Is Buy Now, Pay Later creating a new debt crisis?

What is “buy now, pay later”?

“Buy now, pay later” or “BNPL” is a new form of short-term financing that has become increasingly popular due to the huge growth of online shopping since start of the pandemic. It allows customers to split the cost of online purchases into smaller weekly or monthly payments.

For most customers, BNPL is a new and convenient way to spread the cost of their online shopping over a longer period. However, as the immense growth of the industry continues, concerns are growing around the lack of regulatory oversight.

The largest companies in the industry currently active in the UK are Klarna, Clearpay and Laybuy. Monzo, the challenger bank, has become one of the first UK banks to enter the market and PayPal has also launched its own version of the product.

BNPL providers are quick to claim that their services are offered with “no interest and no fees”, but is this really the case?

How do BNPL businesses make money?

BNPL companies enter commercial agreements with online retailers, promising an increase in both sales volume and the value of an average basket of goods.

The key advantage for retailers is that they can increase sales and also be paid the full amount for goods at the time of purchase (i.e. the risk of missed repayments lies with the BNPL provider). Retailers are happy to surrender a percentage of sale revenue to BNPL companies as a result.

The less well publicised source of revenue for BNPL companies is the charging of late fees and potentially interest to BNPL customers who miss their repayments. This may come as a surprise to many users who will inevitably have seen the “no interest, no fees” statements common across BNPL advertising. The exact revenue percentage BNPL providers make from these fees and missed payments is generally not disclosed.

What are the problems with BNPL?

The key difference between BNPL and other traditional credit lending is that it is not covered by existing regulation. One impact of this is the fact that credit reference agencies cannot see debt accumulated by individuals with BNPL companies, and BNPL companies cannot see whether a new customer already owes money to other BNPL providers.

BNPL companies often conduct ‘soft credit checks’ which is a basic search of certain information on a customer’s credit file, but the search remains invisible to other companies so it does not leave a ‘footprint’ or ‘record’ on the credit file. Critics claim this level of search is insufficient to assess whether a customer can really afford the credit being offered by BNPL companies.

BNPL’s reach has also extended to some surprising sectors. Zilch offers BNPL for grocery shopping at Asda, Tesco, Iceland, Aldi and Morrisons asking for 25% up front then payment by instalments. Some users of BNPL covered in the recent BBC Panorama episode claimed after using BNPL for a number of months they felt ‘trapped’ by the cycle of needing more of it to cover basic livings costs, particularly given the increasing cost of late payment fees adding up.

What happens if you miss your BNPL repayments?

A recent Equifax survey on BNPL stated that 43% of BNPL users have reported missing at least one payment since starting to use BNPL services. The exact approach to missing payments varies slightly across the different BNPL companies, but the consequences can be serious.

If BNPL users cannot pay on time, all BNPL providers will charge late fees which can add up to significant sums of money over time. BNPL companies like Klarna will stop users from accessing its BNPL services, but there is nothing to stop users going to another BNPL company and accruing further debt.

Where late fees go unpaid for some time, BNPL companies may transfer users to debt collection agencies who will use any means necessary to reclaim the money owed. This may include threats of bankruptcy and bailiffs coming to collect the funds which can be distressing to the users concerned. There can also be a significant negative impact on a user’s credit score if any formal debt collection processes are launched.

It is this damage to some users’ ability to use credit more widely that some commentators point to when they suggest that BNPL is contributing to a largely hidden debt crisis in the UK.

Should BNPL be regulated?

The Financial Conduct Authority (FCA) commissioned the Woolard Review in September 2020 to look at how regulation could support BNPL. The Report was published in February 2021 and concluded that BNPL products should be brought within the regulatory perimeter “as a matter of urgency”.

Concerns were raised about the fast growth in the industry and the fact more than one in ten major bank customers using BNPL were already in financial arrears. The FCA welcomed the report’s findings and agreed to work with the Treasury to agree appropriate regulation for the sector.

In January 2022 we are still awaiting news of the proposed regulations for BNPL. For any new regulatory framework to be effective, it will need to balance the advantages of this new and innovative form of credit against basic consumer protections to ensure users can afford the BNPL credit they are offered.

Options under consideration include the regulation of interest free credit agreements where a third party lender is involved (i.e. capturing BNPL companies but leaving direct merchant to consumer credit agreements exempt) or regulating agreements where there is a pre-existing relationship between the lender and the consumer (i.e. capturing BNPL providers who have agreed to finance one or more transactions where repayments go towards each transaction).