Over the last few years buy now, pay later (BNPL) has been enjoying a great deal of success. A popular form of a quick instalment loan plan that allows consumers to break up their purchase costs into smaller, more manageable interest-free portions, BNPL continues to rise in prominence, accounting for $97billion of all global e-commerce transactions in 2020.
However, despite its popularity, BNPL has been faced with a variety of challenges that are affecting the profitability of these types of lenders and the sustainability of the sector as a whole.
According to Rolands Mesters, the co-founder and CEO of Nordigen, the first free European open banking API that provides regulated connections to major European banks, there are lessons that can be learned from the success of the second Payment Services Directive (PSD2).
Here Mesters shares insight into what BNPL can learn from PSD2.
Hailed for its ease of use and quick, convenient application processes, BNPL allows customers to purchase higher-priced products and enjoy the satisfaction associated with instant gratification.
The credit scheme saw an increased rise in users propelled by the continued growth of the e-commerce sector and the reliance on online shopping during the pandemic.
Despite its popularity, BNPL has been faced with a variety of challenges that are affecting the profitability of these types of lenders and the sustainability of the sector as a whole.
While BNPL can be a strong option for customers interested in more manageable payment solutions for high-value items and for consumers looking to lower their monthly spending, the industry in its current state has revealed some significant flaws.
The overarching challenge of the industry is the lack of regulation. Within the EU, BNPL is not currently regulated, meaning there are no set rules and frameworks set in place to guide lenders and to protect their customers. If any issues were to occur, consumers would not benefit from the same safeguards that more traditional credit solutions offer and in case of complaints they are unable to seek alternative dispute resolution options.
In the event of problems with purchases, consumers are not guarded by customer protection legislations, such as the UK’s Consumer Credit Act. It is worth noting that a few of the large BNPL companies have made changes to terms that have been deemed ‘unfair’ after a significant push by UK’s regulator Financial Conduct Authority (FCA), however, it is currently not a requirement within the sector.
The reason why BNPL has so far escaped strict regulation is because the specifics on offer do not meet the criteria of EU’s current consumer credit rules. This is due to the fact that the current directive exempts firms offering credits with short repayment timeframes, no interest rates, and low to non-existent customer fees. This has allowed BNPL firms to set their own rules which may not always be favourable to their customer base.
These rules and risks are often not properly communicated to potential customers, leading to consumers taking out loans they cannot afford or agreeing to conditions which they do not understand. This is supported through data gathered by Which? that polled UK residents and found that a large number of participants did not fully grasp what BNPLs are and how they function, often seeing them as ‘money management tools’.
Instead of thorough creditworthiness assessments, BNPL firms perform ‘soft’ credit inquiries which usually entail looking at only some of the user’s credit datasourced from traditional credit bureaus, or relying on the customer to check their own financial history. This system is unreliable in the long-term as it doesn’t provide a substantial amount of data to analyse. It is also exacerbated by the fact that credit bureaus often rely on outdated financial information. This leads to inaccurate decisions being made, accepting customers who would otherwise be deemed a risk.
It is also not required to share soft credit check results with credit bureaus or other lenders. This can lead to loan stacking. As other firms are not aware of the customer’s other pending loans, new credit will be granted, often leading to some customers falling into debt holes, being unable to repay all their debt, and to loan defaults, which is one of the primary causes of BNPL firms’ profit losses.
With huge players such as Apple coming onto the scene with their own BNPL offering, it is clear that the sector still has a great deal of potential. One way to ensure a sustainable future for the industry is to regulate it, following the example of other successful directives, such as PSD2, which led to the emergence of open banking.
How PSD2 transformed the finance industry
The second Payment Services Directive (PSD2) was implemented in 2018 by the European Commission to help integrate a more efficient payments market. The main aims of the directive were to encourage healthy competition in the finance sector, to more efficiently protect customers and to regulate two emerging services, Payment Initiation Services (PIS) and Account Information Services (AIS). The former enables payments to be made on the behalf of the consumer, with their consent, while the latter allows information to be collected from customers’ bank accounts and stored in one place, enabling an aggregated view of their financial data.
The implementation of PSD2 revolutionised the financial sector, enhancing opportunities for fintechs, banks and consumers alike. Before the implementation of PSD2, banks were not required to grant access to client account information to third-party service providers (TPPs). With the directive, this changed and licensed TPPs could now create connections to banks through secure APIs, creating an opportunity for fintechs and banks to work more closely together and for new data-powered services and products to emerge. This led to the creation of open banking we know today, which allows licensed TPPs to connect to customer bank account data and utilise it for the improvement of customer-focused processes and applications.
Although sharing access to data initially raised concerns about data protection and potential security risks, the opposite has been found true as PSD2 imposed stricter safety regulations to protect customers.
Stringent security criteria that were lacking before were now set in place for electronic payments and the protection of consumers’ financial data, ensuring that all licensed players respected customer privacy. Stronger authentication methods, which were not previously compulsory, had to be implemented to add extra layers of security, such as Strong Customer Authentication (SCA), which required account owners to verify their identities through multiple factors including biometric elements.
In addition to stronger security features, more power was distributed to consumers. They now had more control over who had access to their data and user consent was required for sharing private information. PSD2 also required complaint authorities to be instated, to facilitate an easy process for consumers to air their grievances if there was a need for it. Customers’ liability was also reduced in relation to unauthorised payments and unconditional refunds were initiated to allow consumers to recover funds.
Bringing the long-term viability of BNPL through regulation
Although implementing regulation may seem like a limiting factor in a sector such as BNPL, the example of PSD2 showcases how an approach that takes into account benefits for both financial firms and consumers can lead to a sustainable and symbiotic future for the industry. Introducing consumer protection rules and more in-depth assessments will help protect customers from debt and lenders from credit losses.
One of the main factors that helped the BNPL industry thrive is the lack of friction during the application process. Added friction can be avoided by utilising already regulated fintech innovations, such as open banking, as part of the credit assessment process. Open banking is able to quickly tap into bank account information with customer’s consent, allowing the lenders to thoroughly analyse a large variety of financial data to determine creditworthiness. Not only would it lead to more accurate credit assessments, it would also allow an increased number of thin-file users to successfully apply as long as their data demonstrates that they are eligible.
BNPLs would no longer need to rely on soft credit checks and outdated credit bureau data, instead being able to view real-time, updated financial information, including concurrent loans and risky behaviour. This would in turn strengthen BNPL firms’ accountability, with open banking offering all required tools and data, guaranteeing that customer protection is prioritised.
Similarly, by distributing more power to consumers, their rights would be better protected through dedicated ways to voice complaints through official channels and through specific procedures to receive immediate refunds in the event of issues with products. This will make BNPL more transparent and more trustworthy in the eyes of customers.
Thorough explanations of BNPL services to clients before allowing them to take on new credit will weed out some of the customers who recognise that they are unable to repay. Clients who do sign up will then be fully aware of their responsibilities and the repayment rates will increase. Carrying out this transformation is critical for the industry’s long-term viability, and BNPLs, like open banking, will become a staple of the financial services sector if the essential improvements are made.