All signs point to increased US regulation of Buy Now, Pay Later

Driven by an increase in online and mobile app shopping during the COVID-19 pandemic, the Buy Now, Pay Later (BNPL) market has experienced exponential growth as an innovative consumer offering, particularly for the unsecured credit market. The explosion of the BNPL market, however, is attracting scrutiny from financial services regulators concerned about the lack of specific rules and the potential risks to consumers. Federal regulators have taken a largely hands-off approach to the BNPL sector in the past, but recent noteworthy shifts have signaled regulatory headwinds are on the horizon.

The Consumer Financial Protection Bureau (CFPB) issued a report on September 15 that offers key insights on the BNPL industry and makes it clear that the CFPB plans to increase regulation of the BNPL industry, especially in those areas where there is risk of consumer harm. In December 2021, the CFPB issued market monitoring orders to five BNPL providers to provide data on their BNPL products. This CFPB report summarizes that data, individual and organizational submissions to the CFPB and publicly available sources to provide a review of BNPL's marketplace importance and consumer impacts. The CFPB also engaged many international counterparts to understand their own market reviews. The report identifies several competitive benefits of BNPL products over legacy credit products and discusses areas of potential consumer risks.

Product overview

While there is no single definition of BNPL, the term is used to describe a type of short-term financing that allows consumers to make retail purchases and pay off the balances in typically interest-free, small-dollar installments. The typical BNPL structure divides a US$50 to US$1,000 purchase into four equal installments. Shorter-term BNPL products are usually interest free, while longer-term BNPL products may charge interest. BNPL products can be grouped into two main types, depending on how they are offered to consumers. The first type of BNPL product is offered directly to consumers by fintechs before a purchase is made (the app-driven acquisition model). Such BNPL services include a virtual or physical payment card to make purchases and allow for multiple BNPL purchases up to the predetermined credit limit. The second is offered during a purchase through a merchant who partners with a fintech or financial institution (the merchant partner acquisition model). Revenue for the fintechs or financial institutions that provide both types of these products is primarily derived from fees charged to the merchants that accept the product as a customer payment option. However, revenue may also be generated from late fees or penalties charged to consumers who fail to comply with the terms of repayment.

For purposes of this report, the CFPB defines BNPL as the "pay-in-four" or "split pay" product: a four-installment, no-interest consumer loan, typically with a down payment of 25 percent and the remaining three installments due in two-week intervals. Notably, this report excludes other forms of short-term purchase financing, including:

• Point-of-Sale (POS) installment loans: A consumer installment loan tied to a specific purchase, with monthly payments that may include interest or fixed finance charges. Unlike the pay-in-four product, the POS installment loan is usually intended for large, infrequent purchases (i.e. furniture and high-priced exercise equipment), with term lengths up to three or four years. Down payments are typically not required.
• Post-purchase credit card installment plans: A product enhancement that many credit card issuers have added in recent years that allows cardholders to repay a previously purchased item on a payment plan in fixed monthly installments. While the plan often includes amortized interest or fixed finance charges, it is separate from the borrower's credit card account balance and does not incur revolving interest.

Because the CFPB limited its review to the pay-in-four product, this report is primarily focused on "pure-players:" nonbank tech companies that offer BNPL, although they may also offer other forms of point-of-sale credit.

BNPL providers are subject to some federal and state oversight and regulation. Laws applicable to BNPL programs also vary by business model. The CFPB has enforcement authority over providers of credit, and it has authority to supervise any non-depository covered persons, such as a BNPL provider, in certain circumstances. Some states consider BNPL to be consumer credit and require state licensing or registration, as well as compliance with state consumer credit laws, while other states do not require licensing or registration for BNPL products with no interest or finance charges.

