Regulation of Buy Now Pay Later moves one step closer – beware of unintended consequences

Last week, HM Treasury has released its latest consultation in respect of the regulation of Buy Now Pay Later (‘BNPL’) with only a six-week consultation period for industry feedback. Once the legislation is finalised, the FCA have stated their intent to regulate this industry within 12 months and it will be achieved through a temporary permissions regime. This article summarises the latest consultation and comments on the implications for firms.

Summary of the consultation paper

Surprisingly, given the length of time that this has been delayed from its original expected reading in Parliament before the end of 2023, very little has changed from the initial consultation issued in February 2023, at first sight. It would appear that the change in government has not affected the intent of regulating the sector, nor does it appear that the current economic climate has impacted the intended implementation.

In the main, the FCA will only regulate agreements provided by third-party providers and not those where the merchant/retailer provides the credit themselves. There is also a clear intent to exclude virtually all merchants offering the regulated BNPL product from the need of having credit broking permissions, with exception of those who offer finance within customer’s homes (otherwise known as domestic premise suppliers). Due to this change, the pool of new authorisations will be very low, and it is likely that existing lenders will not be required to vary permissions to add this new type of lending, but this is still to be confirmed.

Unintended consequences?

Whilst there is a fundamental need for firms to provide adequate protection to consumers by preventing unsuitable lending, I do feel however, that the current proposed regime may lead to a significant change in how BNPL is offered, in order to avoid regulation and the associated costs.

Imagine a world where instead of the likes of Klarna or ClearPay offering loans to customers as they do today, they lend money to the retailers (most B2B loans are unregulated), who then lend to the borrower directly as the supplier of the goods. This would result in consumers still being offered loans which do not offer the same protections the Government and the FCA are trying to achieve. Whilst this model would require merchants to become supervised for money laundering purposes, there would still be no need for creditworthiness assessments, still no section 75 rights (which offer customer protection relating to the performance of the product purchased with the loan) and still no access to the Financial Ombudsman Scheme (FOS), which wouldn’t result in a good consumer outcome.

One of the largest liabilities that any lender faces in today’s market, is its FOS liability if it were to become subject to a raft of complaints. Take this example: a BNPL loan is issued for £1,000 (it is usually much less than that) and the BNPL provider receives 10% of the value (£100) in commission from the retailer (again, it is often much less than that). If the loan was then subject to a FOS complaint, the lender would be lumbered with £650 fee (regardless of the outcome), once the very limited number of free cases where the FOS don’t charge, has been exhausted. When considering the costs of implementing this regulation, this can only lead to increased costs to consumers or regulatory avoidance action.

But it’s interest free, I hear you say!! Well, it is, but the retailer then pays commission to the lender for the borrowing which erodes their profit. If commissions rise to pay for regulation, then retailers will have to increase their prices to accommodate the tighter margins on the products they sell. Could this spell wholesale inflation across all retail? Well, if the scenario above where regulation avoidance doesn’t happen then yes. Without a doubt retailers will have to increase prices to all customers to subsidise the offering of regulated BNPL products, or they will consider offering interest bearing products to maintain pricing for cash purchasers, which would require them to be authorised for credit broking. Let’s not forget that inflation on the high street will only result in higher mortgages interest rates, which I am sure everyone would agree, is not a good outcome for all.   

Another major point which will need to be addressed, is how borrowers understand whether the loans they take out will be regulated or not. Are they protected from unaffordable lending? Do they have rights to go to the FOS or claim section 75 rights? If the sector restructures the way in which these loans are provided, then it is more likely that consumers will feel more confusion when using this product which they believe is regulated, but in fact might not be depending on how the sector changes as a direct result of regulation.

In summary…

As I have said before and already in this article, the intent to protect consumers is wholly encouraged, but extreme caution is required as there are unintended consequences that could have a wider economic impact on all of us. The real issue with BNPL is excessive use of the product mainly by young inexperienced borrowers, or the product being used for unsuitable purchases which will only result in debt spiralling.

The consultation closes on the 29^th November 2024 and the consultation details can be found here. We encourage you to leave feedback before the closing date.