After a meteoric rise during the pandemic, the buy now, pay later (BNPL) business faces a future clouded by deteriorating economic conditions, competition from companies like Apple and bank card issuers, and a looming crackdown from regulators.
At least that is the popular belief. Since the Federal Consumer Financial Protection Bureau (CFPB) launched an investigation into the industry last year, regulation has been widely portrayed as a “backlash” and a threat to industry growth. A research note issued Sunday by Goldman Sachs analyst Michael Ng, which prefaces coverage of Affirm Holdings with a neutral rating, notes that “the evolving U.S. BNPL regulatory landscape poses the risk of potential regulation that could… could slow the pace of consumer and retailer adoption. ”
However, a closer look suggests that regulation could actually benefit the leaders in America’s BNPL sector.
While BNPL has existed in the US for over a decade, it exploded during the pandemic. Fueled by a surge in online spending, payment volume for businesses offering to split purchases into interest-free installments increased by 230% from January 2020 to July 2021, accounting for 2.4% of all online retail purchases (and 12% of online fashion spend ) out. in 2021, according to an Accenture report commissioned by BNPL firm Afterpay. BNPL’s global e-commerce market share is expected to double by 2024.
The CFPB’s announcement last December that it was launching an investigation into BNPL understandably caused a stir. Finally, most major forms of consumer lending in the United States are governed by one or more federal and/or state laws. Traditional bank lending is regulated by the state’s Truth In Lending Act (TILA) of 1968. The CARD Act, passed by Congress in 2009, places additional restrictions on credit card issuers’ advertising and lending practices. And high-interest “payday loans” are regulated by many states, some even banning them outright.
There is no existing federal regulatory framework designed specifically for BNPL, which according to industry insiders has left the impression that the industry is not regulated at all. But BNPL is already covered by state and federal credit laws and has been throughout its existence. Because of this, the current regulatory scrutiny is likely to have minimal impact on the operations or lending practices of large BNPL firms, industry sources said. In fact, it could help BNPL continue to grow — and mature — by curbing the practices of some marginal players and making consumers feel like it’s a safe, regulated company.
Most BNPL plans are not regulated by TILA as they bill users in four installments, which is just under the five installment threshold at which TILA kicks in. However, a patchwork of state laws requires BNPL firms to secure lending licenses in most US states, which have strict disclosure requirements and caps on fees and interest payments. And BNPL providers are prohibited from engaging in any unfair, fraudulent or abusive act or practice (UDAAP) under the 2010 Dodd-Frank Act, which gives federal regulators wide latitude to crack down on misleading or predatory BNPL lending.
“I’ll be surprised if [the CFPB] comes out with very specific BNPL regulation,” says Kim Holzel, a CFPB veteran who is now a partner at law firm Goodwin Procter, advising banks and fintechs. “They have rules to settle this now if they want. You have stretched [UDAAP] pretty far, so I don’t even think they need to reach rulemaking to even regulate this space.”
BNPL lenders have faced legal action in the past. Klarna has settled a California class action lawsuit alleging that it failed to disclose the risk that its customers could incur overdraft or NSF (insufficient funds) fees from their bank if they were automatically billed for a BNPL purchase , while maintaining a low bank balance .
A positive outcome of increased regulatory scrutiny could be a reputation boost for the industry’s biggest players at the expense of their smaller peers. Industry leaders like Klarna and Afterpay generate well over 90% of their sales through partnerships with online merchants. These companies do not charge customers late fees for their basic Pay in Four plans, although they do charge for some of their longer-term financing plans.
However, aspiring competitors unable to secure lucrative trading partnerships are left with collecting fees as their main source of income. For example, Chillpay, which was founded in 2019, charges a standard late fee of $4 per missed payment and an additional $4 if the late payment is not made within a week. Australian BNPL firm Openpay, which recently announced it was ceasing US operations, charges variable “plan creation” and “plan management” fees with every BNPL purchase. Established banks are beginning to market BNPL products, but even these come with strings attached — Chase’s BNPL offering doesn’t charge late fees or interest, but it does require a fixed monthly fee to use it.
