By Mark Deakin · May 16, 2022
8 minute read

BNPL regulation and interest rates – so what?

FintechOS: BNPL and Interest rates - plant growing out of jar of money

BNPL regulation has yet to catch up with the boom in online spending that was brought on by the pandemic, and that’s without even considering interest rates. Mark Deakin, VP of research, considers how regulators will respond to the rise in BNPL and how the market will react.

Mark Deakin, VP of research, FintechOS - BNPL regulation expert
Mark Deakin, VP of research, FintechOS

BNPL – buy now, pay later – has become a buzzword in the last few years, and with good reason. The amount of spending via BNPL solutions has increased dramatically as online retail has boomed during the pandemic. In 2021, 20% of ecommerce spending in Germany was through BNPL, for example.

It’s not just retail consumers who have seen benefits from BNPL, either. Afterpay and PayPal have claimed to increase average order values by up to 20%, while Sezzle is reported to improve checkout conversions for first-time customers by 38.7%. Successfully delivering for customers and retailers has allowed some BNPL providers to shine. Klarna, set up in 2005, raised USD 639 million in June 2021 at a valuation of USD 45.6 billion.

So, retail customers are winning, merchants are winning, and BNPL providers are winning, but is it all unicorns and rainbows? All this growth has taken place in very specific circumstances – not only a pandemic preventing people from hitting the high-street, but near 0% interest rates and little-to-no regulation of 0% finance BNPL constructs. As we return to ‘normality’ and regulators begin to take notice of BNPL, what might the future hold?

Too big to ignore – BNPL regulation is on its way

The current flavor of BNPL regulation is light, or completely unregulated, in many markets. This light-regulation environment has allowed many start-ups to gain a foothold in this market using agility and inventiveness to differentiate themselves from more-traditional purchasing solutions, and to resonate with their target retail customers, as well as attract the interest of merchants as partners.

This has seen point-of-sale BNPL providers taking an increasing share of the ecommerce market, to the extent that regulators are now considering whether the ‘light-to-no’ regulation setup is protecting retail customers in an appropriate way.

In February 2021, the FCA launched a consultation regarding bringing BNPL into scope of its regulations, while in the USA, the Consumer Financial Protection Bureau initiated an investigation into this space last December.

The key concerns for regulators with regards to customer detriment center on whether retail customers understand the financing arrangement that they are agreeing to.

Are BNPL providers being clear and fair with regards to the potential consequences of taking the product? This includes the impact of having multiple arrangements, and the affordability of any contingent fees, and the potential impact on credit scores, in the case of late or missed payments.

The reality is that very few BNPL providers carefully consider whether the financing they are providing to a customer is affordable. Indeed, as it stands, the fact that a customer has taken out a BNPL product is unknown to any subsequent lender.

Why BNPL regulation matters for providers

Many in the industry believe that BNPL regulation is a positive step. Certainly, one can make the argument that it is a ‘coming of age’ moment.

Further to that sentiment, the regulation may well end up being anchored on two fundamental principles:

  1. to ensure that customers fully appreciate that they are taking out financing, the terms under which that financing is agreed, and the impact of failing to fulfil those terms.
  2. to ensure that the customers to whom they are providing financing can reasonably afford to take it on.

Like most lenders, BNPL providers sell some of their delinquent debt on to organizations that specialize in collections, with the typical price for that sale in the 10 to 25 cents on the dollar range.

Clearly having a higher proportion of customers in collections procedures will have a huge impact on BNPL providers’ bottom lines. With the cost of living increasing across the western world, it’s easy to imagine that retail customers that take on BNPL products, but wouldn’t pass affordability checks, could increasingly fail to make payments.

For businesses to move from being upstarts and become established players, they need to generate loyalty and demonstrate integrity. The likely asks on them from regulators will help them to do this through lending in a responsible and customer-friendly way.

Interest rates – the hawks are circling…

Post-2008, and the financial crises of that time, the western world has lived in a near 0%-interest-rate environment. For the last 13 years, the western world has also experienced low inflation, in an almost Japan-like trance of low rates, minimal inflation, and limited growth.

The reality of the last two years is challenging that ‘trance’, and is likely to shake economies out of it. With no ability to spend on going out for entertainment, many households increased their financial resilience and stored up cash, which may well be burning holes in pockets now that the economy has reopened for business.

This week (May 1 to 6, 2022), the Bank of England warned Britain’s economy would shrink by 0.25% over the course of 2023, leading to a 5.5% rise in unemployment. Inflation in the UK is predicted to rise above 10% by the end of 2022 – the highest level since 1982.

Meanwhile, the US Federal Reserve increased interest rates by 0.5%, the largest increase since 2000.

Why rising interest rates matter for BNPL regulation

The simplest BNPL implementation sees retailers paying the BNPL provider a fee for each transaction. The BNPL provider then pays the full cash value for the purchase to the retailer.

The retail customer makes a series of payments to the BNPL provider to cover the full cash value. Where the retail customer is late on a payment, they are charged an additional fee.

If interest rates rise, then the cost of borrowing increases. Given BNPL providers offer customers 0% interest, yet pay the retailer for the sale up front, rising interest rates will, if all else stays the same, hit BNPL providers’ bottom line.

The key part of that paragraph is ‘if all else stays the same’. This is clearly not a viable strategy for BNPL providers.

We’ve already seen successful players find different ways to monetize their position in the retail marketplace, and indeed evolve to take greater ‘ownership’ of the retail customer relationship, e.g. Klarna launching its shopping app in 2021.

It’s necessary for this evolution to continue for BNPL flourish, regardless of the interest rate. However, it’s fair to say that rising rates will lead to an increased urgency to successfully find different ways to monetize.

Linking back to the likely encompassing of BNPL regulation, the reluctance to offer interest-charged BNPL solutions over longer terms for these providers will diminish. They, and their products, will be regulated regardless of whether interest is charged, how many repayments are scheduled, and the length of time over which the repayments are made.

This alignment will allow BNPL providers to think more broadly about how they can help retail customers finance the life they want to live, and so, if they capture this opportunity correctly, allow them to deepen and broaden the relationship they have with customers and the increase the number of opportunities to monetize.

It’s important just to be there

The macro-environment is going to challenge most industries. Discretionary spending is likely to fall as the cost of essentials rises, credit risk is going to increase as consumers’ outgoings overtake their income, and the behaviors learned during the pandemic will either persist or fade away. BNPL is certainly not immune to this.

BNPL is an industry led and driven by fintechs. As such, it is extremely well positioned to pivot and evolve. Regardless of whether regulations come in or interest rates rise, we’ll see new concepts and ideas in this space, particularly in how to ‘own’ the customer relationship, build loyalty to, and trust in, brands and embed more solutions to maximize monetization.

In the event regulations do come in or interest rates rise, expect the velocity of ideas to increase further. As per Darwin’s theory, evolutions such as this will create winners and losers in the BNPL space.

Off the back of winning or losing, it’s logical to expect consolidation within the space, either through providers falling away, being acquired by ‘traditional’ players, or indeed through mergers of BNPL providers.

What’s important is to be somewhere within that space, as BNPL is set to remain a lucrative market for a long time to come, regardless of how it changes.

To see how the FintechOS platform can help you enter the BNPL space, read about our BNPL solution.

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