Is the CFPB reining in buy now, pay later loans too soon?

Samuel Corum/Bloomberg

The fast-growing market for buy now/pay later loans has moved from simply a pandemic-era convenience to a vital financial access tool in about four years, making the product a potential vector for consumer risks in a tightening economy. 

The Consumer Financial Protection Bureau's recent move to extend credit card protections to buy now/pay later lenders seems long overdue to some, coming three years after the agency announced plans to monitor the industry. But to some providers, the action seems premature.

After booming during the pandemic when customers welcomed the ease of one-click installment-loan financing for e-commerce purchases, BNPL lending is still in the throes of evolution. Thus, it's the wrong time to apply shackles that could stunt the market's development, according to some key BNPL industry operators. 

The years since 2020 have been an economic rollercoaster for the industry, beginning with consumers flocking to online BNPL offers to buy luxury items, exercise bikes and furniture with zero interest during the pandemic, followed by harder times in 2022 when access to capital shrank and BNPL loan losses and delinquencies spiked. 

But the BNPL industry, which is funded by fees merchants pay to the lenders for closing these deals, has made a rapid recovery from those setbacks. More than half of U.S. consumers have tried a BNPL loan, and 46% currently have an outstanding BNPL loan, according to C + R Research. Certain BNPL heavyweights including Affirm and Klarna have added debit cards that include BNPL offers at the point of sale, along with longer term interest-bearing BNPL loans.

BNPL: A financial lifeline?

With rising inflation and an uncertain job market over the last two years, BNPL loans have become an important financial tool for unbanked and underbanked consumers, according to research by the Federal Reserve Bank of New York. 

Imposing restrictions on the BNPL industry now could have negative effects on the fledgling industry's growth and also on consumers who rely on the loans for critical financial needs, according to the Financial Technology Association, a Washington, D.C.-based trade association representing BNPL and fintech leaders. 

"BNPL products are fundamentally different from credit cards: these products have zero interest on outstanding balance, no ability to revolve a balance, and a profit model centered on user success," said Penny Lee, the FTA's president and CEO, in a statement. 

In addition, BNPL lenders among the FTA's membership currently have an average delinquency rate of under 2%, compared with an average delinquency rate of nearly 9% for U.S. credit cards during the first quarter of this year, according to data from the New York Federal Reserve Bank, the FTA noted.

BNPL giant Klarna also called CFPB's move ill-timed in a blog post last month. 

In Klarna's home base of Sweden, nearly one in four e-commerce transactions are financed via BNPL loans, and Klarna said it's "baffling" that the CFPB is proposing now to treat the newest U.S. financing innovation of BNPL loans — many of which are interest-free — as credit cards, while ignoring the $1.15 trillion in credit card debt.

"Over the last several years, we have seen governments across the world, from Australia to the United Kingdom, recognize the fundamental differences between credit and BNPL products," Klarna said in its blog post.

After several years of observation, the CFPB has determined BNPL loans are "card issuers" under Regulation Z and BNPL loans are to be treated like credit cards, even if the accounts are solely digital, according to the agency's May 21 announcement of a new interpretive rule it's planning to enforce after a public comments period ends Aug. 1, 2024. 

The rule would require BNPL lenders as creditors to provide periodic billing statements and consumer disclosures, and to offer processes to support refunds and resolve billing errors, among other protections within the 1968 Truth in Lending Act. 

Most BNPL providers claim to already meet the CFPB's requirements for providing clear disclosures and providing ample processes for consumers to get refunds and resolve billing errors. 

Key BNPL industry players including PayPal, Klarna and Block's Afterpay already support "clear and transparent" terms and conditions, and the FTA said its members agree these and other common-sense protections should be applied consistently across the industry and to companies offering BNPL loans, the FTA's Lee said.

BNPL lender Affirm noted that it underwrites each credit decision on an individual basis using a proprietary approach geared to encourage customers' financial health, and it charges no late fees. "We're encouraged that the CFPB is promoting consistent industry standards, many of which already reflect how Affirm operates, to provide greater choice and transparency for consumers," Affirm said in a statement.

