Why regulation will help buy-it-now and pay-later giants
After a meteoric rise during the pandemic, the buy now, pay later (BNPL) business faces a clouded future from deteriorating economic conditions, competition from Apple and bank credit card issuers, and a regulatory crackdown. imminent.
At least, that’s the conventional wisdom. Since the Federal Consumer Financial Protection Bureau (CFPB) opened an investigation into the industry last year, the regulations have generally been presented as a “backlash” and a threat to industry growth. A research note released Sunday by Goldman Sachs analyst Michael Ng, who initiates coverage of Affirm Holdings with a neutral rating, observes that “the changing regulatory landscape for BNPL in the United States brings the risk of ‘potential regulation that could reduce the rate of adoption by consumers and merchants.”
Yet a closer look suggests that the regulation could actually benefit US BNPL industry leaders.
While BNPL has existed in the United States for over a decade, it has exploded during the pandemic. Supported by increased online spending, payment volume for businesses offering to split purchases into interest-free installments increased 230% from January 2020 to July 2021 and accounted for 2.4% of all retail purchases in online (and 12% of online fashion spending) in 2021, according to an Accenture report commissioned by BNPL Afterpay. BNPL’s global e-commerce market share is expected to double by 2024.
Thus, the announcement by the CFPB last December of the opening of an investigation into the BNPL caused a sensation. After all, most major forms of consumer lending in the United States are regulated by one or more federal and/or state laws. Traditional bank lending is regulated by the federal Truth In Lending Act (TILA), which dates from 1968. The CARD Act, passed by Congress in 2009, imposes additional limits on the advertising and lending practices of credit card providers. credit. And high-interest “payday loans” are regulated by many states, with some outright banning them.
There is no regulatory framework at the federal level specifically designed for BNPL, which industry insiders say has created a perception that the industry is completely unregulated. But BNPL is already covered by state and federal lending laws throughout its existence. This is why the current regulatory review is likely to have minimal effect on the operations or lending practices of BNPL’s main companies, industry sources suggest. In fact, it could actually help BNPL further develop – and grow – by curbing the practices of some fringe players and creating a sense among consumers that it’s a safe and regulated company.
Most BNPL plans are not regulated by TILA as they charge users in four installments, falling just below the five installment threshold where TILA comes into play. However, a patchwork of state laws requires BNPL companies to obtain lending licenses in most US states. , which impose strict requirements in terms of advertising and limiting fees and interest payments. And BNPL providers are prohibited from employing any unfair, deceptive, or abusive acts or practices (UDAAPs) under the Dodd-Frank Act of 2010, which gives federal regulators broad leeway to crack down on deceptive or abusive BNPL lending. predators.
“I would be surprised if [the CFPB] comes out with very specific BNPL regulations,” says Kim Holzel, a CFPB veteran who is now a partner at law firm Goodwin Procter, advising banks and fintechs. “They have rules to regulate that now if they want. They stretched [UDAAP] far enough, so I don’t even think they need to make any rules to regulate that space.
BNPL’s lenders have been subject to legal action in the past. Klarna was sued in a California class action lawsuit in which it was accused of failing to disclose the risks of its customers incurring overdraft or NSF (insufficient funds) fees from their bank if they were automatically charged for a BNPL purchase while maintaining a low bank balance.
A positive consequence of increased regulatory scrutiny could be an improvement in the reputation of larger industry players at the expense of their smaller competitors. Industry leaders like Klarna and Afterpay make over 90% of their revenue by partnering with online merchants. These companies do not charge customers interest for their basic “pay in four” plans, although they do charge a fee for some of their longer term financing plans.
However, upstart competitors who are unable to secure lucrative merchant partnership deals end up with fee collection as their primary source of revenue. For example, Chillpay, founded in 2019, charges a standard late fee of $4 per missed payment, and an additional $4 if the late payment isn’t made within a week. Australian company BNPL Openpay, which recently announced it was closing its US operations, charges a variable “plan creation” and “plan management” fee for each BNPL purchase. Settlement banks are beginning to market BNPL products, but these also come with strings attached – Chase’s BNPL offering does not charge late fees or interest, but requires a flat monthly fee to use.
