The “buy now pay later” (BNPL) market continued its trend of increasing valuations and consumer uptake through the end of 2021. BNPL’s popularity is largely due to its simple repayment terms and low cost relative to traditional revolving credit card debt and small-dollar, short-term credit alternatives. BNPL transactions usually offer 0% interest and are repayable in a fixed number of monthly installments. Some providers charge consumers late fees for missed payments, and they also charge merchants a processing fee (typically as a percentage of the consumer’s total transaction amount). Because BNPL providers usually do not use a “hard” credit pull to qualify applicants, BNPL is more accessible to younger consumers and those with thin or damaged credit.
To date, the bulk of BNPL transactions have been relatively small-dollar purchases, such as fashion and lower cost electronics. The average BNPL transaction amount is less than $200. However, a recent Accenture report commissioned by BNPL provider Afterpay suggests that the next stage of BNPL’s growth may be fueled by bigger-ticket consumer purchases, like travel and healthcare expenses.1
BNPL providers are also looking to leverage growing consumer familiarity with BNPL to expand into the small-to-medium business market. For example, Mastercard Pay & Split, a card-based BNPL product for businesses, launched in the Asia Pacific region in November. The program is similar to BNPL options available on some consumer credit cards in that it allows customers to convert purchases from any Mastercard participating merchant to an installment plan.
Despite the fact that BNPL transactions are consumer credit (as the CFPB recently emphasized), providers have so far enjoyed a lighter regulatory burden than consumer installment lenders.2 BNPL products that have four or less installments and a zero-percent interest repayment structure are exempt from some key federal and state consumer protection laws. For example, the Truth-in-Lending Act (TILA), which is the primary federal statute mandating cost-of-credit disclosures on consumer loans, does not apply to companies whose loan products are either repayable in four or fewer installments or on which no interest is charged.3 BNPL providers are often exempt from state licensure and regulatory requirements based on these features.4
As we noted in last quarter’s newsletter, BNPL’s combination of explosive growth and thus far light regulation has attracted the attention of regulators globally. On December 16, 2021 the CFPB officially joined the fray by sending orders to Affirm, Afterpay, Klarna, PayPal and Zip requiring them to provide information about their BNPL products by March 1, 2022. The CFPB issued the orders pursuant to its mandate to monitor consumer risk in the financial services market.5 On January 12, the CFPB issued a request for public feedback on both customer and merchant experiences with BNPL.
The CFPB’s stated concerns about BNPL include accumulating consumer debt (i.e., ability to repay), lack of a robust regulatory framework, lack of consumer protections, and harvesting and monetization of consumer data. Regarding debt levels, the CFPB and consumer advocates have focused on the fact that a consumer may take out BNPL transactions from multiple providers simultaneously, which makes it harder to track payment schedules and keep the aggregate amount of BNPL debt manageable. Because credit bureaus are only beginning to report BNPL debt and not all BNPL providers report to the credit bureaus, providers currently have little insight into whether an applicant has multiple outstanding transactions.
The CFPB’s December 16 orders align with these concerns and focus on the following features of the BNPL product and market:
- Underwriting practices;
- Interest and fees;
- Reporting to credit bureaus;
- Collections and re-presentment of failed payments;
- Consumer disclosures;
- Transaction volume;
- Customer returns and refunds;
- Number of failed payments (i.e., insufficient funds);
- Average transaction amount (and number of transactions per customer) and how the provider determines customer maximums;
- Repayment options (including whether customers are automatically enrolled in auto-pay and how they may terminate auto-pay);
- State licensure;
- Customer complaints and inquiries;
- Customer demographics; and
- Data collection and monetization.
It is too soon to tell what the CFPB’s approach to BNPL will be, but its treatment of two other non-traditional consumer financial products, earned wage access6 and income share agreements,7 provides some context. In 2021, the CFPB issued an advisory opinion to the effect that non-recourse earned wage access products, when structured to conform to CFPB guidance, are not “credit” because the recipient already owns the funds advanced and is not required to repay them. However, the CFPB reached the opposite conclusion regarding income share agreements, issuing a consent order against Better Future Forward, Inc. based on a finding that the company’s income share agreements were credit products and therefore subject to the TILA.
Determining the appropriate regulatory treatment of BNPL will be a more complicated task for the CFPB. First, unlike income share agreements and earned wage access, BNPL transactions carry an absolute obligation to repay funds advanced. This makes BNPL easily recognizable as consumer credit under most statutory definitions. However, many BNPL products have been structured so as to be clearly exempt from TILA and many state regulatory schemes because of their lack of periodic interest and short repayment term.
Second, in addition to being relatively inexpensive and extremely popular with consumers, BNPL transactions lack the complex terms and high relative cost that characterize other products the CFPB has criticized.8 The CFPB’s determination of how to treat BNPL will therefore likely turn on a nuanced analysis of consumer benefits and risks. In other words, when it comes to BNPL, the CFPB is more likely to wield a scalpel than a hammer.
This approach would be consistent with that of the U.K.’s consumer finance regulator, the Financial Conduct Authority (FCA). As in the U.S., BNPL is largely exempt from regulation as consumer credit in the U.K., due in part to the short repayment term and lack of interest charges associated with the product. That is changing, however. In response to a February 2021 report commissioned by and presented to the FCA Board, the FCA opened a consultation on BNPL regulation, which ended on January 6, 2022.
Although the FCA has not yet announced its next steps, it is clear that any new rules will be based on the principle of “proportionate regulation” intended to maintain consumer access to BNPL. The UK’s regulatory efforts are likely to focus on two areas the UK Treasury and the FCA have identified as problematic: lack of clear disclosures regarding the financial impact of credit, particularly the cost of default, and underwriting focused on credit risk rather than ability to repay.
