Regulation Beckons for BNPL

Regulation Beckons for BNPL

Back in the 90s, the American economist Clayton Christensen first used the phrase “disruption” to describe the process through which large incumbent companies were being usurped by smaller, more agile entrants into the marketplace. Fast forward three decades and the term “disruption” has become common parlance. Netflix disrupted the entertainment industry, Google disrupted traditional linear advertising, Airbnb disrupted travel… you don’t need an MBA to list off a couple examples of both disruptor and disrupted. 

NYU Professor Scott Galloway said that investors need only look at the most inefficient industries of today to figure out what is next in line for disruption. While a lot of his analysis focuses on the massive inefficiencies of higher education in the U.S., another industry that still retains some vestiges of inefficiency is finance. The rise of fintech from the ashes of the Financial Crisis is a testament to how overly complex the system was previously. Whereas before we had long and lengthy processes to do pretty much anything, now you can open a bank account in minutes, send money halfway across the world in seconds, or buy stock with no commission fees — all from the comfort of your couch. 

One area of finance that had been relatively undisrupted, however, was consumer credit lending. The humble credit card has managed to hang around for decades with little to no real innovation. That is, of course, until the rise of buy now, pay later (BNPL).

A few months ago, my colleague Anne Marie wrote a great piece about the BNPL landscape, but to give you the TL;DR, BNPL is a type of short-term financing that allows consumers to easily make digital purchases on credit and pay it off in installments — kind of like the old layaway plans used for big purchases like the family fridge or TV. 

However, because BNPL is usually offered at the point-of-sale (i.e. the checkout page of a website) and allows customers to make a down payment of as little as 25%, it has become incredibly popular for purchases of all sizes. This has led to a raft of BNPL companies popping up like Affirm and Klarna, as well as big operators like PayPal and Square also moving in to get a piece of the pie. 

A recent survey by C+R Research showed that about 60% of U.S. adults have used BNPL when buying products. Of those who’ve used it, 80% plan on using it for holiday gift-buying, according to data intelligence firm Morning Consult.

So it seems that BNPL is set to be the next major disruption in the financial industry. However, last week the Consumer Financial Protection Bureau announced that it was opening an inquiry into the companies that are leading the charge with BNPL programs. With new records of lending expected to be reached in the U.S. this holiday season, the CFPB has issued orders to all of the above companies (and more) to collect information on how their services affect the accumulation of debt, regulatory arbitrage, and data harvesting in the consumer credit market.

So what does this mean for the burgeoning BNPL industry?

Right now, probably not a lot. Though the announcement of the CFPB inquiry rattled the stock price of companies involved, it appears that the agency is trying to fully comprehend how these companies operate in terms of using consumer data (the hot topic of the day!), as well as how consumers themselves are using the services. 

However, one growing trend related to disruption in the financial industry is a kickback against making things too easy to access. In the investing world, for example, zero-fee brokers like Robinhood have faced a lot of criticism in recent years for allowing inexperienced investors access to complex financial instruments like options. This led to a lot of investors making trades in the past couple of years that they didn’t fully understand. In many cases, a lot of money was lost. In some cases, it even led to tragedy.

Though BNPL is similar in concept to the layaway plans of old, the apparent trend of consumers using the service for smaller purchases is slightly concerning. Similar to the way you shouldn’t use your credit card to buy a carton of milk, using these payment plans for smaller purchases is encouraging consumers to kick the financial can down the road while taking on debt almost immediately. With the Wall Street Journal reporting that Equifax will start tracking payments on more BNPL plans from early next year, the risk that availing of these plans could damage consumer credit scores is serious.

Ultimately, it’s unlikely that such an inquiry will halt the rise of BNPL though. What we are likely to see is BNPL being further incorporated into the ecosystems of larger companies that already offer a suite of financial services. PayPal is already in the space, with CEO Dan Schulman saying the use of BNPL surged 400% on Black Friday. Square is in the process of buying AfterPay. With regulation of some form likely on the horizon, these are also the companies that will be able to stomach any changes to the process best.