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Buy Now Pay Later: Will Regulation Burst the Bubble?

 
 

Payments | Annmarie Mahabir |
01 February 2022

The exponential growth in e-commerce and the impact of the pandemic have fuelled the rise of ‘Buy Now Pay Later’ (BNPL), making it one of the biggest retail trends in 2021. This is set to continue in 2022, with new players entering the market and new partnerships and acquisitions being established.

BNPL has largely been driven by consumer appeal, easy availability and the promise of no interest and no fees – if payments are made on time. It is popular across all demographics for different reasons but has especially gained traction among millennials and Gen Z consumers as a means of financial empowerment. For consumers, it provides an easily accessible method of borrowing, instant gratification, a flexible returns policy and the ability to manage finances by spreading the cost of purchases over an agreed period.

For retailers, it reduces basket abandonment, increases sales and adds stickiness, without any risk. BNPL providers pay merchants up front and issue loans to consumers while bearing all the credit risks and administration costs of running the loan programme. They typically charge the retailer a fee of around 2-7% of the transaction plus a fixed fee, depending on their business model.

If managed correctly, BNPL offerings can be a convenient and cheap way of accessing credit, but late or missed payments can lead to late fees, blocked accounts, bad debt and even impact credit ratings. BNPL company Laybuy revealed that in a six-month period in 2021, almost half their revenue came from late fees. This is revenue gained from people’s inability to pay, and there is growing concern that BNPL practices are leading to financial hardship and debt accumulation in an industry where oversight is needed to protect consumers.

THE GROWTH OF BUY NOW PAY LATER

Research and Markets’ Global Buy Now Pay Later Market Report 2021 forecasts that BNPL spend will grow by 22.4% from 2021 to 2028, reaching over $20 billion by 2028. In the UK, an FCA survey found that the total value of BNPL transactions in 2020 was £2.7 billion and is expected to grow rapidly by 2024. According to UK consumer protection charity Citizens Advice, 45% of people aged 18 to 34 and 31% of those aged 35 to 54 have used BNPL to make purchases in the last year. And the BBC estimates that approximately 15 million adults in the UK are actively using BNPL, an increase of more than 2 million in 2021.

Looking at BNPL provider data, Afterpay found that retailers using their service had a 50 to 200% increase in basket size. Klarna and Affirm reported a 58% and 87% increase in average orders, respectively. Equifax estimates that BNPL users spend 51% more on clothes each month than online shoppers who pay up front. PayPal launched its BNPL service in October 2020 and in one year has processed over £2.5 billion in payments globally.

The data paints a powerful picture. Unprecedented times caused by the COVID-19 pandemic led to the explosive growth of BNPL at a time when many people were experiencing financial uncertainty and needed an easily accessible form of credit.

THE PROBLEMS FOR CONSUMERS

BNPL clearly fills a gap in the market, and consumers welcome the convenience, flexibility and allure of interest-free credit. However, the rapid growth, with no regulatory framework, has led to a lack of uniformity in the market. The differences in product offerings, terms of use and the many providers and business models can be confusing for consumers. As with other forms of credit, there are risks for consumers, and the BNPL industry must manage these appropriately.

Because the market is currently unregulated, BNPL providers are not obligated to perform full affordability checks on consumers, and users can accumulate debt across multiple lenders. In many cases, users see this as a technology innovation and don’t realise they are taking out a credit agreement and could be referred to debt collectors if payments are missed. Citizens Advice reported that consumers were charged £39 million in late fees over a one-year period. Of those who were referred to a debt collector for missed payments, 96% said there had been negative consequences.

These statistics justify the concern that many consumers are spending more than they can afford on non-essential purchases while unable to pay essential bills, causing spiralling consumer debt. The voices calling for tighter controls and market regulation are getting louder.

THE REGULATORY GAVEL

As concerns about consumer debt increases, the UK Financial Conduct Authority (FCA) commissioned a review, led by Christopher Woolard, which found that “BNPL represents significant potential consumer harm”, such as its promotion to consumers, poor consumer understanding of the product, lack of affordability assessments and inconsistent treatment of customers in financial difficulty. The Woolard Review recommended that the industry be regulated to ensure better protection for users, and the FCA is currently undergoing a consultation process to define the regulation framework.

