Testify Now, Regulate Later: BNPL Goes to Washington
I Reached Out to Klarna & Sezzle For More Context
Hey all, Jason here.
It’s November, and, especially with the ongoing supply chains issues, you know what that means: Christmas shopping season is already firmly underway. One fintech product is set to have a blockbuster holiday season: Buy Now, Pay Later. It’s also getting attention from legislators and regulators. In this week’s issue, we go deep on last week’s Congressional hearing on the category.
On the topic of holidays, if you’re in NYC, Nik Milanović (of This Week in Fintech) is organizing a Fintech Formal on December 2nd — you can learn more & RSVP here (I have FOMO already!)
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Testify Now, Regulate Later? Buy Now, Pay Later Goes to Washington
If you’re not an avid C-SPAN watcher, you may have missed last week’s House Financial Services Committee hearing.
Held by the task force on financial technology, the hearing, titled “Buy Now, Pay More Later? Investigating Risks and Benefits of BNPL and Other Emerging Fintech Cash Flow Products” was primarily focused on the exploding buy now, pay later category, though it also including written testimony and discussion of earned wage access products, “fake” earned wage access (as described by consumer advocacy groups), and overdraft avoidance products.
Within the BNPL category, the hearing focused exclusively on “split pay” products, popularized by firms like Klarna, Sezzle, and Afterpay and now offered, in various formulations, by companies including Affirm, Paypal, and, increasingly, established banks and credit card issuers.
I’m not a frequent watcher of these hearings, and, I will say, I was generally pleasantly surprised at the depth of understanding and quality of questions from Congresspeople from both sides of the aisle (personal anecdotes of ‘when I was a kid’ waiting tables at Applebee’s or getting an employer pay advance when a steelworker in the 1970s notwithstanding).
Please Raise Your Right Hand
It shouldn’t come as a surprise that most of the witnesses testifying (and politicians asking questions) at the hearing had fairly obvious agendas. The hearing included written statements, an oral summary, and Q&A with:
Dr. Kristen Broady (Brookings Institution)
Penny Lee (Financial Technology Association)
Lauren Saunders (National Consumer Law Center)
Marisabel Torres (Center for Responsible Lending)
Brain Tate (Innovative Payments Association)
While testimony from trade associations like the Financial Technology Association (represents BNPL companies like Klarna, Sezzle, and Afterpay but also Stripe, Plaid, Wise, Ribbit Capital, and others) and the Innovative Payments Association (various banks, prepaid providers, and earned wage access companies) generally cast emerging fintech products positively, consumer advocacy groups NCLC and CRL saw opportunities, especially in BNPL products, but highlighted risks and advocated for increased regulatory scrutiny.
The trade associations are limited in their ability to speak to specific practices and consumer outcomes, and it would’ve been preferable to see executives from BNPL companies themselves provide written statements and be available to answer questions — that’s why I reached out to the teams at Klarna and Sezzle for some additional context (more on that below).
Brookings Institution
Dr. Kristen Broady of the Brookings Institution, a non-partisan think tank, focused on the racial wealth gap in her written testimony and highlighted opportunities for fintech to help close the gap. In her testimony, she notes:
“Data and research show that Black people have on average higher unemployment rates, lower earnings, lower rates of homeownership, and pay more for credit and banking services – all factors that result from a history of structural racism in the U.S. These factors contribute to vast disparities in financial health, and wealth creation and accumulation between their households and white households. The ability of Black households to spend, save, borrow and plan – within the context of structural racism – can be used to explore the nuances of disparities in financial health and wealth creation.”
The fintech opportunities Dr. Broady argues can help close this gap include:
Cash flow smoothing products for thin/no file consumers
Interest-free buy, now pay later products (specifically cites Klarna)
Products to help save and invest, like high-yield savings accounts and automated/micro savings and investing tools
Use of alternative data and machine learning to extend affordable credit to more consumers
This is a pretty standard industry laundry list of products that the companies that offer them typically put forth as “transparent,” “democratizing financial services,” and “expanding choice access, and inclusion.” Which, for the most part, is true!
But some of these products also exploit gaps in regulations that were designed decades ago and may not always be as “transparent” or supportive of financial health as they purport to be.
Regardless of fintech companies’ alleged good intentions, these products deserve equal regulatory scrutiny to existing products and services. This may require Congress, the CFPB, and other banking regulators to expand or update the regulatory perimeter to provide clear guidance for novel products.
The Brookings Institution’s Dr. Broady also highlights a host of other policy proposals that could help close this racial wealth gap (and, I would argue, generally be supportive of low/moderate, volatile income and credit-challenged consumers), including:
Mandatory financial health curriculum for middle and high schoolers
Enhanced broadband and 5G deployment
Raising minimum wage for companies with over 500 employees
Financial Technology Association
Of those testifying, Penny Lee of the Financial Technology Association, representing BNPL providers, was the most unabashed advocate of the product category, describing it as reducing debt and alleviating consumers’ budget stress.
