After a meteoric rise during the pandemic, the buy now, pay later (BNPL) business is facing a future clouded by deteriorating economic conditions, competition from the likes of Apple and bank credit card issuers and a looming regulatory crackdown.
At least, that’s the conventional wisdom. Since the federal Consumer Financial Protection Bureau (CFPB) opened an inquiry into the industry last year, regulation has generally been framed as a “backlash” and threat to the industry’s growth. A research note issued Sunday by Goldman Sachs analyst Michael Ng, which initiates coverage of Affirm Holdings with a neutral rating, observes that “the evolving US BNPL regulatory landscape results in the risk of potential regulation that could reduce the pace of consumer and merchant adoption.”
Yet a deeper look suggests regulation could actually benefit the leaders in the American BNPL sector.
While BNPL has been around in the US for over a decade, it exploded during the pandemic. Buoyed by a rise in online spending, payment volume for companies offering to split purchases into interest-free installments grew 230% from January 2020 through July 2021, and made up 2.4% of all online retail purchases (and 12% of online fashion spending) 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.
So the CFPB’s announcement last December that it was opening an inquiry into BNPL understandably created a stir. After all, most major forms of consumer lending in the U.S. are regulated by one or more federal and/or state laws. Traditional bank loans are regulated by the federal Truth In Lending Act (TILA), dating back to 1968. The CARD Act, passed by Congress in 2009, places additional limits on credit card providers’ advertising and lending practices. And high-interest rate “payday loans” are regulated by many states, with some banning them outright.
There’s no existing federal-level regulatory framework specifically designed for BNPL, which industry insiders say has created a perception that the industry isn’t regulated at all. But BNPL is already covered by state and federal lending laws, and has been throughout its existence. That’s why the current regulatory scrutiny is likely to have only a minimal effect on major BNPL firms’ operations or lending practices, industry sources suggest. In fact, it could actually help BNPL to grow further—and grow up—by curbing practices of some marginal players and creating a sense among consumers that it’s a safe, regulated business.
Most BNPL plans aren’t regulated by TILA because they bill users in four installments, falling just below the five-installment threshold where TILA kicks in. However, a patchwork of state laws require BNPL firms to secure lending licenses in the majority of U.S. states, which impose strict requirements in terms of disclosure and limiting fees and interest payments. And BNPL providers are banned from employing Unfair, Deceptive or Abusive Acts or Practices (UDAAP) under the 2010 Dodd-Frank Act, which gives federal regulators plenty of leeway to crack down on misleading or predatory BNPL lending.
“I’ll be surprised if [the CFPB] comes out with a very specific BNPL regulation,” says Kim Holzel, a veteran of the CFPB who is now a partner with law firm Goodwin Procter, advising banks and fintechs. “They have rules to regulate this now if they want to. They’ve stretched [UDAAP] pretty far, so I don’t even think they need to reach rulemaking in order to regulate this space at all.”
BNPL lenders have faced legal action in the past. Klarna settled a California class-action case in which it was accused of not disclosing the risks of its customers incurring overdraft or NSF (non-sufficient fund) fees from their bank if they were automatically billed for a BNPL purchase while maintaining a low bank balance.
A positive consequence of heightened regulatory scrutiny could be a reputational boost for the industry’s largest players at the expense of their smaller competitors. Industry leaders like Klarna and Afterpay make well over 90% of their revenues by partnering with online merchants. These firms don’t charge customers late fees for their basic “pay in four’ plans, although they do charge fees for some of their longer-term financing plans.
However, upstart competitors who are unable to secure lucrative merchant partnership deals are left with collecting fees as their primary source of income. For example, Chillpay, founded in 2019, charges a standard late fee of $4 per missed payment, and another $4 if the late payment isn’t completed within a week. Australian BNPL firm Openpay, which recently announced it was closing its operations in the US, charges variable “plan creation” and “plan management” fees with every BNPL purchase. Establishment banks are beginning to market BNPL products, but those come with strings as well–Chase’s BNPL offering doesn’t charge late fees or interest, but requires a fixed monthly fee to use.
