Matt Bivons
Buy now, pay later (BNPL) is an old form of payment that is new again in a big way. And that could mean trouble for BNPL fintechs that are just getting to know the world of lending and the pitfalls associated with traditional banking infrastructure.
Recent data from FIS — one of several payment processors — pegs BNPL at a $100 billion industry, or 2.1% of global e-commerce transactions. Marqeta, another processor, says BNPL transactions on its platform have increased 350% this year.
The success of the BNPL format has been attributed to the lift it provides to merchants at checkout and the convenience it offers consumers seeking to avoid interest payments and debit card fees. Last year, at least 91% of consumer loans in California were BNPL.
According to Klarna, one of the largest BNPL providers, the average order value at checkout increases by as much as 45% when shoppers are given the opportunity to pay for their purchases in four interest-free payments. BNPL is so convenient, compared to old-fashioned installment loans, that consumer advocates worry it encourages people to take on more debt than they can manage.
If that happens, the BNPL providers could get hurt badly during an economic downturn. In a report published in the summer, Fitch Ratings, one of the Big Three U.S. credit rating agencies, described the performance of BNPL debt as “opaque.” The report cited a survey in which nearly one in three respondents (31%) had either been late with a BNPL payment or incurred a late fee.
But the other side of BNPL is not just consumer credit risk, which BNPL providers say they can manage with non-traditional, data-driven underwriting. BNPL providers also face a double whammy of risk on the merchant side.
Three-sided loans, in which a lender relies on a merchant to act as a reseller, became a focus of regulatory scrutiny with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.
Dodd-Frank did many things. Among the most influential provisions was the creation of a Consumer Financial Protection Bureau endowed with the authority to act against any provider of consumer financial products or services who engage in “any unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.”
In the last six months, the CFPB announced enforcement actions against lenders as diverse as Nationwide Equities Corporation, a reverse mortgage broker, and Better Future Forward, which offered students income-share agreements (ISAs) to finance post-secondary education. While the allegations of wrongdoing vary, they all have to do with the kind of information provided to borrowers.
With three-sided loans, the information provided to borrowers is not controlled by the lender, and the risk of a provider being held accountable for merchant misconduct is substantial. In July, the CFPB took action against GreenSky after merchants allegedly used the fintech’s platform to secure up to $9 million in loans for customers without their authorization.
At first glance, BNPL providers may seem to be safe from similar enforcement activity. Consumers typically initiate BNPL lending themselves and authorize access to their accounts. But regulators are finding other reasons to crack down.
In January 2020, the California Department of Business Oversight (DBO) announced a $300,000 settlement with Sezzle. According to the Department of Financial Protection & Innovation, “The DBO concluded that the purported credit sales made by Sezzle’s merchant partners were not bona fide but, rather, were structured to evade otherwise applicable consumer protections.”
The DBO also reached settlements with QuadPay, AfterPay and Klarna for not fully complying with state lending regulations.
These suits could be the tip of a massive iceberg. In May, an AfterPay user named Brooke Miller brought a class-action lawsuit alleging that the BNPL provider had deceived customers with misrepresentations and omissions about the risks of using Klarna. Among those risks were overdraft fees for insufficient funds imposed by users’ banks. A similar suit was filed against Klarna a week later.
Klarna, of course, has no control over overdraft fees. One of the financial industry’s little-known secrets is that American banks and credit unions are typically incapable of reporting the status of their customers’ accounts in real time.
Outdated batch architecture not only exposes BNPL providers to class action lawsuits, it’s also why you can’t call your credit card provider and determine the exact amount needed to pay off all your outstanding debt and interest. It’s why your debit card company can’t send you an in-app message warning you that you are about to overdraft your account with your next BNPL payment.
Modern architectures that provide real-time calculations and reporting solve these problems, and as their benefits become more widely known, there will be increasing pressure on both traditional financial institutions and fintechs to upgrade.
For BNPL providers, switching to modern architecture for loan management and servicing can minimize third-party merchant risk. In addition to ensuring borrowers get the disclosures they need in real time, providers can also use automation to flag potential compliance and security risks. They can alert customers to the status of their accounts and even offer alternative financing if a borrower is at risk of overdrawing the account.
BNPL providers can adopt modern lending infrastructure even if a consumer’s bank does not. That is the beauty of new API-based banking-as-a-service stacks. By adopting modern lending infrastructure, BNPL providers get insurance against unfair practices and the ability to do business with the transparency customers need to borrow responsibly.
BNPL providers have already shown themselves to be adept at leveraging technologies like the cloud and mobile to deliver a better user experience. By taking advantage of recent innovations in infrastructure, they can avoid accusations of unfair practices while achieving the transparency they need to help their customers borrow responsibly. It’s the checkout lift they owe themselves.
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