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Buy now pay later: how to protect consumers without regulating it out of existence

Hand holding phone with "Buy now, pay later" message.
The BNPL market is booming but users need better protections through balanced financial regulation. Shutterstock

Calls to regulate the booming “buy now, pay later” (BNPL) industry have not deterred big brands like Apple and Amazon from the idea of offering consumers an interest-free, no-fee way to spread payments for purchases. Apple cited “users’ financial health” when it announced this new feature, but research shows financially vulnerable people need more protection.

It’s possible to regulate this sector to safeguard consumers without completely restricting access. By learning lessons from previous efforts to regulate the payday lending sector, for example, the industry and its regulators could take steps to prevent misuse.

The use of BNPL payment platforms almost quadrupled in 2020, with transaction values reaching £2.7 billion. In 2021, UK BNPL transaction value grew by as much as 70% to £6.4 billion or 5% of the total e-commerce market.

This form of credit allows people to pay for online purchases in instalments, without a credit record check. It tends to attract younger borrowers, with a quarter of users aged 18-24 years old and half aged 25-36 years old, according to data shared by providers with the UK’s financial regulator, the Financial Conduct Authority (FCA).

Unfortunately, it has also encouraged some shoppers to spend more than they can afford. Citizens Advice says two in five BNPL users have struggled to repay, and one in four of those that have missed a payment have been contacted by debt collectors.

And while BNPL was conceived as a convenient way to purchase big-ticket items such as sofas and TVs, the rising cost of living means people are now using it to pay for essentials such as food and toiletries. Research has also found that users who are unable to repay their BNPL sometimes use credit cards with typical interest rates of 20% to delay repaying their debt.

Woman with bills and credit cards.
Some BNPL borrowers are using credit cards to manage their installments. Shutterstock

A rise in overstretched users is not only detrimental to consumers, it could also damage businesses. Retailers have increasingly relied on BNPL to boost sales by allowing people to spread the cost of goods over a series of payments. They pay the provider a fee for the purchased goods and the BNPL business model is reliant on consumers’ repeat use.

Retailers have used this to navigate recent challenges like Brexit and COVID-19. Up to 92% of merchants surveyed last year had integrated their first BNPL solution since early 2020. But the rising cost of living crisis has changed the economics of this form of credit for all involved.

Regulatory lessons

As a result, regulation looks increasingly likely, and necessary, to provide consumers with greater protection from financial harm. The FCA has already enforced new contractual changes to terms and conditions to help protect consumers using Klarna, Clearpay, Laybuy and Openpay. These new measures include protecting consumers that cancel their goods through BNPL from being charged a late payment fee.

At the moment, the hope is that other providers will follow suit. This regulation needs to be enforced across the sector in a way that shields consumers without removing access to this form of finance.

The regulation of payday lending in 2015 provides valuable lessons for BNPL. My research on the experience of borrowers shows that, while “high-cost, short-term” credit regulation protected users from falling into too much debt, it also excluded many people from accessing this credit at all.

Ultimately, this regulation restricted consumer choice by forcing several high-profile lenders into administration. Their business models no longer worked due to the stricter rules on lending and a cap on the cost of credit, combined with an influx of pre-regulation compensation claims.

Protecting consumers

Financial regulation that aims to protect consumers must support those on the lowest incomes that are shouldering the greatest burden in the cost of living crisis. More generally, an uplift in benefits in line with inflation would be useful. Credit is not always the right solution, but affordable community finance providers such as credit unions and community development finance institutions should also be promoted.

Computer, coffee, phone credit card, yellow background
Balanced regulation can both protect consumers and maintain access to this form of credit. Shutterstock

For BNPL regulation specifically, regulators can and should design rules that will ensure that consumers are protected but also able to continue to use this increasingly popular form of finance. According to my research, the following measures would help:

  • Clarifying that BNPL is a form of credit and the implications of using it so that consumers can make informed decisions.
  • Ensuring providers make sufficient and appropriate checks about whether consumers can afford to repay loans alongside their other financial commitments to reduce overall debt. This would rely on access to real-time data to prevent multiple loans with multiple providers.
  • Adding greater consumer goods protection to match other forms of credit such as credit cards, which offer a refund if goods are lost or damaged.

The BNPL model is unlikely to disappear any time soon. Instead, BNPL companies are already starting to adapt to a more regulated future by changing their business models to some extent. For example, Klarna’s moves to report its data to credit scoring companies certainly indicates it is pre-empting regulation of the sector, as well as an economic slowdown that could curb its growth in the near future.

Even with this outlook, however, confidence in the sector remains. Thoughtful regulation will ensure present players and new entrants can build responsible BNPL offerings that online shoppers can continue to add to their baskets.

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