Regulatory issues

The marketing of BNPL products can make them appear to be a zero-risk credit option, but the report identifies a number of risks associated with BNPL products. According to the CFPB, its analysis of typical BNPL product features "demonstrates that some market participants' offerings appear to be structured to evade certain federal consumer lending requirements." The discrete consumer harms that the CFPB identified in the context of BNPL products include:

• Lack of standardized disclosures: The CFPB found that most BNPL lenders do not currently provide the standard cost-of credit disclosures or periodic statements required by the Truth in Lending Act/Regulation Z. According to the CFPB, "The lack of clear, standardized disclosure language may obscure the true nature of the product as credit and make important information about loan terms, including when and how fees are assessed, and when payments are due, less accessible."
• Dispute resolution challenges: Dispute resolution is the top-ranking BNPL-related complaint category in the CFPB's Consumer Complaint Database. The CFPB found a lack of uniform billing dispute rights, which may lead to operational hurdles and financial harm. According to the CFPB, most BNPL lenders surveyed are currently not following Regulation Z's credit dispute resolution provisions and consumers sometimes are required to pay BNPL installment amounts in dispute pending dispute resolution.
• Compulsory use of autopay: The CFPB found that most BNPL lenders require that borrowers use autopay and, in addition to debit cards, allow repayments by credit cards. In addition, the CFPB found that some BNPL providers make removing autopay challenging or impossible.
• Multiple payment representments: Many BNPL providers re-present (i.e. attempt to reauthorize) failed payments, in some instances up to eight times for a single installment.
• Late fees: The CFPB found that at least one BNPL provider's policy permitted it to impose multiple late fees on the same missed payment.
• Overextension: The CFPB's review found that BNPL product structures and business strategies may contribute to consumer overextension, which can manifest itself through loan stacking (which can occur when a consumer takes out two or more concurrent BNPL products from different providers) and sustained usage (which can occur over a longer time horizon and results from habitual BNPL usage leading to delinquency or default on other debts and financial obligations).
• Data harvesting: The BNPL industry provides an example of the data harvesting that is occurring at the intersections of digital commerce, content and lending. BNPL providers often collect a consumer's data—and deploy models, product features and marketing campaigns based on that data—to increase the likelihood of incremental sales and maximize the lifetime value they can extract from the consumer.

Next steps

In his prepared remarks coinciding with the release of the report, CFPB Director Rohit Chopra noted that he has asked CFPB staff to pursue a number of additional steps in relation to BNPL products, in addition to ongoing market monitoring, including assessing how the credit card industry writ large is incorporating BNPL features.

• First, Director Chopra has asked CFPB staff to identify potential interpretive guidance or rules to issue with the goal of ensuring that BNPL providers adhere to many of the baseline protections that Congress has already established for credit cards. He noted that CFPB staff will also be conducting outreach to investors and new market entrants "seeking to enter the marketplace in a compliant manner," and that the agency "will use their input as part of our broader effort to ensure a level playing field."
• Second, Director Chopra has asked CFPB staff to "identify the data surveillance practices that BNPL providers engage in that may need to be curtailed." Specifically, the CFPB will be examining some of the types of demographic, transactional and behavioral data that is collected for uses outside of the BNPL credit transaction, including for the purpose of sponsored ad placements, sharing with merchants and developing user-specific discounting practices. The CFPB will also be coordinating with the Federal Trade Commission, which launched a rulemaking process on commercial surveillance, and, if finalized, these rules will be enforceable by the CFPB in the financial services arena.
• Third, CFPB staff will continue to formulate options on how the industry and consumer reporting companies can develop appropriate and accurate credit reporting practices.
• Fourth, the CFPB will take steps to ensure that BNPL providers are subjected to appropriate supervisory examinations. The CFPB is inviting BNPL providers to self-identify to the CFPB if they wish to be examined and is also reviewing its authorities to conduct examinations on a compulsory basis. Director Chopra noted that CFPB staff will also be working with state regulators that license nonbank finance companies on examinations of these firms.
• Finally, Director Chopra has requested that steps be taken to ensure that the methodology used by the CFPB and the rest of the Federal Reserve System to estimate household debt burden reflects the reality of today's market by including BNPL transactions.

While Director Chopra did not provide timelines for these next steps, the CFPB appears to be laser-focused on ensuring that competition in markets for consumer financial products and services—including BNPL—is based on product quality, customer service and pricing, not regulatory arbitrage. Understanding when and if the BNPL arrangement falls within or outside of the scope of regulation is key. Going forward, we expect to see the CFPB use a number of tools to oversee the BNPL sector, including the authority to bring claims of unfair, deceptive or abusive practices (UDAAP). As BNPL products continue to grow in popularity and the industry continues to add products and services to meet consumer need, market participants should ensure they understand their regulatory obligations and licensing requirements, know how to navigate the processes and procedures to achieve compliance with the evolving regulatory regimes and develop structures to address regulatory risks.