Affirm's Chief Financial Officer Michael Linford also recently countered a recent report about the risks of "phantom" or hidden BNPL loans that aren't routinely relayed to credit-reporting agencies. Linford said the report "falsely suggested that transaction volume across BNPL made up about one-third of the increase in credit card balances in 2023 and that there's a hidden balance of $700 billion in consumer debt."

BNPL purchase volume from 2022 was estimated to be about $36 billion compared with $3.2 trillion in credit card debt during the same period, and BNPL loans would represent about 1% of all credit card volume on that basis, according to Linford.

In addition, the most popular form of BNPL loans, "Pay in 4," where BNPL lenders split purchase repayments into four equal installments over six weeks, accounted for about 0.3% of $1.1 trillion in outstanding credit card balances in 2023, Linford said. The CFPB's guidance appears to be aimed at protecting consumers who might get into trouble by taking out too many BNPL loans, or put other lenders at risk from extending loans to consumers already bogged down by BNPL obligations, said Daniela Hawkins, a partner at Capco. 

"It's obvious that BNPL lenders are targeting consumers who are struggling to make ends meet, and there's a risk of BNPL loans becoming predatory. With this proposed guidance, the CFPB wants to make sure consumers have the right education and protections here, so they don't get into trouble," she said. 

Significant economic changes also are likely having an effect on who's taking out BNPL loans, she said. 

"When BNPL loans first boomed during the pandemic, it was dual-income households buying a $2,000 Peloton bicycle spread over several paychecks, but four years later with inflation and spiking grocery prices, it's sometimes consumers using BNPL loans to put food on the table," Hawkins said. 

Requiring BNPL lenders to suddenly conform to the same key protections consumer credit cards offer could also be a "heavy operational lift" for industry participants and force business model changes or even consolidation, Hawkins said.

How banks could benefit from CFPB action

One category of BNPL lenders that may indirectly benefit from the CFPB's proposed new guidance is regulated financial institutions already offering point-of-sale installment loans, including American Express, Citigroup, Citizens Bank, Barclays, U.S. Bank and others. Inspired in part by the popularity of BNPL loans, these firms that are already fully in compliance with Truth in Lending and Regulation Z have expanded their own installment loan offers at the point of sale, often tied to existing credit card lines but with special promotional financing.

Another fintech, Splitit, operates in a hybrid role by integrating with merchants to offer consumers installment plans using their existing credit cards, so it's not originating a new loan. 

Reports suggest that BNPL firms have extended about $50 billion in credit to U.S. consumers, most of which isn't reported to credit bureaus. Apple's BNPL service Apple Pay Later vowed to report all loans to credit bureaus, and Affirm has an agreement to report some loans and repayment activity to Experian, but most fintechs' BNPL loans requires only a soft credit check for instant underwriting, using consumers' basic information.

"BNPL providers have been acting like credit cards but saying that they are not, which has thoroughly confused consumers," said Nandan Sheth, Splitit's CEO, who believes the CFPB's proposed rules could be a significant setback for BNPL fintechs that don't currently have to invest in Regulation Z and Truth in Lending compliance.

Jifiti, which uses a similar white-label approach to connect merchants to U.S. banks' existing credit offers at the point of sale, also foresees the potential for consolidation among BNPL firms whose financing doesn't come from banks. 

"The playing field has already been leveling in the BNPL market, due to macroeconomic influences, inflation and high interest rates, and the CFPB rule will likely further shift the market in favor of banks and regulated lenders," said Yaacov Martin, Jifiti's CEO, who predicts the BNPL industry may eventually experience consolidation as a result of the CFPB's tightening regulatory control of the burgeoning industry.

Morningstar DBRS, a financial credit ratings agency based in Toronto with offices across the U.S., said the CFPB's move is likely "a precursor" of additional regulations the agency plans to propose and enforce on the BNPL industry in coming years. 

"While some of these protections and processes may have already been offered by BNPL lenders, the CFPB's rule essentially levels the playing field in the space for new and existing players, as well as relative to credit card issuers," said Yanni Koulouriotis, a vice president at Morningstar DBRS, in a note to investors last month.