FCA regulation will protect consumers and position BNPL as a sustainable product with more transparency and greater checks for credit risk and affordability, bringing it on par with other credit products, such as credit cards. It will ensure that people are treated fairly and provided with clear information to ensure they can make informed choices about whether they want to use the product. As a credit product, BNPL should be appropriately regulated to protect all users.

Many countries, including the UK, the European Union, the USA, Australia and New Zealand, have raised concerns about consumer debt and are actively looking into passing new regulations for BNPL. I predict that as more data becomes available and the debt crisis rears its ugly head, more countries will follow suit.

THE CHANGING FACE OF BNPL

As the market becomes increasingly saturated with major banks, payment schemes and new entrants competing for market share, BNPL growth is extending across markets to banking, luxury retail, travel, hospitality, insurance, trading, healthcare, and the list is growing. Many global retailers are building their own in-house solutions with the aim of protecting their customer base and better controlling the services they provide. Others are forming partnerships or making acquisitions to build out their own services, such as Amazon’s partnership with Affirm and Square’s acquisition of AfterPay. As competition heats up and the market expands, it becomes even more critical that the industry is regulated and brought in line with other credit products.

Will regulation burst this expanding bubble? Time will tell, but it seems safe to say that it won’t! During the pandemic, BNPL enabled significant strides towards financial inclusion, and its impact should not be underestimated. Yes, regulation will curb over-spending as stronger credit risk and affordability checks are implemented, but consumers will continue to use BNPL because of the convenience it provides.

TECHNOLOGICAL IMPACT OF BNPL REGULATION

Regulation will play a great part in shaping BNPL innovation and the emergence of new technologies and products, which will bring new opportunities and challenges. For businesses to compete and gain sustainable competitive advantage, they must have the right technology to power these products.

For example, to provide a seamless and secure customer experience while also increasing affordability checks to protect consumers and enable them to make informed purchasing decisions, payment fraud systems must have the ability to analyse data in real time and generate accurate credit risk predictions without sacrificing the merchant checkout experience. This will require powerful predictive risk analytics capabilities and machine learning algorithms to develop and test new credit and risk models. Open Banking can play an important part in sharing wage and income data to enable businesses to make more accurate lending decisions and develop bespoke credit offerings.

Consumer demands will accelerate the growth of instalment products as banks and fintechs develop new bespoke and customisable solutions. We are already seeing this with Barclaycard, Monzo and Revolut and even Visa, Mastercard and Amex instalment programs. Big BNPL providers, such as Klarna, AfterPay and Affirm, could use their significant amounts of consumer spend data to develop personalised financial services products and super apps to help consumers better manage their lives.

FINALLY …

If regulation can strike a balance between consumer protection and innovation, where the risk of financial hardship is balanced against BNPL benefits, it would certainly have a positive impact on the consumer credit market and beyond. However, regulation will not happen overnight, as the industry will need time to implement compliance requirements and technology changes. What is clear though, is that BNPL innovation is continuing apace across industries, even to trading and cryptocurrency platforms, and there must be the right technology to power these innovations and the appropriate regulatory oversight to protect consumers.

Annmarie Mahabir

VP & Principal Industry Consultant, Payments

Annmarie is a Payments leader with 25+ years of experience in Payments, Banking, and Fintech. Passionate about payments innovation, she specialises in payments processing, solution delivery, and consultancy. With an MBA in business and expertise in technology, she is a trusted advisor to clients, who appreciate her ‘big picture’ view. Before joining Endava, Annmarie held senior technical and leadership roles at Visa and other global payment organisations, delivering innovative solutions for clients across Europe, the US, Asia Pacific, and the Middle East. Having lived in the UK, the US, the Caribbean, and travelled widely across Europe, she is truly a global citizen. When not working, Annmarie enjoys nature, walking, travelling, and spending time with family, while also making time for her mentoring work with university students in London.

 

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