“Some of the companies that seem to have smart rules are taking shortcuts to get ahead of their competition. That could be their downfall,” says Tony Alexis, former chief regulatory officer at CFPB and also a partner at Goodwin Procter.
Nikita Aggarwal, a lawyer and fellow at the Harvard Kennedy School’s Carr Center for Human Rights Policy, who hosted an informal roundtable for BNPL industry executives earlier this year, said representatives of major U.S. companies BNPL spoke optimistically about regulation in the sector at the event. One firm said tougher regulatory standards could help weed out smaller companies with more predatory lending practices and could boost the reputation of the industry as a whole.
Ironically, new rules could help big BNPL companies against not just smaller competitors, but big banks as well. “There are a lot of other competitors coming into the [BNPL] space. We see traditional credit card companies entering the market and calling their product BNPL when there are finance charges or other types of charges embedded in it. It’s not really an BNPL product when there are these types of fees involved,” says Harris Qureshi, director of public policy and regulatory affairs at Afterpay. “That’s one of the things we’ll probably see: a clarification of what’s [BNPL] products and what are not.
One of the main consequences of the regulatory attention given to BNPL will be an overhaul of the way BNPL purchases are considered in the credit reporting process – a potential benefit for both the industry and its customers. . No major BNPL vendor currently reports user data to credit bureaus because BNPL’s spend analytics infrastructure is lacking. If BNPL companies provided consumer data, the three major credit bureaus would treat BNPL purchases like any other form of credit, which could have a perverse effect on users’ credit scores, even when they pay on time, as calculated by FICO.
In the current reporting infrastructure, a $200 BNPL purchase paid off in full and on time over 2 months would have the same effect as opening a credit card with a credit limit of $200, capping it immediately, paying it off in 2 months and then canceling it – behaviors that would hurt someone’s credit score, as calculated by market leader FICO. This is because a credit score is increased by having a low rate of credit utilization (i.e. not going over a credit card limit) and having long-standing accounts. On the other hand, opening too many new accounts can hurt your score.
A standardized system for considering BNPL in credit reports and FICO scores would benefit the industry by allowing customers to build credit through BNPL purchases and understand how BNPL spending affects their credit rating. BNPL providers, including Klarna, Affirm and Afterpay, have been working with the three major credit bureaus to develop a uniform BNPL credit reporting system for over a year.
“We want to wait [to report users’ BNPL data] until there is a clear idea of what the outcome will be on consumer credit scores,” says Qureshi. “We want to make sure that what we do…accurately reflects the on-time repayment history that we see from our customers.”
Examining the historical precedent in Australia sheds light on the impact of the regulatory process on BNPL. In Australia, an early adopter of the BNPL, where a third of citizens say the BNPL is their preferred method of payment, newspapers and policy makers began discussions about regulating the BNPL early in the last year. Although BNPL’s Australian loans are not subject to a 2009 National Consumer Credit Protection Act – just as the US BNPL is not generally subject to TILA – they are subject to a 2001 Consumer Credit Protection Act. Securities and Investments that gives regulators the power to intervene in cases of “significant consumer harm,” similar to the nebulous UDAAP guidelines that allow US regulators to go after the BNPL.
The industry response to the regulatory issue in Australia has been swift and united: in March, a coalition of most major Australian BNPL providers drafted and signed an industry code of practice, effectively self-regulating their activities to a greater extent than the current law. Although the current Australian government is reviewing the issue of regulation at the national level, the initial conversation did not materially change BNPL’s business practices in Australia and instead generated a united code of conduct.
While US regulations may ultimately help the BNPL giants, the industry still faces its share of challenges. New entrants like Apple threaten the market share of established companies. Klarna, which has just laid off 10% of its global workforce, recently announcement a fundraising at a valuation of just $6.7 billion, down 85% from its valuation of $45.6 billion in June 2021. BNPL’s business model has generally not been profitable on the American market. A Jefferies analyst told Forbes that the bank does not expect Affirm to be profitable for at least 2-3 years.
“My prediction that the big upheaval will be the one that outlasts the economy,” says Alexis. “The biggest thing you’re trivializing is consumers, and if consumers get into debt, they may not continue into debt and just walk out of the market. Some companies really need people to buy goods.