Buy now, pay later services: the regulation debate

Answer

So-called ‘buy now, pay later’ (BNPL) services, such as Klarna, Clearpay and Laybuy, offer customers flexible payment methods for online and in-store purchases. These include spreading the cost of purchases across three to four equal instalments or paying an interest-free lump sum up to 30 days after delivery. Some payment providers also offer their customers the option of longer-term financing arrangements for larger purchases, which allow them to pay for products monthly over a period of six to 36 months. The latter option incurs interest and is, therefore, a type of a regulated credit product.

According to a recent survey commissioned by Compare the Market, one in five shoppers has used a BNPL scheme over the past year. They are viewed by their users, who are often millennials or members of Gen-Z, as an easy alternative to more traditional forms of credit, such as credit cards and other more formal credit arrangements. With over 80 million customers worldwide, the growing popularity of the Swedish payment provider, Klarna, is evident. In August last year, the company was valued at £4.3 billion, making it the most highly valued privately held fintech company in Europe.

How do BNPL service providers make a profit?

Many BNPL service providers are merchant-funded. This means that a large proportion of their profit is made by charging retailers a percentage of the value of every order that is placed using these payment options. Despite this cost, over 4,000 retailers in the United Kingdom, including household names such as Marks and Spencer, H&M and ASOS, have adopted this new technology into their retail strategies. In return, companies have seen an increase in both the amount of sales they receive and the average cost of every order. It is also reported that customers have been shopping more frequently.

An additional revenue stream for some BNPL service providers is late fees. For example, customers who fail to make payments that they owe to the New Zealand-founded Laybuy are charged a late fee 24 hours after being sent a reminder email about their delayed payment. If the customer fails to make their repayment after a further seven days, they are charged another late fee. Rather than highlighting the negative aspects of late fees, Gary Rohloff, the co-founder of Laybuy, regards them as an “incentive [for customers] to pay”. To prevent customers from incurring further costs that they may not be able to pay, Laybuy and other BNPL service providers prevent customers from making any new purchases until they have cleared the payments that are due.

What are the risks?

At the point of purchase, some BNPL payment providers, such as Klarna, perform soft credit checks on their customers to ensure that they will be able to keep up to date with their repayments. This includes an examination of an individual’s credit history, age and other factors. Laybuy, on the other hand, performs hard credit checks through the external provider, Experian. For Klarna users, the results of these credit checks are not passed onto other credit lenders at this stage. However, use of these payment methods can nonetheless have a negative impact on users’ financial well-being and credit score. If users are unable to keep up to date with their repayments, BNPL payment providers often pass accounts onto debt collection agencies after a specified period of non-payment has elapsed, ranging from 45 days to several months.

An alarming 41% of BNPL users assessed in Compare the Market’s survey stated that they did not know that missing a payment could affect their credit score. The lack of clear, readily-accessible information about the risks surrounding these types of payment methods has the potential to seriously jeopardise users’ longer-term credit-borrowing plans, such as securing a mortgage to buy a property.

The regulation

Despite growing calls for reform from debt charities, these products remain largely unregulated. This is because the vast majority of products offered by BNPL service providers do not charge their customers interest. Therefore, they fall beyond the remit of regulation by the Financial Conduct Authority (FCA).  

In November last year, changes implemented by the FCA did, however, come into force regarding the repayment of interest on longer-term financing options provided by BNPL firms. Some of these reforms include firms no longer being able to charge backdated interest on amounts of money that have been repaid by the consumer during the initial BNPL offer period. Firms must also give prompts to consumers, to remind them when the initial offer period is about to end, so that consumers are more likely to repay the credit before they incur interest.

In conclusion, BNPL service providers can be regarded in a very positive light, as they allow consumers to shop more flexibly. Customers can now easily make pre-payday purchases and only pay for online purchases after they have had the opportunity to try them on. There are also obvious benefits for retailers, with customers spending more with each order and shopping more frequently.

However, there are downsides for both consumers and retailers. If not used responsibly, BNPL services have the potential to result in customers getting into debt and negatively impacting their credit score, which can have long-term effects on their financial health and future borrowing potential. Retailers may also see an increase in the number of returns they receive from customers and, therefore, must consider this factor before implementing these payment methods.

Ria Sadrudin is a second-year trainee solicitor at Shoosmiths. She is based at the firm’s Nottingham office.