RAPID GROWTH OF BUY NOW, PAY LATER (BNPL) INDUSTRY REVEALS CHALLENGES FOR CONSUMERS, LENDERS, AND REGULATORS

Two-thirds of BNPL users are subprime; lack of standards for disclosure of fees, payments, data collection, and credit reporting challenge understanding of credit quality and total debt burden

BOSTON, April 15, 2022 /PRNewswire/ -- Weak regulatory oversight including a lack of standards for the disclosure of fees, payments, data collection, and credit reporting may lead to problems for the rapidly growing "buy now, pay later (BNPL)" industry, according to a new paper from the Mossavar-Rahmani Center for Business and Government at The Harvard Kennedy School.

The paper ("Grow Now, Regulate Later") notes that globally BNPL products are expected to account for $680 billion in transactions by 2025 or about 12% of all eCommerce sales on goods. This growth is being driven primarily by younger consumers, with two-thirds of BNPL borrowers falling into the subprime category (TransUnion survey), making them especially vulnerable to negative changes in an economy that is already unstable. At the same time, the unprecedented nature of the industry and lack of oversight makes it difficult to properly evaluate the risks including significant subprime borrowing and total consumer debt burden.

"While there are many good actors and the industry offers access and convenience for consumers, it is naturally engaging in what we call 'regulatory arbitrage' which has allowed it to generally avoid the kind of oversight required of credit card companies, banks, and other traditional lenders," said Marshall Lux, the paper's principal author and a Fellow at the Kennedy School. "This, combined with the fact that the BNPL industry has yet to experience a full credit cycle, is a potential source of future problems for both consumers and lenders."

A Legal Gray Space

Despite its significance, the U.S. BNPL market currently exists in what the paper calls "a legal gray space," largely because it can be so difficult to categorize segment products. While BNPL companies can and have already done much to protect consumers – providing voluntary credit bureau reporting and fee disclosure at the point of sale (POS), for example – the scale, novelty, and potential consumer impact of BNPL products warrant immediate and more thorough oversight, the paper's authors say.

In December 2021 concern about the industry prompted the Consumer Financial Protection Bureau (CFPB) to issue information collection orders to leading BNPL companies to assess the "risks and benefits [to consumers] of these fast-growing loans." This is expected to lead to future actions but, the authors note, many consumers are struggling with their debts today.

As cited in the Wall Street Journal this week, emerging signs may be a harbinger of trouble. Subprime credit spreads are widening, and short sales on BNPL stocks are increasing. While yield premiums on bonds and short interest represent short-term patterns, they nonetheless suggest the market's apprehension about the future of some subprime credit products, including BNPL.

The Kennedy School paper concludes that a few regulatory interventions can help BNPL products continue to create value for merchants, consumers, and the financial system while protecting those most vulnerable. These include:

• Mandatory fees and rights disclosure at point-of-sale can help consumers understand the real cost of BNPL financing and make clear that BNPL products lack the consumer protections of similar products, like credit cards. 
• Credit bureau reporting standards can help BNPL permanently improve consumer access to finance while increasing accountability for both consumers and lenders.
• Data privacy standards can protect consumers from potentially exploitative use of data as some BNPL companies struggle to generate profit through monetization of new consumer data. 
• Services and/or charge dispute settlement procedures can help eliminate a large volume of current BNPL consumer complaints and provide a more even playing field for credit cards and BNPL products.
• Stress testing and stress scenarios can help improve understanding of the potential impact of an economic shock. This is especially important given the uncertain outlook and the lack of ongoing Covid-related government income support.

"BNPL's real innovation has been at the point of sale where the convenience and ease of financing purchases has accelerated online merchant sales and made credit available to those who might otherwise be excluded," said Lux, citing a 2021 RBC Capital Markets report suggesting that online BNPL increases conversion rates 20-30% and lifts average ticket sales 30-50%. 

"There is lot about this that is positive, but better oversight should lead to a more sustainable business model for the BNPL industry and an improved experience for all concerned," Lux said.

SOURCE Mossavar-Rahmani Center for Business & Government