The Woolard Review, commissioned by the FCA to review the unsecured credit market, has recommended that buy now pay later (BNPL) firms should be regulated "as a matter of urgency". Chris Laverty and Jarred Erceg look at what this means both operationally and financially for firms in that sub-sector.
The Woolard Review
There's been increasing and well-documented concern about the BNPL sector. Use of BNPL nearly quadrupled in 2020 with 11% of consumers (5 million individuals) saying they had used a BNPL product since the start of the COVID-19 situation.
While acknowledging that BNPL can provide a cheaper alternative to high-cost, short-term credit (HCST), the Woolard Review identifies several areas of potential harm, including:
Many BNPL providers currently complete ‘soft’ credit checks. However, these focus on credit risk to the provider, rather than affordability of the consumer.
Potential to create high levels of debt
A recent survey revealed that 24% of BNPL users spent more than they planned because BNPL was available at the checkout1. Consumers can access multiple BNPL offers from various providers, rendering credit limits at individual providers meaningless.
Skewed business model
As BNPL business models rely on merchant fees, there is concern that the overall consumer journey is designed to drive sales "without due consideration for the affordability of the commitment the consumer is taking on".
Lack of consumer awareness
Consumers are not always aware they are taking on debt, or what the consequences of non-payment are.
Impact on wider credit markets
BNPL providers are not required to report repayment history to credit reference agencies (CRA) and, therefore, other consumer finance providers are not able to have a complete view of a consumer's financial position when assessing for affordability.
BNPL to be regulated by the FCA
As a result of this review, BNPL will be brought under FCA regulation. This means BNPL firms will be required to undertake affordability checks and consumers will have the right to complain to the Financial Ombudsman Service (FOS). As with other regulated entities, BNPL firms will need to evidence operationally robust processes and sustainable financing, and have a wind-down plan in place.
Processes need to be developed and staff trained, all of which take significant time and financial resource. Will a more onerous application process reduce consumer take up of BNPL products? Management should consider what this might mean for a firm’s revenue streams at a time when additional investment is required.
In addition, the withdrawal of government support, such as the furlough scheme, could lead to higher default rates, further affecting a firm’s liquidity position. Cash flow modelling and stress-testing for different scenarios will help provide better clarity on working capital requirements and indicate whether additional funding might be required.
Affordability assessments must meet FCA requirements
While the exact regulatory details for BNPL firms have not yet been confirmed, the FCA’s approach in other areas of consumer credit provides a useful guide.
While some BNPL firms already undertake ‘soft’ credit checks, it's now a firm’s responsibility to ensure that these affordability assessments are as accurate and robust as possible. Firms should ensure that any automated data gathering processes are granular enough to pick up all income and expenditure items, including debts with other lenders.
On a recent FCA webinar, the FCA raised concerns that automation can often miss key expenditure items and questioned whether an automated process was suitable for all types of customer. This is something that BNPL firms should bear in mind.
Firms will also need to put in place robust measures to monitor affordability on an ongoing basis for repeat customers. The FCA have previously highlighted poor relending practices in other areas of consumer credit, criticising firms who rely on historical information or prepopulate application forms, so it's unlikely that these practices will be allowed.
Part of assessing affordability means identifying vulnerable customers. The FCA expects that, once-flagged, these people experience a more-appropriate, tailored customer journey and so BNPL forms will need to ensure they have suitable processes in place to cater for these vulnerable customers.
Importantly, BNPL firms need to be extremely transparent in their affordability assessments, maintaining detailed records. These will be vital in the event of any customer complaints to the FOS to mitigate risk of damaging redress claims.
The impact of customer complaints and redress claims
Once under FCA regulation, BNPL customers will be able to refer complaints to the FOS, especially where they took on debt that they then feel is unaffordable. Given that Resolver, a free complaints website, received 4,962 complaints about BNPL credit from April to September 2020, up 22% on the previous six months2, this is significant.
It's also likely that claims management companies will start to play a part, which has the potential to considerably increase the number of complaints. In the HCST sector we saw an increasing number of affordability complaints after the FCA implemented stricter regulations. In several recent restructurings of HCST lenders, the claims generated by CMCs were a significant factor in the firm’s liquidity concerns or ultimate demise.
The consequences of claims against a consumer credit firm are much wider than any redress payments that need to be made to the customer. Management should be aware of the cost involved in the claims management process, including training and resource required to look back at records to adjudicate those claims.
The FOS requires that each claim should be looked at on its own merits, which makes it difficult to automate the process entirely. The claimant always retains the right to be referred directly to the FOS, which brings an automatic £650 case fee, regardless of the outcome.
BNPL firms should consider how coming under the FOS’ remit will increase complaint volumes and include all these strands of cost in their forecasts to understand what impact this may have on both their operations and cash flow.
BNPL firms should prepare now
It's not yet clear when regulation will take effect. The FCA will consult on how to implement regulation, with reporting by the FCA board currently scheduled for a year’s time. We'll write again once more regulatory details are known.
BNPL firms will welcome the fact there will be common standards across all providers of BNPL products, and now is the time to prepare. Those firms who can implement robust systems and processes and prove their operational readiness will be best placed to retain the confidence of both the regulator and the consumer.