Banks seek to provide the benefits of BNPL amid regulatory concerns

Banks entering the buy-now-pay-later market will find significant competition as well as potentially some allies.

By John Hintze

New payment models sometimes referred to as “layaways on steroids” are rapidly gaining in popularity. While some models appear to fit under the current regulatory regime, enabling consumers to spread payments for big ticket items, others are raising concerns.

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Layaways, in which consumers make a set number of payments before taking home a reserved item, such as refrigerator or washing machine, have long been a merchant sales tool to facilitate purchases. That changed more than 13 years ago when Swedish fintech firm Klarna stepped in as an intermediary and offered plans at the point of sale that divided payments into three or four interest-free installments over a month or two, says Stewart Watterson, strategic advisor, retail banking and payments, at Aite-Novarica group.

Such plans, originated and underwritten at the point of sale, then took hold in South America, especially Brazil, Watterson says, and later in the U.S. with the launch of Affirm Holdings in 2012. A wide variety of fintech firm intermediaries currently offer the so-called buy-now-pay-later (BNPL) plans, with their global market size valued at $141.8 billion in 2021 and anticipated to grow at a compound annual growth rate of 33 percent through 2026, reports GlobalData.

However, the BNPL model, which facilitates sales similarly to credit cards, has come under scrutiny by the Consumer Financial Protection Bureau, which in December 2021 announced requested information from five major BNPL providers and noted it is pursuing its inquiry alongside regulators in Australia and Europe. In September, the CFPB published insights from its study that confirmed the BNPL market’s rapid growth and uneven consumer protections.

The CFPB specifically identified plans that “split a purchase into smaller installments, typically four or less, often with a down payment of 25 percent due at checkout.”

The description of those plans, often referred to as “pay-in-4” plans, is important because it describes the BNPL products the CFPB is focusing on–typically agreements between BNPL fintech firms and merchants—from those now involving banks, which are eyeing the consumer demand for the shorter-term alternatives to traditional bank products. U.S. Bank has stepped into that market, for example, by enabling consumers to bundle several credit-card transactions into a term loan that is paid off monthly over six to 24 months, and for which the bank assesses a fee each month.

The bank’s product provides the convenience of a single, shorter-term loan at a lower rate than outstanding credit-card debt, but it also resembles more traditional bank products, providing monthly statements and more borrower protections. The U.S. Bank product was developed in-house, and the term plan is originated after the credit-card transactions, another difference from the typical BNPL’s point-of-sale approval.

‘That tells you something may be starting to run a bit amok.’

Scott Pope, SVP for payments, CRO risk and compliance at U.S. Bank, said at the American Bankers Association’s 2022 Regulatory Compliance Conference that the bank is looking to launch other products in the BNPL space. He added that he also sees a use case for pre-purchase models, where consumers can establish short-term plans upfront to pay for large purchases, and it currently is working on providing point-of-sale BNPL products, in which fintech firms would act as intermediaries.

“We’re working out a way for us to partner with them to perform the credit underwriting and the AML/CIP checks upfront,” he said, and the bank would perform any additional due diligence deemed necessary, hopefully also in real time.

“We would be the lender of record as well as the funder,” he said.

Those roles are split respectively between Cross River Bank and Goldman Sachs in their partnership with Opy U.S., a subsidiary of Australian fintech Openpay Group, which launched BNPL products eight years ago. Opy U.S. and its banking partners launched their first BNPL in the U.S. in 2021, specifically targeting consumers funding home or auto repairs, medical procedures and other larger ticket purchases.

Gary Stein, chief product and compliance officer at Opy U.S. and a nine-year alum of the CFPB, says those verticals are especially attractive because consumers have relationships with the service providers that engender a certain loyalty toward them and a desire to pay for those services.

The products also tend to have a longer payment schedule and charge a financing fee for each payment similar to U.S. Bank’s approach, features that Stein said set Opy U.S. apart from its “frenemies” in the marketplace.

“We are collecting something from the consumer,” Stein said.

That contrasts, Stein added, with the with BNPL products the CFPB is reviewing in which consumers make payments every few weeks for a few months, with no interest or finance charges to remind them of their debt, and for items with much lower price tags. In an extreme example, restaurant chain Chipotle uses BNPL fintech ZIP to allow customers to pay for their purchases in four installments over six weeks.

“That tells you something may be starting to run a bit amok,” Stein said.

He added that the short-term and zero-finance features of the products may mean they’re not subject to the Truth and Lending Act requirements set out in the Federal Reserve’s Regulation Z rules. In fact, “regulatory arbitrage” is one of the justifications the CFPB states for its inquiry. Its December announcement specifically identifies Affirm, Afterpay, Klarna, PayPal and Zip, and adding that BNPL companies may not be adequately evaluating which consumer protection laws apply to their products.

“For example, some BNPL products do not provide certain disclosures, which could be required by some laws,” the CFPB points out, adding while BNPL applications may look similar to a standard checkout with a credit card, the same protections do not apply. In addition, many BNPL companies do not provide dispute resolution protects available to other borrowers. And different late fees and policies apply.

Risks for the consumer

Another CFBP concern is that consumers may quickly become regular users of BNPL for everyday discretionary buying, “especially if they download the easy-to-use apps or install the web browser plug ins.” Keeping track of multiple purchases on multiple schedules may become difficult, resulting in bank-account overdrafts and charges by the consumer’s bank and BNPL provider.

In fact, the regulator’s study found that the five BNPL lenders originated 180 million loans totaling more than $24 billion in 2021, nearly a tenfold increase over 2019, and they extended loans to a broadening array of products. In addition, their loan approval rates rose by nearly 6 percent in 2021 over the previous year, despite consumers’ increased financial stress in the second year of the pandemic, and at least one late fee was levied on 10.5 percent of unique users in 2021, up from 7.8 percent in 2020.

The CFPB notes that consumer use of BNPL spiked during the pandemic and saw “massive growth” during the Black Friday and Cyber Monday shopping weekends in late 2021. Banks entering the BNPL market will find significant competition and potentially also allies.

“This explosive growth has caught the eye of many investors, including significant venture capital money. Big tech companies are also entering the arena,” the CFPB adds.

BNPL products were originally designed for cash-oriented consumers with scant credit histories, and they have become more prevalent in the last five to seven years, Watterson says, as alternative-underwriting methods have become more mainstream. Traditional credit scores from agencies such as Equifax and Experian comprise credit histories that include conventional loans and credit cards, he says, while “alt data” looks at a consumer’s record for paying utility bills, rent and other nonfinancial transactions, as well as subprime borrowings that may not be reported to the agencies.

In its report, the CFPB noted debt accumulation and overextension as one of the “areas of risk of consumer harm.” The regulator says BNPL is engineered to encourage consumers to purchase and borrower more, resulting in the accumulation of several loans within a short term frame.

“Because most [BNPL] lenders do not currently furnish data to the major credit reporting companies, both [BNPL] and other lenders are unaware of the borrower’s current liabilities when making a decision to originate new loans,” the CFPB adds.

Inconsistent consumer protection is another potential harm listed in the study, since BNPL products may not offer the protections found elsewhere in the consumer financial marketplace, such as standardized cost-of-credit disclosures, and may force consumers to opt in to autopay and levy multiple fees on the same missed payment. The study also found that BNPL lenders are increasingly shifting their business models to “proprietary app usage,” enabling them to collect and sell customers’ data, threatening their privacy.

“We will be working to ensure that borrowers have similar protections, regardless of whether they use a credit card or a [BNPL] loan,” says CFPB Director Rohit Chopra.

John Hintze is a frequent contributor to ABA Banking Journal.