Buy Now, Pay Later: A Regulatory Minefield

We’re seeing more brands enter this space, thanks to a rise in e-commerce

In the world of retail, the concept of Buy Now, Pay Later is not new. Customers have been able to take ownership of an item and pay it off in instalments since the 19th Century. Today, a younger, Millennial and Gen-Z audience has engaged with so-called “BNPL” shopping habits. Advances in e-commerce platforms have made it easier than ever for customers to get a short-term, interest-free loan at the point of sale.

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With the continued popularity of online shopping, young people are attracted to the idea of spreading payments and being able to try before they buy. The market has grown in the wake of the Covid outbreak, with E-commerce purchases surging to account for between 30 and 40% of all sales during the pandemic. Today, brands like Klarna, Clearpay and Affirm are well-known providers of BNPL services. Some e-commerce platforms allow these firms to engage a plugin on their online checkouts, so the customer can add a short-term loan quickly at the moment of purchase.

Here at Brit, we understand how important it is for brokers to look ahead and protect your clients. In this article, we’ll cover the growth of BNPL and what increased regulation might mean for businesses.

BNPL transactions accounted for £2.7bn worth of sales in 2021

Looking at the numbers, we can see that BNPL accounts for significant sales figures, explaining why so many new brands have entered the space.

Throughout the last year retailers have seen the proportion of sales where the customer has opted for BNPL increase by between 25% – 30% at the point of sale. As BNPL has become more popular, various territories around the globe now have new regional brands offering short-term loans. So-called “soft” credit checks make these loans scalable over a large range of customers. While this has made it easier to approve a volume of loans at the point of purchase, it hasn’t come without controversy for BNPL providers.

25% – 30% at the point of sale

Offering loans on this scale carries potential risks

To ensure that a BNPL business can function, it’s necessary to capture as many customers as possible at the point of sale. Traditional loans require a series of credit and background checks before releasing funds to a particular customer. In the case of BNPL providers, these credit checks are minimal, which raises the risk of people defaulting when they cannot pay.

Big-name BNPL providers like Klarna and Afterpay have reported that between 3-5% of their loans fall into losses. While this doesn’t represent a considerable amount in what these companies turn over, it has still attracted controversy. A number of negative press articles circulated as industry watchdogs called for increased regulation.

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As more young people engage with this form of fast finance, industry voices have lobbied for increased regulation to protect BNPL users from falling into debt. Some users have been approved for a loan they aren’t necessarily able to pay off. With an estimated one in ten BNPL customers already having existing debt arrears, the Financial Conduct Authority has intervened.

The FCA announced stricter regulations for the industry to protect consumers

In February 2021, it was announced that BNPL providers will fall under FCA regulation, with the aim of trying to ensure that people can continue to benefit from these products, with the right consumer protections. Most recently in February 2022, the FCA carried out a review into the terms and conditions being offered to customers with respect to the 2015 Consumer Rights act. A number of firms including Klarna and Clearpay, subsequently announced changes to their contracts, which have resulted in these firms no longer being able to suspend customer accounts without notice and has also led to some customers receiving refunds in relation late fees on cancelled items. While additional regulation is seen as good news from a consumer protection point of view, there are industry voices raising concerns that increased regulation could stifle the market. But this is seen as a necessity for protecting vulnerable people from falling into debt and protecting consumers from financial hardship should be the industry’s main priority.

From an operations perspective, it will be interesting to see how BNPL firms can incorporate affordability criteria, whilst also maintaining the flexibility of their product and use of soft only credit checks.

From a financial perspective, Mizuho Securities analyst Dan Dolev noted in a report released in December 2021:

"delinquent receivables nearly quadrupled compared to recent levels at Afterpay Ltd" as well as "rising charge-offs and declining recoveries at Affirm and net charge-offs increasing by approximately 1,000 basis points as a percentage of gross receivables at Sezzle Inc"

Dan Dolev Mizuho Securities analyst

Dolev's analysis shows that the users of these services are falling into debt, and their inability to repay is affecting the providers themselves. The rising instances of customers being unable to settle with providers creates more uncertainty over the industry as a whole. This uncertainty is partly what drove the FCA to step in and protect consumers in the first instance.

Dolev also included details on a proprietary survey which showed that " 53% of buy-now, pay-later, or BNPL, borrowers with a household income of less than $75,000 had missed a BNPL payment at least once. Further, 40% of BNPL users surveyed borrow through multiple BNPL apps, and the user, on average, reported a credit card balance of about $1,700, separate from BNPL debts."

This information shows that people across various territories on lower incomes are exposing themselves to the risk of debt. With lower income families at risk from BNPL debts, the industry will need to adapt to the new regulations set out by the FCA.

Calculating risk for credit

With the introduction of new regulations, the key stakeholders in BNPL providers will be anxious to know about the implications for the industry

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Along with increased scrutiny comes the potential for consumer complaints to be brought to the Financial Ombudsman. The FCA's new regulations came about following a review that concluded that, "Many consumers do not view interest-free buy-now-pay-later as a form of credit, so do not apply the same level of scrutiny, and checks undertaken by providers tend to focus on the risk for the firm rather than how affordable it is for the customer", and it is this, in addition to the large increase in the use of these products that could potentially lead to increased liability.

When we consider the full affordability checks that might be required, we can see why existing providers are sensing a need to adapt.

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Some brands within the space are opting to restructure their operations altogether to cope with the new rules. One of the biggest providers, Klarna, has retooled as a bank, offering bank accounts across global markets. This is so they can maintain relevance within an industry that’s set to change. The implications of new regulations will affect current providers of BNPL, both old and new. Make sure you have a conversation with your clients so they fully understand how these new rules will affect their operations within the market.

The Future of BNPL

The last few years have seen a marked increase in the use of BNPL, particularly from the Millennial/Gen-Z age group. The growth of BNPL hasn’t come without its difficulties. The necessity of regulation will protect consumers and allow the industry to grow in a sustainable way. As there are risks involved with these short-term loans, it is the role of the broker to have open conversations with clients.  Whether they are providers of BNPL services or financial institutions thinking about entering this emerging market, these new rules will affect operating within the market.

John Meyers, a Financial Lines Underwriter here at Brit shares his perspective;

"Given the changing regulatory landscape BNPL providers are facing, it will be interesting to see what solutions companies are able to implement, in order to satisfy local regulators, whilst also maintaining the attractiveness of the product to consumers and retailers alike.”

John Meyers Brit Insurance Financial Lines Underwriter

We are here to make sure that you can protect your clients from whatever lies ahead. Our financial institutions insurance can help protect your clients and prepare for the future of BNPL.