“Some of the companies that look like they have smart rules take shortcuts to get ahead of their competitors. That may be their undoing,” says Tony Alexis, former Head of Regulation at the 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 organized an off-the-record roundtable for BNPL industry leaders earlier this year, said representatives of major American BNPL firms spoke optimistically about regulation in the sector at the event. One firm said that higher regulatory standards could help to shut out smaller firms with more predatory lending practices and might boost the industry’s reputation as a whole.
Ironically, new rules could help the big BNPL companies against not only the small competitors, but the big banks as well. “There are a lot of other competitors coming into the [BNPL] space. We see traditional credit card companies coming into the market and calling their product BNPL when there are finance charges or other types of fees that are baked in there. It’s not truly a BNPL product when there’s those types of charges involved,” says Harris Qureshi, Director of Public Policy and Regulatory Affairs at Afterpay. “That’s one of the things that we’ll likely see: a clarification of what are [BNPL] products and what are not.”
A key consequence of the regulatory attention given to BNPL will be an overhaul of how BNPL purchases factor into the credit reporting process–a potential plus for both the industry and its customers. No major BNPL providers currently report users’ data to credit bureaus, because the infrastructure for analyzing BNPL spending is lacking. Were BNPL firms to provide consumer data, the three major credit reporting agencies would treat BNPL purchases like any other form of credit, which could perversely ding users’ credit scores–even when they pay on time–as calculated by FICO.
Within the current reporting infrastructure, a $200 BNPL purchase that’s paid off over 2 months in full and on time would have the same effect as opening a credit card with a $200 credit limit, maxing it out immediately, paying it off in 2 months and then canceling it–behaviors that would harm someone’s credit score, as calculated by market leader FICO. That’s because a credit score is raised by having a low credit utilization rate (meaning not maxing out a credit card limit) and by having long standing accounts. By contrast, opening too many new accounts can hurt your score.
A standardized system for factoring BNPL into 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 score. American BNPL providers including Klarna 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 sense of what the outcome is going to be on consumers’ credit scores,” says Qureshi. “We want to make sure that what we’re doing … accurately reflects the on-time repayment history that we see from our customers.”
Looking at historical precedent in Australia illuminates the impact of the regulatory process on BNPL. In Australia, an early adopter of BNPL where one-third of citizens say BNPL is their preferred payment method, newspapers and policymakers initiated conversations about regulating BNPL early last year. Although Australian BNPL loans are not subject to a 2009 national consumer credit protection act—just as American BNPL does not generally fall under the purview of TILA— they do fall under a 2001 securities and investments act that gives regulators authority to intervene in cases of “significant consumer detriment,” similar to the nebulous UDAAP guidelines that give American regulators license to go after BNPL.
The industry response to the regulatory question in Australia was swift and united: this March, a coalition of most major Australian BNPL providers wrote and signed on to an industry code of practice, effectively self-regulating their business to a greater extent than current law. Although the current Australian government is revisiting the question of national-level regulation, the initial conversation did not substantively change BNPL business practices in Australia and instead generated a united code of conduct.
While American regulation could ultimately help the BNPL giants, the industry still faces its share of challenges. New entrants such as Apple threaten the market share of established firms. Klarna, which just laid off 10% of its global workforce, recently announced a fundraising round at just a $6.7 billion valuation, down 85% from its $45.6 billion valuation in June 2021. The BNPL business model has not yet been a profitable one in the American market. An analyst for Jefferies told Forbes that the bank didn’t project Affirm would be profitable for at least 2-3 years.
“My prediction that the big shakeout is going to be who survives the economy,” says Alexis. “The biggest thing you’re commoditizing is consumers, and if consumers are falling into debt, then they may not continue to go into debt and just withdraw from the market. Some companies really need people to buy goods.”