Buy Now, Pay Later Regulations: Impending Changes

November 17, 2022
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by Mike Levine

Buy Now, Pay Later (BNPL) is facing renewed regulatory pressure. As the short-term financing option explodes in popularity (experts state an estimated growth of $450 Billion in transaction value between 2021 and 2026), consumer protection watchdogs and government agencies are looking to assert the ground rules of BNPL lending. 

The latest step toward increased BNPL regulation comes after the Consumer Financial Protection Bureau (CFPB) issued its year-long BNPL inquiry report. The investigative paper included clear recommendations for industry oversight. CFPB Director Rohit Chopra also followed up with public comments about the agency’s intent to regulate Buy Now, Pay Later providers in a similar manner to traditional credit institutions.  

Areas of risk leading to BNPL regulation changes

Suggested industry changes and BNPL regulation include supervisory examinations, consumer credit check requirements, transparency disclosures, and dispute resolution rules. The CFPB plans to introduce such consumer protections to address several areas of risk revealed in its report. 

Over-leveraged consumers on essential purchases 

While apparel and beauty products maintained an 80% share of BNPL transactions in 2020, that number has dropped to 58.6% in 2021 as users finance essentials such as groceries, insurance, and utilities. Purchases of “necessities” through BNPL services grew by a massive 434% in 2021. Such products are hard to return and introduce extended delinquency risk during economic downturns. 

As a result, the CFPB recommends guidance related to lending disclosures (BNPL services do not currently provide complete disclosures  nor payment data). BNPL regulation regarding data sharing on debt type and credit assessment submission can help traditional lenders defer risk related to high-risk consumer debt.  

BNPL users skew younger 

Young borrowers are more likely to have a loan in default status. The BNPL user experience is primarily focused on Gen Z (18-25 years old) and Younger Millennials (25-33 years old), resulting in possible debt risk. 

To address age concerns, age screening and user data reporting regulations may help. Many BNPL services already use third-party services to match input age to submitted personal identification, but such protections are not required (nor employed by all firms). The Federal Trade Commission (FTC) also posted a reminder in September that BNPL services should follow FTC Act consumer protections regarding transparency in user acquisition and loan advertising directed towards vulnerable persons.     

Loan stacking 

Buy Now, Pay Later users can finance purchases across multiple services, leading to overextension. Loan stacking also results in sustained usage risk, where habitual borrowers make minimal repayments but subsequently carry high levels of debt. 

CFPB suggests real-time data reporting on BNPL consumer usage as an effective control. Requirements for transparency can also support consumer safety, as consistent displays of a user’s purchasing power, credit limit, and repayment schedules can help increase timely payments and defer late fees. Forced autopay (a service common to BNPL) may come under scrutiny, as it restricts user payment autonomy.

BNPL chargebacks and payment penalties

A customer may wish to dispute a transaction, but the dispute period can take far longer than the repayment term. Customers become liable for all payments and interest, even during instances of fraud that will result in an eventual fund reversal. Without BNPL regulation, some firms shift dispute responsibilities. There are reports of providers refusing to engage with or recognize their role in a consumer transaction dispute between merchants and issuers, even after the firm facilitated the purchase and has full awareness of the ongoing representment process. At the same time, late payments continue to add up, leaving consumers with the brunt of the financial damage.  

BNPL also creates conditions for increased chargeback activity. Just under 14 percent of individual loans in 2021 involved a purchase that was returned or disputed, up from 12.2 percent in 2020. The immediacy of the product (and debt) separates consumers from the payment process, leading to overborrowing and possibly giving rise to friendly fraud. Increases in late fees and burgeoning interest payments can result in malicious attempts to recoup losses via BNPL chargeback. 

Lastly, the current implementation of BNPL in the U.S. showcases systemic problems, with only 32% of American consumers stating they experienced no issue with their Buy Now, Pay Later purchase. As result, 19% of respondents stated that they filed a chargeback, far more than the 6% in the U.K. Enhanced regulatory guidance can likely help address problems associated with BNPL in the U.S. A likely step from the CFPB is the incorporation of BNPL firms into Regulation Z and the payment dispute procedures for established credit products.   

Data harvesting concerns

Buy Now, Pay Later firms collect data to assess and assist users. The CFPB does worry about Big Tech companies involved in BNPL earning unfair market advantages that harm price competition and tread on consumer data protections. Additionally, the benefits of collected data can result in increased merchant sign-on fees, advertising earnings, and affiliate revenues for BNPL firms—potential revenue sources that put more focus on acquisition at the expense of consumer protections. 

In response, the CFPB plans to offer guidance on data surveillance practices to BNPL firms. Baseline consumer data protections established by Congress for institutional lending services and data collection are expected. Emphasis will also be placed on the BNPL user experience and limiting obfuscation (mazes of screens, hard-to-see icons, or buried information on contracts). 

The growth of loan approvals and charge-off rates 

Buy Now, Pay Later firms continue to approve more loans for users, up from 69% in 2020 to 73% in 2021. The charge-off rate for uncollectible loans also increased from 1.83% in 2020 to 2.39% in 2021. The risk of delinquencies continues to grow, especially as late fees jump (10.5% of users earned a late fee in 2021, up from 7.8% in 2020). 

The CFPB will look into required supervisory exams to help resolve risks related to charge-off rates and loan volume. It will also look into BNPL regulation for credit reporting and how BNPL providers conduct credit checks (firms typically do not report to the credit bureaus). There is also an agency focus on labeling BNPL services as card issuers so that they fall under the jurisdiction of the Truth in Lending Act. 

Expect regulatory changes in the coming months 

At present, Buy Now, Pay Later firms operate in a regulatory gray area. Due to short-term payments (often four equal installments over a period of months) and no initial interest charges or fees, BNPL doesn't function within the traditional lending space, leading to exemptions and minimal consumer protections. 

But the Buy Now, Pay Later market is expected to reach $3.98 Trillion in value by 2030, growth that will catch the attention of consumer watchdogs. If the recent comments offered by the FTC and CFPB give any insight, new BNPL regulations are coming. Official protections take time to catch up to the pace of technology, but lending risk will likely result in increased scrutiny and eventual regulatory guidance


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