The Financial Conduct Authority (FCA) reported a tripling of lending to customers in 2020 alone. It is surely one of the notable positives out of restricted movements during the pandemic. But it is not just about ubiquity and lending growth. It is also the poster child for innovation in retail finance. BNPL shows us all what is possible when technology, e-commerce and consumer needs are matched well. What’s not to love?

An unregulated landscape

BNPL sits in a class of agreements between parties that is quite vast such as invoicing and gym memberships. As such it is largely unregulated and has been deliberately exempt from consumer credit laws and regulations. The decision to exempt it, some fifty years ago, was sensible at the time as the majority of these types of arrangements posed little risk. But unlike most of those traditional arrangements, BNPL is plain and simple, lending. It may appear to only separate the timing of purchasing goods or services from repayment, but it is a contractual agreement to make repayments, and it can lead to interest, and fees being charged. 

BNPL has the potential to overcommit the customer and cause harm if not conducted well. Therefore, being unregulated seems a little at odds with what most people might expect today, against a backdrop of increased consumer protections that focus on reducing detriment and harm from lending. Looking at how BNPL has evolved over these last few years, it feels that regulation and coverage by law are necessary and timely. 

Change is afoot

The industry is bracing itself, even pre-empting what might happen with BNPL, in order to get in front of it. The FCA led a detailed review of practices in unsecured credit – The Woolard Review. This review identified BNPL as being different from other forms of arrangements, exempt from consumer credit laws and regulated activity, and as presenting a high risk of consumer detriment.  Key areas of concern are around how it is used, promoted, understood, and whether good practices are in place to manage the risks and harm to customers. The FCA recommended it be brought within its perimeter of conduct rules, and the Treasury is consulting on making statutory changes that will remove current exemptions. 

In a sign of what is to come, the FCA has taken a pre-emptive strike on the main providers. Showing an intent to exercise its full powers, it recently issued publicly the findings of a review of the four largest providers of BNPL loans covering compliance with consumer contract regulations and consumer rights. It raised concerns in respect of contractual terms that were considered unlikely to comply with the rules. According to the FCA, the four providers involved have been ‘fully cooperative’ and ‘agreed’ to changes, including for some, a voluntary refund of inappropriately charged fees. 

Providers are pretty savvy though and it seems clear where this will likely end up – not too dissimilar from other forms of lending. Many providers are revising terms, providing new options for payment at the point of sale and creating more prominent messaging and options. Their internal practices are also sharpening up. Providers are strengthening their credit risk controls – adopting good practices in line with more traditional lending products (and providers) in assessing customer indebtedness and ability to afford repayments, as well as better overall management of their credit risks. 

However, it is important to note the requirements are not certain. The questions, as the Treasury put it, are – what is to be included within the scope (that is, what is no longer to be exempt) and what controls need to be in place to manage this. Their conundrum, remembering that BNPL looks and feels a lot like other types of arrangements, is: cast the statutory net too wide and they risk including arrangements that do not require such attention and may have unintentional ramifications on a wide range of practices. But, cast it too narrowly, and it is easy for providers to avoid any requirements by slightly tweaking their products and practices. 

Unregulated BNPL is becoming significant

Short-term interest-free credit used to purchase more substantial items (as labelled by the Treasury and FCA) is not what the lawmakers and regulators are concerned with – it is not what is growing rapidly or causing detriment to consumers. The focus of their attention is what they call unregulated BNPL agreements, which typically target lower value items, often non-essential and fast consumable items like clothing. This is big and growing with estimates of over £5 billion last year, and projections into the tens of billions by some analysts.

There is potential for BNPL to be much, much bigger

If the wider market foray into BNPL continues, it will likely cannibalise existing lending, particularly of credit cards, but it may also increase spending levels overall. Should BNPL purchases shift upward in value, this will see total exposures grow quickly. Individual online retail shopping amounts for BNPL are relatively low. But aggregating spending over multiple purchases for a customer mounts up. If purchases shift to more substantive goods – the territory of short-term interest-free items mentioned previously - it will account for a sizeable chunk of the quarter trillion-pound unsecured market. Having the largest BNPL providers sit outside the regulatory perimeter, or inconsistent practices between lenders, undermines the whole unsecured market. 

The outlook for BNPL providers

Analysis by Redburn, as reported in the FT, suggests BNPL providers that only offer this product are unlikely to be sustainable in the long run. Whilst they look attractive today, they will soon be outgunned by incumbent lenders. However, those able to deepen their offerings and relationships with a broader suite of products and services will see sustainable value, leveraging BNPL as an effective acquisition generator for new business. 

This reinforces a further point, that the type of customer who is attracted to and uses BNPL now is younger and without a credit history. Yes, BNPL may be  positive for greater financial inclusion, but it also points to a possible vulnerable customer group who are less aware, less financially astute, less resilient, and so more susceptible to harmful practices.  

Providers should therefore aim to build on that foundation with a very clear long-term perspective. A view that covers decades not just the next few years, this is how BNPL can become the backbone of how people spend on low to moderate purchases when requiring credit. 

About the author: Phillip Dransfield is Partner at 4most, a UK based, credit and life insurance risk consultancy and is recognised internationally as one of the most dynamic and successful risk consulting firms.