The popularity of buy now pay later (BNPL) continues to grow but many users remain unaware of the risks. Chris Laverty and Jarred Erceg look at the impact of regulation, as well as the effect of increasing competition and current investor demand on the sector.

In 2023, nearly half of adults (48%) in the UK used BNPL to spread the cost of purchases. The total amount spent using BNPL rose to £16.8 billion, a 12.8% increase from 2022. Given the total UK spend online in 2023 was 1.3% less than 2022, this only illustrates the increasing popularity of BNPL as the impact of the cost-of-living crisis continues to affect consumers.

However, 22% of BNPL users have missed one or more repayments in the six months to December 2023 and been charged late repayment fees, according to research that shows people are turning to BNPL to cope with inflation and rising living costs. More than a quarter of these people had a negative impact on their credit score or were contacted by a debt collection agency as a result.

Consumers miss repayments but still unaware of BNPL risks

As consumers continue to struggle with the impact of the cost-of-living crisis, BNPL firms are contending with a greater proportion of customers facing financial difficulty, leading to rising default rates and pressure on profitability. This is a particularly pertinent issue for firms given the high volume, low margin nature of the sector and that the FCA believes 50% of consumers will be considered vulnerable at some point. BNPL providers have a tricky path to navigate – originating enough loans to support sales and meet the expectations of retail partners, while ensuring that credit losses are limited.

The FCA also remains concerned that too many consumers are unaware of the risks of using BNPL. According to FCA research, nearly one in five users (19%) report being unaware of the fees charged by their provider. This means a reasonably large number of users are unaware of the full potential cost of using BNPL.

The impact of regulation

Should the sector be regulated, consumers will have the right to complain to the Financial Ombudsman Service if they feel they were mis-sold or unaware of risks, increasing the possibility of actual or contingent compensation payments. This has been a significant issue for other sectors in the past, (for example, high-cost short-term credit), where redress payments have contributed to the exit of several market players. BNPL firms will need to ensure they embed the comprehensive FCA rules around assessing affordability and the treatment of customers in financial difficulty into their processes.

FCA research published in October 2023 has found that BNPL usage is associated with higher use of other credit products, including high-cost credit, and signs of falling into difficulty with debt. Analysing other credit usage (loans, credit cards, overdrafts) showed that 41% of BNPL users used other credit more, while only 10% used other credit less. The impact of the cost-of-living crisis will have pushed consumers into taking on more debt. The withdrawal of many consumer credit lenders from the market will also have affected these figures.

However, management need to view these statistics through the lens of the Consumer Duty rules as they may need to evidence to the FCA that their BNPL services are delivering good consumer outcomes and not encouraging consumers to take on debt they can't afford.

Regulation will also mean some BNPL firms will need to undertake more rigorous affordability checks to the extent there are concerns around current processes. Careful consideration should be given to whether increased credit checks and more comprehensive affordability assessments will lead to higher rejections of applications and what the consequence of this may be profitability.

Still no clarity on the timing of regulation

Despite the government’s Woolard Review recommending ‘urgent’ regulation back in February 2021, it was reported in July 2023 that Treasury officials were considering delaying the introduction of regulation. Following this, a coalition of consumer advocates and debt advice groups wrote to the Chancellor urging him to proceed.

Labour has made BNPL regulation a pledge in its election manifesto, creating a dividing line with the Conservative party, saying it will‘bring forward long overdue consumer protection regulation in areas like buy now pay later.’ We can therefore hope for more clarity after the election, expected later in 2024.

The FCA continues to work to support consumers ahead of full regulation, for example via a Dear CEO letter reminding BNPL firms of their obligations around financial promotions (as set out in Section 3 of the Consumer Credit sourcebook). In October 2023, PayPal and QVC changed the terms of their contracts to make them ‘clearer and fairer’ after the FCA expressed concerns that customers were at risk of harm due to how some of the contract terms were drafted.

Business models tested by competition and softening investor interest

The market share of existing providers is being challenged as larger banks enter the market. NatWest, Virgin Money, HSBC and Monzo all now provide BNPL products, benefiting from existing credit card networks and internal credit risk processes. Global tech firms, such as Apple, have also entered the market; with Apple immediately becoming a significant player due to its leading position in the digital wallet market. This increased competition is likely to put a downward pressure on margins.

BNPL firms may also be experiencing softening investor interest. While Klarna has recently reported its first quarterly profit in four years, many BNPL firms are loss-making. In a recent sector report by Moody’s, the ratings agency questions how long investors will continue to back the sector after several years of losses, especially as the cost of funding is higher. Moody’s suggests that BNPL firms now need to focus on profit rather than increasing market share: “If losses are not contained, and new equity injections are not secured, then many BNPL will deplete their equity over the next few years.” This strategy is echoed by David Sykes, Chief Commercial Officer for Klarna: “It’s very clear that the markets are looking for something different now. It’s not about future growth; it’s about profitability today.”

In trying to increase profitability, firms face a delicate balance in setting a level of consumer fees and charges that will be acceptable to a future regulator versus setting the merchant fee where increases may negatively impact retailers already operating in a challenging market. BNPL firms will  be cognisant of a high level of competiveness with other BNPL firms wanting to work with retailers. 

Regulation and market forces may create stress for firms

Regulation will ensure consistent standards are adhered to across the industry. However, the impact of regulation and cost of compliance, combined with other market challenges in the sector, may also create stress for some firms. When the regulation of high-cost short-term credit (HCSTC) was introduced in 2014, 38% of HCSTC providers exited the market by March 2016 through withdrawing, not applying for authorisation or going into a formal insolvency process.

For the BNPL sector, some players may choose to exit the market, some will be acquired, some may have periods of significant restructuring, both operationally and financially to deal with future regulation and the impact to historic portfolios. Those that survive will need to ensure they have a sustainable business model and are operationally resilient, with robust internal controls to withstand the increased burden of regulatory compliance and the evolving consumer finance sector.

For more insight and guidance, contact Chris Laverty or Jarred Erceg.