Rapid Growth of Buy Now Pay Later Market Raises Global Consumer Protection Concerns as CFPB Watches and Waits (For Now)

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The explosive growth of “buy now pay later” (BNPL) products is a staple of the fintech news cycle. The model, which gained popularity with point-of-sale financing options offered by straight play providers such as Affirm, Afterpay and Klarna, has iterated quickly as card networks and big tech companies enter the market. Factors behind BNPL’s surge include an increase in online shopping during the pandemic, skepticism about credit card use among younger population segments, and a decrease in the friction involved in BNPL transactions as they are introduced earlier, and more seamlessly, into the transaction flow. 

A few of the more significant recent developments include:
  1. Card Networks Launching BNPL Platforms: The major card networks, as dominant providers of consumer credit at the point of sale, are working to drive BNPL transactions over card rails. Last summer, Visa introduced its Visa Installments program, which converts cardholders’ existing credit lines into a BNPL option displayed at the point of sale. Mastercard recently announced that it is partnering with several financial services companies to offer BNPL options instantly at checkout or display pre-approved BNPL options through mobile apps. Mastercard’s platform will also be open to existing BNPL providers looking to expand their reach.
  2. Major Acquisitions. Against a backdrop of brisk investment and rising valuations, August and September brought two high-profile deals in the BNPL space. Square announced on August 1 that it plans to acquire Afterpay for $29 billion in an all-stock deal set to close in early 2022. On September 7, PayPal announced its cash acquisition of Japanese BNPL platform Paidy. 
  3. Competition among Big Tech Players. Apple and Goldman Sachs have announced the launch of Apple Pay Later, a BNPL product that allows Apply Pay users to make purchases using funds borrowed from Goldman Sachs and make installment payments using any credit card. The recently-announced partnership between Amazon and BNPL provider Affirm embeds the BNPL option in the checkout process for eligible Amazon customers on purchases of $50 or more. Affirm has also partnered with mega-retailers Walmart and Target. 
The global consumer uptake of BNPL has caught the attention of financial regulators. The key concern, as with other consumer credit products, is whether BNPL encourages consumers to become overburdened with debt. This conversation centers on two issues: affordability (underwriting) and transparency (disclosure). These are the same issues that frame the so-called “cycle of debt” debate in the US, where small-dollar lenders have been criticized for exploiting consumers’ cognitive biases and vulnerabilities to make unaffordable loans. However, because BNPL products typically have simple repayment terms, regulators may be more likely to focus on affordability and impulse buying than disclosure with respect to BNPL.
 
Globally, consumer advocates, as well as financial regulators, are considering underwriting and affordability – particularly relative to less experienced borrowers. In the US, UK and Australia, the transaction structure and lack of periodic interest on many BNPL products have allowed them at least a partial exemption from key consumer credit protection laws. However, there are indications of increasing regulatory attention. 
 
For example, the UK’s Financial Conduct Authority (FCA) recently issued a request  for public feedback on the BNPL market and the appropriate scope of new BNPL regulations. In particular, the FCA is seeking input on the potential for consumer harm from various elements of the BNPL business model. The FCA’s stated goal is to develop “proportionate” regulations that protect consumers without stifling innovation or reducing consumer choice.
 
Just ahead of the FCA announcement, Klarna publicized plans to modify its UK product to include more robust (though optional) credit checks, a “pay now” option, and checkout disclosures intended to make clear that the transaction is a loan and carries missed payment penalties. The UK’s advertising regulator criticized Klarna last year for using social media posts to promote spending as a way to improve mood.
 
Last March, the Australian Finance Industry Association, an industry group, also moved to address consumer protection concerns proactively by issuing a BNPL “Code of Practice.” The Code attempts to address the affordability issue by obligating signatories to take into account customers’ vulnerabilities in the underwriting process. Interestingly, those vulnerabilities include not only financial capacity but other life circumstances, such as a “relationship breakdown”, domestic violence, and “having different cultural assumptions or attitudes about money.” 
 
Citing concerns about excessive debt, Sweden's national legislature has amended the country's Payment Services Act to prohibit payment service providers from presenting BNPL options above “direct pay” methods in the checkout process.
 
The CFPB, the primary national regulator of non-banks in the US, has not yet intervened directly in the BNPL market. On July 6, the CFPB published a blog post aimed at explaining BNPL and its risks to consumers. The post adopts a mildly cautionary tone, advising consumers to make sure they understand their finances and budget before using BNPL and explaining that some providers charge late fees or report missed payments to credit bureaus. 
 
US industry watchers were generally encouraged by the neutral tone and lack of strong warnings in the post. However, recent data on the repayment behavior and financial status of BNPL customers, as well as the lack of robust underwriting by many providers, is attracting regulator’s attention globally. For example, a recent study published by Credit Karma indicates that a third of US BNPL customers have missed one or more payments.1 Of those customers, 72% reported that they believed the missed payments lowered their credit scores. These risks are intensified when consumers take out more than one BNPL transaction simultaneously – behavior that neither regulators nor other BNPL providers can track given that most BNPL transactions are not reported to credit bureaus. Additionally, BNPL providers often base their credit decisions on “soft” credit pulls and the customer’s repayment history with the provider rather than full credit reports and income levels.
 
The CFPB’s recent classification of income share agreements as “credit” within the meaning of the Truth-in-Lending Act (TILA), which we cover in this newsletter, is indicative of a new (or regained) boldness in bringing emerging consumer credit products into the regulatory fold. The CFPB’s consent order with Better Future Forward, an ISA provider, was based on the Bureau’s deceptiveness authority under the Dodd-Frank Act – an avenue that is less likely with mainstream BNPL products given their simple and familiar structure. BNPL products that do not impose a finance charge and are payable in four or fewer installments are clearly excluded from TILA coverage. However, if there is sufficient evidence of unaffordability and resulting consumer harm from BNPL use, the CFPB could use its flexible abusiveness authority to address these issues. 
 
Underwriting for ability to repay is now required by statute with respect to credit cards and mortgages in the US. The CFPB is sensitive to affordability and cycle-of-debt concerns. In 2017, the agency used its abusiveness authority to propose a rule that would have required payday lenders to underwrite for an applicant’s ability to repay the loan, as well as other credit obligations (including other payday loans). This provision of the rule was rescinded by a subsequent rulemaking in 2020. However, the Chopra-era CFPB is expected to take up this effort again and, with sufficient supporting data, could cast a wider net with a new rule that includes BNPL. This outcome would be more likely if data trends suggest that BNPL use is associated with negative impacts to consumers’ financial status over time. 

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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