The CFPB has voiced similar concerns and is closely monitoring the FCA’s response to BNPL. In the press release accompanying its December 16 orders, the CFPB indicated that it is “working with its international partners”, including the FCA, in developing its BNPL strategy.
Assuming the CFPB does decide to intervene in the BNPL market, it could do so using one or more of the following authorities: (1) rulemaking, (2) published guidance (other than a formal rule), (3) enforcement, or (4) targeted supervision. We briefly consider each of these options below.
- Rulemaking: The CFPB has rulemaking authority under the Dodd-Frank Act and eighteen other federal consumer financial protection statutes (including TILA).9 The agency could, for example, use its authority to identify and prohibit “unfair, deceptive, or abusive acts or practices” (UDAAP) under the Dodd-Frank Act to initiate a rulemaking on BNPL. To do so, the CFPB would have to first make a finding that one or more BNPL features meet the statutory standards for unfairness, deceptiveness, or abusiveness. Alternatively, the CFPB could rely on its broader authority to prescribe rules “to administer and carry out the purposes and objectives of the Federal consumer financial laws”.10 In addition to standard notice-and-comment procedures, any CFPB rulemaking would require a cost-benefit analysis, including evaluation of the rule’s potential to limit consumers’ (including rural consumers’) access to credit, and consultation with appropriate prudential and federal regulatory agencies.11
- Published Guidance: The CFPB could also provide regulatory guardrails for the BNPL industry by publishing a guidance document. The agency took this approach with earned wage access, issuing an advisory opinion on when the product will be considered “credit” subject to the TILA and admitting one large provider to the CFPB’s Compliance Assistance Sandbox. However, this approach may be less effective where, as with BNPL, the question is not whether a specific statutory regime (such as TILA) applies but what product features are acceptable from a consumer risk standpoint and whether additional disclosures are needed.
- Enforcement: Additionally, the CFPB could use its UDAAP authority to undertake enforcement actions targeting problematic product features or practices that meet the statutory standards for unfairness, deceptiveness or abusiveness. The CFPB has authority to pursue administrative proceedings and litigation with respect to any provider of consumer financial services and could use the data from its December 16 orders to establish the necessary factual basis for an enforcement action.12 This option is much less time consuming than a rulemaking, but it is also significantly less effective as a means of providing the regulatory guidance and certainty the BNPL industry needs. It also could not be used to impose specific BNPL disclosure requirements.
- Targeted Supervision: Finally, the CFPB could subject selected BNPL providers to regulatory supervision, which would include reporting and examination requirements. The CFPB has the authority to do this with respect to any provider upon a finding that there is “reasonable cause” to believe that the provider is engaged in “conduct that poses risks to consumers.”13 Such a finding must be based, at least in part, on complaints the CFPB has received and may be made only after notice to the provider and a reasonable opportunity for response.14
To sum up, the rapid growth of BNPL and its exemption from the Truth in Lending Act and many state consumer financial protection laws makes it an obvious target for regulatory attention. Determining the appropriate scope of any prospective intervention in the BNPL market, however, will require the CFPB to engage in a nuanced analysis of consumer behavior and the effects of BNPL on financial wellbeing. The data the CFPB is now gathering could be used as a basis for formal rulemaking or enforcement.
In order to initiate a rulemaking or take enforcement action under its UDAAP authority, the CFPB will have to determine that one or more BNPL product features are unfair, deceptive or abusive. Key to any such determination will be the effect of BNPL on consumers’ financial health, the transparency of BNPL terms, and the type and volume of consumer complaints. In developing its strategy, the CFPB may be influenced by the FCA, which has so far indicated that it will chart a measured course intended to balance consumer protection with access.
1 Economic-Impact-of-BNPL-in-the-US-vF.pdf (yourcreative.com.au)
2 Here, we are referring to loans disbursed in cash and not tied to a specific purchase, such as loans available from certain online consumer lending platforms.
3 12 C.F.R. § 1026.2(a)(17).
4 The scope of state consumer financial protection statutes varies widely; however, licensure requirements often apply only to consumer loans on which the lender imposes interest (and other finance charges) above the state usury limit. Late fees are generally not considered finance charges and so usually do not count towards the cap. BNPL providers have also made the argument that their products are not loans but credit sales and so are not subject to state licensure requirements. However, the California Department of Financial Products and Innovation rejected this argument in a 2020 enforcement action against Afterpay, Sezzle, and Quadpay, finding that the providers were required to have consumer lending licenses.
5 12 U.S.C. § 5512(c)(1).
6 Earned wage access is an arrangement whereby an employee is able, through a third party who contracts with the employer, to receive earned wages between regularly scheduled payroll dates.
7 ISAs are an alternative to traditional student loans in which a provider advances funds for postsecondary education in exchange for future payments based on a percentage of the student’s post-graduation income. Unlike a loan, the ISA agreement does not contain an unconditional obligation to repay a fixed amount. Instead, the student’s obligation is satisfied when she either pays the maximum repayment amount or a certain period of time passes. If the student’s income falls below a specified threshold for a given month, no payment is required.
8 Examples include overdraft, deposit advances, and payday loans
9 12 U.S.C. §§ 5526, 5512(b).
10 12 U.S.C. § 5512(b)(1).
11 12 U.S.C. § 5512(b)(2).
12 12 U.S.C. § 5531 (a).
13 12 U.S.C. § 5514(a)(1)(C).