A world of regulatory pressure on installment payment firms

Providers of installment payments — also called buy now/pay later — have risen in popularity over the course of the past year. And they're starting to catch the attention of regulators.

The BNPL industry won its first battle when the U.K. Parliament voted against a bill that would more heavily regulate BNPL firms, which fall outside of the U.K.'s lending laws. The Labour-led proposal would have introduced new regulations within three months of the passage of a broader financial services bill.

While the bill failed, BNPL firms will likely face new regulations in the U.K. following a Treasury review of unsecured credit. This follows regulations in Sweden, requiring merchants to initially present payment methods that do not create consumer debt. And merchants cannot pre-select the option of paying with invoices or installments in their online checkout pages.

In the U.S., California regulators recently fined Sezzle, Afterpay and Quadpay for operating without a lenders' license, requiring these companies to obtain licenses in the state.

And in Australia, regulators in late 2020 required BNPL companies to publicly disclose their target markets and ensure those markets will not incur financial harm.

Most of the regulatory moves focus on BNPL products as a source of credit or debt risk for consumers. While the installments do not carry interest and are often a way for merchants and consumers to support larger purchases, point of sale credit is still debt. The regulators in California, U.K., Sweden and Australia all mentioned the risk of consumers buying products they can't afford and thus taking on financial risk.

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"The fast growth of BNPL firms made some politicians consider whether they should be regulated — and if so, how," said Zil Bareisis, head of retail banking at Celent, adding there are some countries such as Germany that are averse to debt, but that is not the case in the U.K. "So there is always a risk that some people might over-leverage themselves and not be able to pay back their loans," Bareisis said.

In the U.K., BNPL firms may have also gotten unwittingly compared to Wonga, the U.K.'s largest payday lender, which collapsed in 2018. Wonga's struggles shed light on the U.K.'s payday lending industry, in which some lenders were charging APRs as high as 1,500%. BNPL lenders don't charge interest — that's part of the appeal — but their fast growth during a financial crisis has sparked worry among consumer groups, thus drawing the attention of regulators.

"I certainly don’t want to compare BNPL firms with the 'old style' payday lenders; I'm just simply highlighting the fact that a relatively easy availability of credit, even if it’s short-term borrowing, is making some concerned that there will be those that won’t be able to afford it and will get into financial difficulties," Bareisis said.

BNPL firms have existed for years in Europe, reaching other markets slowly until the coronavirus pandemic and related economic crisis hit in 2020. That caused a rush of BNPL firms and other no-interest point of sale financing, with many of the industry's largest companies reporting triple-digit growth in just a few months. Motley Fool's research arm found nearly 40% of people came into the BNPL market to avoid credit card debt and to buy items they could not afford.

With that growth came investor interest. Affirm's IPO and earlier investment rounds vaulted the company's stock price and market cap to more than $26 billion. The rest of the BNPL market, including Klarna, Splitit, Afterpay and others, has attracted additional VC investment during the past year.

But there's also been a flip side, as Capital One decided not to allow credit card purchases for BNPL in late 2020, but continued to allow BNPL purchases with debit cards.

There may also be financial risk for the BNPL firms, given that merchants get paid upfront and the consumers receive their purchases immediately, said Austin Mac Nab, a managing partner at VizyPay, a West Des Moines, Iowa-based payment processor and merchant services firm specializing in small to medium-sized businesses. VizPay is often part of a merchant product bundle that includes an unrelated BNPL option.

The BNPL firms charge fees that can vary, but usually range from 3% to 7% for each transaction, potentially leaving the BNPL firm on the hook, depending on its relationship to the merchant, Mac Nab said.

"COVID has enhanced that in a way that may place these purchases outside of the consumer's budget," Mac Nab said. "And the risk for that falls more on the BNPL firm than the merchant."