The FCA never met a credit innovation that they didn’t immediately want to wrestle to the ground.
But we can’t really blame them.
Innovation in credit products is generally about finding ways to lend more, more profitably.
This inevitably leads to concerns for vulnerable consumers and the FCA’s role is to minimise customer determent.
Sometimes that regulation is so wide-sweeping or strict it rightly or wrongly gets the blame for squeezing out entire industry segments and even decades-old businesses. Payday loans and doorstep lending are two recent examples; although in the case of the Payday loans the number of specialist lenders has gone down while consumer borrowing has gone up.
Does this suggest that the FCA’s regulations have had the desired effect?
Now, the FCA has turned its attention to Buy Now Pay Later (BNPL) products, typified by lenders such as Klarna, Clearpay and Laybuy (the three largest BNPL lenders in the UK), which allows consumers to indulge in some retail therapy and then spread or delay payments. At the time of writing, the FCA has closed its window of consultation and now it’s simply a matter of waiting and seeing whatever regulation or legislation they deem necessary.
If you have a BNPL product as part of your business, or you’re thinking about creating one, should you simply sit on your hands and hope that the FCA’s ruling is equitable?
Or is there something you can do now to predict the FCA’s decisions and make preparations?
The answer is “probably” and “absolutely” – in that order.
It’s simply a case of getting our heads around exactly why BNPL has caught the FCA’s attention and why the solution is far from straightforward.
Innovation Doesn’t Happen in the Middle of the Road
When a popular and profitable credit innovation appears on the scene it frequently aims to make it easier and faster for people to borrow and for lenders to be able to increase the range of people they can qualify.
But because the goal of these innovations is typically focused on increasing the lenders’ profits, this can sometimes be at the expense of people who can’t afford to borrow or who don’t know how to assess the affordability of the credit they’re being offered.
Of course it would be great if there was a middle ground in which innovation perfectly balanced profitability with protection of vulnerable consumers, but it would be naïve to expect the industry not to follow the money.
We can have the capitalism argument another time, but for now let’s look closer at why new BNPL products have achieved such rapid success, and why it attracted the attention of the FCA.
No Checks… No Problems…
BNPL as a credit product isn’t new. What makes this new wave of BNPL products original is that, because it’s funded by the vendor, it typically comes with 0% APR and doesn’t always require any credit checks.
For example, a customer can bring £100 of shoes to the checkout, and agree to a 3-month BNPL. The store pays the lender a set fee for the transaction, and the consumer pays back the loan in interest-free instalments.
On the surface this looks like a win for everybody. The vendor makes more sales, the customer gets more new stuff quickly and easily, and the lenders make consistent, predictable profits.
But it’s the very frictionless nature of the process that concerns the FCA.
Because BNPL is not classed as credit, no credit information is recorded with the bureaux. This, in theory, allows consumers to rack up repeated credit purchases with different lenders and overextend their ability to repay the BNPL loan.
It also means that other lenders that DO rely on credit checks have no way of knowing if their prospective customer has recently racked up thousands in BNPL loans. Again, running the risk of a consumer racking up more debt than they can afford to repay, and leaving other lenders with delinquent accounts.
If, at this point, you’re wondering why the BNPL is exempt from current FCA rules, you’re asking the question that is at the heart of why this issue is so contentious and why many businesses are waiting for the FCA’s ruling .
All Businesses Buy Now and Pay Later
There’s an old Asimov short story (The Dead Past) about a technology that allows people to literally look into the past and view famous scenes from history. But it’s restricted because people realised that the past also includes things that happened mere milliseconds ago, and they now have the ability to spy on anybody anywhere, virtually in real time.
It’s a similar issue with BNPL. Any time you have a situation in which you receive your goods or service before you pay, a BNPL is technically in effect, even if the gap between the two events is mere seconds.
Most businesses, for example, are accustomed to purchasing items from vendors as and when they need them and then settling the bill at the end of the month.
Many service providers work under an arrangement in which they receive 50% of the payment in advance, and the remaining 50% on completion.
Every time you go to a restaurant, you eat their food first, and then settle up at the end of the evening (Nandos, I suppose, is one notable exception).
All of these instances are, technically-speaking, BNPL arrangements.
This might sound like splitting hairs but this is the challenge the FCA is facing. Any regulations it creates to address the proliferation of BNPL products in new markets and segments, needs to avoid adding onerous friction to established business practices.
Imagine if every time you visited a restaurant you were required to go through a credit check before you’re offered a table!
Obviously this isn’t going to happen, but that’s why it’s still unclear how the FCA is going to tackle this. How do they define the BNPL products they want to regulate, without unintentionally affecting every other business in the country?
And even if they can thread this needle, will the FCA be able to regulate this new sub-industry without destroying its profitability?
Getting Ahead of the Curve
The FCA is well aware of the difficult balance it needs to achieve, and it would be amazing if they nail it with the first round of regulations. We can expect this story to rumble on for some years, which is why a “wait and see” approach is ill-advised.
Whether you already have a BNPL product, or in the process of creating one, it makes sense to try and get ahead of the curve.
If you can predict the moves the FCA is likely to make, you can start making adjustments now that will hopefully avoid the need for messy, knee-jerk changes further down the line.
And the answer to this thorny question is actually simpler than you might expect.
As a lender, you don’t have the challenge of trying to find a definition of BNPL that takes in these new products but excludes the casual BNPL operations that most businesses rely on. Instead skip to the end of the equation.
The bottom-line is that the FCA wants to protect vulnerable consumers from over-borrowing. And naturally, it’s in your financial interests to do the same. Because the profits from these BNPL products come from the vendors rather than the consumers, a certain level of bad debt can be absorbed, but that doesn’t mean that profits can’t be improved by keeping loan defaults to a minimum.
As long as you can accomplish this without adding excessive friction to the process, this will maintain or improve profitability, while also bringing you into line with the requirements that the FCA are likely to impose.
For example, you could put a customer’s first purchase through with minimal checks, ask for a little more information for repeat business, and then move to a credit check on the third or fourth purchase.
Alternatively, you could scale it based on the overall amount borrowed and the materiality of that borrowing to the customer, only increasing the level of checks once a certain level is exceeded.
And even when you reach a point at which you decide to implement credit checks, using a modern decisioning system you can ensure swift decisions that don’t require manual reviews.
In some ways, the fact that informal BNPL arrangements have existed in the business world for so long makes it less likely that FCA will take a heavy-handed approach or seek to squeeze these BNPL products out of existence.
This is good news for both the lenders who offer BNPL products and the consumers that enjoy them responsibly.
If you offer a BNPL product – or are thinking of doing so – talk to one of our modelling specialists about how GDS Link can improve and modernise your lending technology.