Yaacov Martin
The U.S. is notoriously behind on forward-thinking regulation for fintechs, which is unsettling considering the number of U.S. citizens in serious debt. As of the third quarter of 2021, American citizens owed more than $15 trillion, nearing the highest level in the nation’s history.
Buy now, pay later (BNPL) services offer customers accessibility and flexibility for payments, but unregulated services mean people can unintentionally put their financial health at risk. Some BNPL providers penalize consumers up to 25% of their purchase for repaying late. And a Credit Karma study showed 72% of consumers in the U.S. ended up with lower credit scores after using unregulated BNPL services.
But the right set of regulations will resolve this issue and ultimately provide an opportunity for banks to enter and become leaders in the BNPL arena.
The Consumer Financial Protection Bureau (CFPB) is keeping a close eye on consumer credit products. A probe announced in December 2021 asked major players Affirm, Afterpay, Klarna, PayPal, and Zip to provide insight into the risks and benefits of their products.
While BNPL players have positioned themselves as the driving force for financial inclusion, policymakers will discover that many of these providers need to make far more progress regarding customers’ financial well-being. Regulation is the way to ensure that.
Although regulators will take some time to reach conclusions and implement real hardline requirements, the ramifications will be immediate.
Here’s what we expect:
The journey to fair and responsible lending
The right set of regulations will soon show that fair and responsible lending goes hand-in-hand with accessible and affordable consumer financing.
The CFPB regulation probe will level the playing field in the long term. Fintechs have shown there is a need for BNPL, and have proven that it is possible to scale these offerings throughout both in-store channels and e-commerce sites. However, traditional lenders and banks, which already offer services that adhere to reporting protocols, can now also flourish in the BNPL space with the right technological partnerships.
By partnering with a BNPL provider, banks can deploy agile, responsible BNPL solutions that will benefit both merchants and consumers. By offering white-labeled BNPL options from banks, merchants could increase sales and average order value (AOV). Consumers will benefit from high acceptance rates provided by banks and other regulated financial institutions. Plus, leading banks and lenders often offer the most competitive loan programs.
What’s the most viable way to regulate the BNPL industry?
Let’s analyze which countries are on the right track. The U.K. was one of the first movers regarding regulation. But despite the Woolard Review published by the U.K.’s Financial Conduct Authority (FCA) in early 2021, which explained the urgency to regulate the BNPL industry, there is no new regulatory regime expected to bring unregulated BNPL products under the FCA before 2023.
However, the FCA used the Consumer Rights Act to secure changes to unfair or unclear terms in the contracts of four BNPL fintechs to ensure that consumer credit markets work better. In-depth reporting should be the next step — there must be an exchange of information between providers and credit bureaus for visibility into how consumers utilize BNPL services.
Meanwhile, Australian Treasurer Josh Frydenberg recently announced several proposals to update Australia’s regulatory framework so the government can oversee payments policies and systems. If the Australian government achieves the ideal balance between regulating the industry and encouraging innovation, it could be a road map for other countries.
While BNPL companies have made significant strides regarding financial inclusion and accessibility, there is room to bring more responsibility into the BNPL space by making certain checks and credit reporting compulsory for all providers.
The first step in that direction is for regulators to differentiate between providers — some already report account activity to credit bureaus, for example. These providers should therefore be assessed differently during the CFPB probe and the creation of new regulatory regimes.
There are two characteristics that need to be evaluated by regulators:
- Late fees/no-payment fines and practices
Regulators will have to ensure that they rein in these practices in accordance with existing guidelines pertaining to regulated products. There is no reason to allow for an exception.
2. Reporting practices
Regulators will need to establish a certain reporting threshold for BNPL providers, which can be lighter than that of traditional regulated products. BNPL companies that currently meet the threshold will not have to alter their practices. Those who don’t will have to implement reporting measures and tools to give the regulator the visibility it requires.
Furthermore, not all BNPL services are unregulated, like those provided by banks and traditional lenders. For example, Andrew Rostami, president of Citizens Pay, a bank that offers responsible BNPL services, said, “We’ll look at things like your debt-to-income ratio, what additional debts you have, and your income just to make sure you have enough income to cover all your debt payments.”
Regulators and policymakers must assess and collaborate with both unregulated and regulated BNPL services to mold the industry and ensure consumers have access to affordable and responsible credit options.
Surviving the regulatory clampdown
Traditional banks that are regulated won’t only survive, they’ll thrive. Why? As regulators crack down on BNPL providers, banks, who have been conforming to regulation for years, will strengthen their position in the market.
As Affirm, Klarna, and Afterpay grew, they were always accompanied by competitive moves from Citizens Bank, Goldman Sachs, Capital One, and investments and partnerships from major U.S. card brands.
Banks have already adapted to meet shifts in the consumer financing market while staying firm to their values of responsible lending. Take the term Barclays coined: “positive friction.” This means the bank simply includes checkpoints in the customer journey to encourage consumers to reflect on the financing they’re signing up for at the point of sale (POS) and feel in control of their spending.
We will see larger fintechs survive, too. They have been anticipating this change for a while and they are prepared to collaborate. Their evaluations are also too high to allow them to fold as the landscape changes. Afterpay claimed that it has already been collaborating with policymakers in countries where it operates and stated that it looks forward “to continuing to work closely with regulators and policymakers.”
However, more than 170 startups are competing in the unregulated BNPL space, with new players born every month. The proliferation of these new, smaller BNPL providers, which don’t follow responsible lending best practices, will slow down due to regulatory barriers to market entry.
The implications for merchants
The knee-jerk reaction of merchants will be to suddenly reel at the thought of newly imposed limits and compliance requirements. With existing BNPL solutions from direct-to-consumer fintechs, merchants benefit from increased sales due to accessibility and, with little or no credit checks, transactions are often approved.
Merchants may think they won’t benefit from regulation to the degree they benefited without it as it makes BNPL less accessible with further barriers to entry.
But what many merchants fail to realize is that regulation doesn’t stifle innovation and agility. For example, a collaboration between regulated entities and technology companies could strike the balance between accessibility and responsibility.
Many retailers are also unaware of the risks of unregulated BNPL services that are offered irresponsibly: They can potentially damage the relationship with consumers. Consumers may even associate any debt or negative financing experience, such as a loan rejection, with the moment they walked into a specific store or visited an online retail brand, not with the lender.
There seems to be a merchant shift toward wanting to strengthen consumer purchasing power with fair financing instead of exposing consumers to fees and fines with non-regulated BNPL solutions.
Take the proclamation from global retailer IKEA at Money 2020 in Las Vegas: It stated that balancing responsible lending with accessibility is essential for the customer journey. Ultimately, POS lending or consumer loans are only sustainable — at a micro or macro level — if they are responsible. That’s the silver lining of BNPL regulation from a merchant standpoint.
New regulatory probes are set to shake up the BNPL industry for the better: cutting out questionable BNPL services, protecting consumers from debt, and boosting merchants’ brand image. What regulators must keep in mind, however, is that not all BNPL services are unregulated, like those provided by banks and traditional lenders, who are perfectly poised to work with regulators to build the future of accessible consumer financing.
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