“Some of the companies that look like they have smart rules are taking shortcuts to stay ahead of their competitors. That could be their downfall,” says Tony Alexis, former Head of Regulation at CFPB and also a partner at Goodwin Procter.
Nikita Aggarwal, an attorney and fellow at the Harvard Kennedy School’s Carr Center for Human Rights Policy, who organized a confidential roundtable for BNPL industry leaders earlier this year, said representatives from major American BNPL firms expressed optimism about regulation in the sector the event. One company said higher regulatory standards could help shut out smaller companies with more predatory lending practices and boost the industry’s reputation overall.
Ironically, new rules could help the big BNPL firms not only against the small competitors but also against the big banks. “There are many other competitors [BNPL] Place. We see traditional credit card companies come into the market and call their product BNPL when there are financing fees or other types of fees coming in. It’s not really a BNPL product when it comes to these types of fees,” said Harris Qureshi, director of public policy and regulatory affairs at Afterpay. “That’s one of the things we’re likely to see: a clarification of what is [BNPL] products and which are not.”
A key consequence of the regulatory attention BNPL will receive will be an overhaul of the way BNPL purchases feed into the credit reporting process – a potential benefit for both the industry and its customers. Currently, no major BNPL providers report users’ data to credit bureaus due to the lack of infrastructure to analyze BNPL spend. If BNPL firms were to provide consumer data, the big three credit bureaus would treat BNPL purchases like any other form of credit, which could affect users’ FICO-calculated credit scores — even if they pay on time.
Within the current reporting infrastructure, a $200 BNPL purchase, paid out in full and on time over 2 months, would have the same effect as opening a credit card with a $200 credit limit, exhausted immediately and paid out in 2 months and then reversal – behaviors that would damage a person’s creditworthiness, as calculated by market leader FICO. That’s because a credit score is enhanced by a low credit utilization rate (ie, failing to hit a credit card limit) and by long-standing accounts. In contrast, opening too many new accounts can hurt your score.
A standardized system for considering BNPL in credit files and FICO scores would benefit the industry by allowing customers to build credit through BNPL purchases and understand how BNPL spending affects their credit scores. American BNPL providers, including Klarna and Afterpay, have been working with the three major credit bureaus for over a year to develop a unified BNPL credit reporting system.
“We want to wait [to report users’ BNPL data] until there is a clear sense of how the outcome will affect consumer creditworthiness,” says Qureshi. “We want to make sure that what we do … accurately reflects the on-time payback history that we see from our customers.”
A look at historical precedents in Australia illustrates the impact of the regulatory process on BNPL. In Australia, an early adopter of BNPL where a third of citizens cite BNPL as their preferred payment method, newspapers and policymakers started discussions about BNPL regulation early last year. Although Australian BNPL loans are not covered by a national Consumer Credit Protection Act 2009 – just as American BNPLs are generally not within the purview of TILA – they are covered by a Securities and Investments Act 2001 which gives regulators the power in cases of “significant Consumer Disadvantage,” similar to the nebulous UDAAP guidelines that give American regulators license to prosecute BNPL.
Industry response to the regulatory issue in Australia has been swift and consistent: in March this year, a coalition of most of Australia’s major BNPL providers wrote and signed an industry code of practice, effectively self-regulating their business to a greater extent than current law . Although the current Australian government is reviving the issue of regulation at the national level, the initial discussion did not materially change BNPL’s business practices in Australia, instead producing a consistent code of conduct.
While American regulation could ultimately help the BNPL giants, the industry still faces some challenges. Newcomers like Apple threaten the market share of established companies. Klarna recently laid off 10% of its global workforce announced a fundraising round with a valuation of just $6.7 billion, down 85% from its June 2021 valuation of $45.6 billion. BNPL’s business model was not yet profitable in the American market. A Jefferies analyst told Forbes that the bank does not forecast that Affirm would be profitable for at least 2-3 years.
“My prediction that the great shakeout will be the one that survives the economy,” says Alexis. “The most important thing you commodify is consumers, and if consumers go into debt, they might not go into debt any more and just pull out of the market. Some companies really need people to buy goods.”