The buy-now-pay-later (BNPL) finance model is far from a new idea. While merchants had long offered trusted customers easy terms before the early 20th century, such facilities were provided on an industrial scale as the age of consumerism dawned. Large manufacturers and retailers started offering contractual credit that allowed customers to have their goods immediately and pay for them by instalment. In 1919, for instance, General Motors set up the GM Acceptance Corporation to arrange affordable loans that would help millions of US citizens to become car owners.
Customers still like credit and merchants still like to offer it, but the BNPL model has changed considerably over the past decade. Not all forms of it are regulated in the UK – a situation the watchdogs have been wanting to remedy for some time.
A year ago, the Financial Conduct Authority (FCA) published the findings of a review of the unsecured consumer credit market that Christopher Woolard had chaired in 2020 while serving as the authority’s interim CEO. This argued that there was “an urgent need to regulate all BNPL products… BNPL represents a significant potential consumer harm.”
The regulator is particularly concerned about short-term loan facilities that require no down payment and, generally, charge no interest. Brief invoice deferrals of this type have traditionally applied in situations such as tallying up with the milkman at the end of the week – circumstances where the sums involved are small and statutory intervention would be overkill.
Why has the FCA become so exercised about something that’s been a handy tool for many decades?
A key reason for its increasing concern is that BNPL finance has become such a ubiquitous option in recent years as a seamless part of almost every online purchase. That’s the view of Andres Korin, co-founder and CFO of Debite, which offers BNPL finance to young businesses.
The increasingly “embedded nature of lending and the ease of access to data allows any financial transaction to be turned into an instalment arrangement”, he says.
In other words, advances in ecommerce tech have rendered consumer borrowing a little too easy for the FCA’s liking. With just a couple of taps of a smartphone, you can pop a product that would otherwise have been unaffordable into your online basket. The danger is that the wide availability of convenient credit makes it easier for unwary consumers to run up debts they can’t repay.
BNPL in practice
A third of UK adults have used BNPL, according to research by Equifax, with 4.1 million people trying it for the first time last year. Consumers aren’t necessarily resorting to BNPL to get hold of luxury items, either: 12% of consumers have used it to pay for groceries and other essentials.
The FCA says that it’s been “consistently calling for a change to the law to bring BNPL products under our regulation. As soon as Parliament decides the scope of that change, we will consult on the rules that providers will need to follow. Although we don’t yet have regulatory oversight of these firms, we’ve already secured changes to unfair contract terms and warned them about misleading adverts.”
The Woolard review notes that the sector’s advertising “often focuses on aspiration, tapping into consumer desires to live a certain lifestyle”. It also points to evidence indicating that the customer journey towards a BNPL purchase can be designed to “exploit consumer biases” and encourage people to not think too hard about the fact that they’re getting into debt.
But it also acknowledges that BNPL offers several potential benefits. It’s much cheaper than most regulated credit options if repaid on time, for instance. And it can be a lifeline to people who’d otherwise resort to using a payday lender – or worse.
A legislative balancing act
Azad Ali leads the UK and EU financial services regulation practice at the London office of international law firm Skadden, Arps, Slate, Meagher & Flom. He believes that the government has so far been “very thoughtful and measured in its approach” to regulating the sector.
“It wants to maintain short-term interest-free credit options in the shape of products such as cycle-to-work schemes, store charge cards and season-ticket loans, but also to prevent BNPL borrowing that can pass under the radar and leave consumers overextended,” he says.
Ali expects the government to introduce statutory consumer protection measures covering pre-contractual information, creditworthiness checks and the form and content of credit agreements. But he stresses that it is “concerned not to stymie ongoing trends in digitalisation. That concern extends to acknowledging the merits of innovation in the consumer experience.”
Ali adds: “The government is also mindful that distinctions between traditional instalment payment plans and BNPL can be blurred – and that the more familiar instalment options can be a source of harm to consumer. It has therefore expanded the purview of the consultation.”
The key challenge to the legislators is how to keep BNPL credit as accessible as possible while also protecting people from accumulating excessive debts. How, for instance, can a potential customer’s overall credit exposure be tracked without making BNPL finance too onerous for them to use – and too costly for providers to offer?
Could open banking accelerate credit checks?
Steve Perring is head of compliance and risk at Deko, which provides multi-lender checkout finance options for merchants. He suggests that the use of open-banking data could help with creditworthiness and affordability assessments.
“Considering that BNPL products are driven by innovative technology, it seems that the two would go hand in hand,” he says. “In fact, open banking could help to enhance affordability assessments across the consumer lending market, giving lenders access to information verifying a potential customer’s income and expenditure.”
But open banking has been something of a damp squib to date. The total number of retail payments in the UK stands at about 2.9 billion a month on average. In October last year, a mere 7.1 million open-banking payments were made, according to the Payment Systems Regulator. The government’s joint regulatory oversight committee on the future of open banking will shortly be publishing a report discussing how to boost that number.
But, if consumer uptake increases significantly, there are several barriers to using open banking for affordability assessments. The first of these are cost and licensing considerations. Firms might need to be licensed as an account information service provider, or at least partner with one, to access bank account data. To be able to manage loan repayments, they would need to be licensed as a payment initiation service provider.
“Both of these options would require additional systems and controls, of course, and compliance oversight,” says Perring, who adds that the technology is no guarantee of access to usable data.
“Automated lending decisions based on open-banking data will need to be closely monitored and validated regularly. We have already seen some examples where banks have failed to publish accurate information,” he reports.
There is, then, plenty of work for the legislators and regulators to do. Azad reckons that “it could be 2024 before all the consultations are completed and the new rules come into force”.
If these can achieve the appropriate level of control over the BNPL sector and get the balance of accessibility and consumer protection right first time, they may just be worth the wait.