit score while they use Sezzle's product.

How banks or card companies fall under any new BNPL regulation remains to be seen, Riley said.

"It will depend on how the loan is structured," Riley said, adding if the bank is underwriting the loan or purchasing the loan, it may be subject to Ability to Repay (ATR) standards, similar to requirements for credit cards under the CARD Act of 2009.

"Standard rules on fair lending and clarity would also likely apply," Riley said. "As with most other standards that apply to insured banks, it is likely to expect safety and soundness provisions, which will help cure the delinquency issue."

Sweden

An early move to curtail BNPL came in Sweden, Klarna's home country. In May 2020 the

Swedish Payment Services Act

, which governs the country's payment system, was amended to require merchants to present a list of payment options that do not contribute to consumer debt.

There is also a requirement that merchants present the bank-operated Swish payment app, and merchants can no longer pre-select paying in invoices or installments in online checkouts.

Klarna has sparred with the Swedish government over the rule, with the Swedish Consumers Agency in late 2020 claiming

Klarna breached

the country's BNPL regulations.

While Klarna later updated its user interface to include a "

pay in full

" option that avoids installments, the BNPL fintech and Swedish regulators are still at odds over interpretation of Sweden's BNPL "no debt first" payment rule.

Ahead of a potential initial public offering, Klarna CEO and co-founder Sebastian Siemiatkowski in September told

CNBC

the company's default rate is about 20% to 30% lower than that of credit cards.

United Kingdom

Siemiatowski's remarks to CNBC were partly aimed at a U.K. audience, with the Klarna CEO saying the company could "have done a better job" in the U.K. in focusing on areas other than credit, adding Klarna allows users to pay directly from their bank accounts in some European markets.

The U.K. Treasury, which has been signaling plans to regulate BNPL lending since early 2021, opened a

public comment period

for BNPL rules in late October that will close on Jan 6, 2022. That will be followed by a consultation with the Financial Conduct Authority that could push regulations to late 2022 or 2023, according to

The Guardian

.

The regulatory proposals that have come thus far include rules defining which consumers are in financial distress, and guiding how BNPL firms engage with those consumers. There may also be requirements that consumers have a venue to complain to the U.K.'s Financial Ombudsman Service if they are unhappy about their experience with a BNPL lender.

Momentum for BNPL regulation in the U.K. followed an

FCA report

that found the BNPL market tripled during 2020 in the absence of regulation, creating potential harm for consumers.

”The launch of HM Treasury consultation is a welcome step forward, setting out plans for proportionate regulation that’s in the interest of consumers and encourages innovation," a Klarna spokesperson said in an email. “At Klarna, we continuously set the standard for the sector. However, there are still bad products out there, so we are pleased that regulation is now clearly underway."

European Union

In late June the European Commission revised its rules for consumer credit and product safety in response to the growth of digital financial services options during the pandemic.

In the

European Commission's document

, Vera Jourova, vice president for values and transparency, said: “Consumers face many challenges, especially in the digital world which revolutionised shopping, services or financial markets. This is why we are stepping up consumer protection on two fronts: we are making it easier for consumers to avoid risks related to having a credit and we are putting even stronger rules for product safety in place. It will also put more responsibility on market players and make it more difficult for bad actors to hide behind complicated legal jargon.”

This is a prelude to more stringent rules for BNPL, according to the

RFI Group

, a London-based financial services and technology research and consulting firm.

The update requires the clear presentation of information so consumers are informed, along with tighter rules for creditworthiness, which would provide cover for BNPL-specific regulations or be used by member nations to write new rules for BNPL lenders, RFI Group said, citing UBS research.

There are also potential overlaps between the EU and EU member-state rules limiting high fees for alternative credit products, which would support tougher rules for BNPL lending, according to RFI.

Ireland

BNPL in Ireland is unregulated, but a

new bill

in Parliament would expand the definition of credit in a manner that could cover most BNPL lending.

If the bill passes, it would add agreements that include deferred payments to a list of regulated lending products such as traditional loans. It would also redefine retail credit firms to businesses that provide direct or indirect credit.

That would bring BNPL fintechs and companies that partner with BNPL fintechs under regulations that are similar to those for loans, according to commentary from

Dillon Eustace

, a Dublin-based law firm. These rules include anti-money-laundering controls, and financial fitness standards for lenders and borrowers.

Australia

Australia's central bank in late October prohibited BNPL firms from banning merchants from passing surcharges onto consumers for BNPL services, a move that would cut into a major source of revenue for BNPL fintechs.

The

Reserve Bank of Australia

is working with the Treasury to write regulations to enforce the decision, which follows a two-year review of the BNPL industry. The central bank is arguing that BNPL lending has become expensive and a necessity for merchants given the product's growth, and there is a public interest in BNPL providers no longer being to enforce no-surcharge rules.

RBA research found 60% of consumers would decline BNPL loans if there were a surcharge of 4% or higher, and the average BNPL fees charged to merchants are between 4% and 6%, according to

Reuters