How could the BNPL regulatory update impact risk assessments?

The UK Treasury recently published a consultation on how it will regulate BNPL, potentially making the UK the first major credit market to regulate these booming, innovative products.

The FCA said the sector quadrupled to £2.7bn last year during the pandemic - to about 1% of the UK’s entire credit market - with more than 5 million active users. Three-quarters of them are aged 18-36 and mostly buy clothes and shoes.

The Treasury’s plans would mean some big changes to the BNPL business model and consumer experience.

Here’s what we expect to see…

Key points in the consultation

But first, let’s recap on the key points from the consultation:

●      The Treasury wants to keep BNPL in the UK as it’s seen as less risky than credit products with interest rates and also as a valuable new source of credit for consumers and retailers.

●      Regulation will be lighter than for credit cards (or other types of consumer credit) but it will still be a big change for many BNPL providers.

●      Providers will be subject to a lot of the rules in the Consumer Credit Act and to the requirements of the FCA.

Important details are still to be decided, but to help protect consumers and credit providers now, the Credit Referencing Agencies will be working closely with firms, the FCA and the government on creditworthiness assessments and fair debt collection.

How we expect this to shape credit risk assessments and collections

There has been at least some evidence that firms operating in the UK are being preemptive and proactive about the anticipated regulation of the BNPL sector.

However, currently BNPL credit providers are adopting different approaches when screening new customers - some only check ID Verification, others check affordability, and those that are predicting the regulations will tighten are conducting both soft and hard searches.

The Treasury udpate will mean that those not conducting soft and hard searches, will have to do so alongside affordablity checks and the BNPL providers will be required to share transactional data with the bureaux to protect consumers from over indebtedness.

Right now, it isn’t clear how multiple transactions from a consumer in a short period of time (and with several retailers) might affect their credit score. It will depend on the type of footprint logged against their credit file and how the bureaux treat the aggregated exposures and volumes that drive the credit score.

How Klarna has made changes

While regulations are still in the early stages, mitigating risk and protecting consumers from bad debt is already something the BNPL industry is tackling.

Ahead of the update, Klarna (one of the biggest providers of BNPL credit) made major changes to its services – including:

·       New wording to make it “absolutely clear” to customers that they are being offered credit, with penalties for missed payments

·       A pay now option alongside its offer to spread payments over several weeks/months

·       “Stronger credit checks” (leveraging open banking data) to prove they can afford repayments

·       Removed late fees from its longer-term repayment plans of 6 months and over.

Better protecting consumers, and credit providers

For consumers

In terms of fair credit risk assessments and collections, the update will no doubt help protect consumers from overspending/spending beyond their means. With more visibility of previously hidden BNPL credit, credit worthiness assessments can help ensure that consumers don’t take on debts they cannot reasonably pay across all credit risk products.  

What’s more, like with the Klarna example, education and transparency of the terms and repercussions will be essential.

For credit providers

Responsible lending protects both parties for obvious (debt) reasons. The challenge is that many bad loans come from first-time borrowers who may not have much credit history to inform lending decisions.

It’s likely credit providers and lenders will increase their spend with the bureaux due to needing additional data sets and volume of searches to on-board and monitor these new customers.

For example: An individual may use a single credit card which was credit checked on application and monitored. The same individual may be checked several times with different BNPL providers when shopping with different retailers over a short period.

The future of BNPL

There is clearly demand for instant access credit options, particularly amongst the younger generation, and this is unlikely to go away as this generation helps to boost the UK economy after the lifting of lockdown restrictions - with a particular focus on spending on clothing.

Credit providers can take precautions today to better protect consumers, themselves and help support economic growth – whilst giving consumers what they want.