In her written testimony, she stated, “BNPL solutions are being offered to solve pain points associated with traditional payment options, including high cost revolving debt, harmful credit checks, and over-indebtedness.”
She compared BNPL products favorably to credit cards, arguing that:
They are lower cost, charging little or no interest or fees
They are more transparent, which helps consumers understand and thus control their finances
Help users budget, and thus better manage cash flow and avoid “risky” debt products
Are more flexible
Result in less debt and repayment that takes place over a shorter period of time
These are the standard talking points in any discussion about BNPL. And while they appear reasonable on their face, they focus narrowly on how a consumer uses a single BNPL provider, rather than holistically on how using one (or multiple) BNPL providers to finance purchases impacts a consumer’s overall financial health.
The reality is, because BNPL generally do not underwrite using bureau data nor report usage back to bureaus, it’s difficult if not impossible to know how BNPL usage impacts consumers’ overall financial health.
Recent TransUnion data found that users of point-of-sale loans (higher dollar amount, longer term loans that are reported to CRAs) were more likely than the general population to have increasing card balances — meaning POS loans weren’t replacing card balances, but rather enabling these consumers to take on additional debt. The same could be true with “split pay” BNPL — the reality is, deterministic data isn’t available to answer this critical question.
Ms. Lee also argues that BNPL products are already subject to ‘robust’ regulation, including:
AML
Fair lending
Credit reporting
Debt collection
Privacy
Fair treatment of customers
Electronic funds transfers
This is a pretty common tactic among emerging product categories (crypto has used this same playbook) — point to regulations that clearly apply (like AML or EFTA) and say “see, we’re already regulated!”
This disingenuous argument is designed to be misleading; “split pay” products are likely seeking to avoid being designated as “credit” because that would entail a host of additional regulations and consumer protections that would risk de-railing their business model, most notably any requirements to determine users’ ability to repay.
National Consumer Law Center
If the FTA is giving the “pro” case on BNPL, Lauren Saunders of the NCLC takes a considerably more skeptical view of the product. In her written testimony on behalf of the NCLC, she says (emphasis added):
“Buy-now-pay-later products, if affordable and truly free to the consumer, may help consumers manage larger purchases without the long-term debt and high costs of credit cards. But some BNPL products may have deceptive and abusive profit models built on the expectation of late fees from struggling consumers.
Consumers may be led to take on debts they cannot afford to repay, and managing frequent irregular BNPL payments can be challenging. If there is a problem with the product or service the consumer financed, refunds may be difficult to obtain, without the dispute rights that credit cards have.”
Ms. Saunders further argues that BNPL shouldn’t be viewed as a way to provide credit to or build a credit history for the “underserved,” given that most BNPL providers neither use bureau data to underwrite nor report payments back to the bureaus — though they may, according to Ms. Saunders’ testimony, report late or defaulted payments.
If the NCLC’s perspective on the opportunities vs. risks of BNPL is mixed, its position on “fake” earned wage and overdraft products is clear. Discussing the practice of “tips,” common in many “cash advance” and “fee-free” overdraft products, including those from companies like Chime and Dave, Ms. Saunders states in her written testimony (emphasis added):
“The use of purportedly voluntary “tips” to disguise interest charges is an evasion, pure and simple, that should not be countenanced. The tips are unlikely to be truly voluntary, and the label does not change the cost to or the impact on consumers.”
Saunders highlights issues I’ve written about before, such as automatically and repeatedly defaulting users to 10% (or higher) tip amounts and deploying cognitive behavioral cues and language that could be manipulative (emphasis added):
“Companies can employ strategies to make it difficult not to tip or to make the consumer feel compelled to tip. Earnin users reported having their access to advances restricted if they did not tip enough. Earnin appears to have changed that practice after it became public.
The SoLo app — which requires consumers to designate the “tip” in advance of funding — “notes that loans are much more likely to be funded when users tip the maximum amount.”
Default tip amounts are often set in advance and may be difficult to undo. An Earnin user reported being completely unable to undo the default tip, even after deleting the app and reinstalling it. An article about SoLo noted that “the only way to avoid [a tip] is through a toggle in SoLo’s settings menu, which must be reactivated for each request. There’s no way to opt out of donations while making the request itself.”
These companies argue “tips” and expedited funding fees (which, disappointingly, didn’t get much attention in the hearing) aren’t finance charges and don’t need to be disclosed as such are calculated as an APR, making it more difficult for consumers to compare products and their cost in a consistent manner.
Center for Responsible Lending
Marisabel Torres, representing the Center for Responsible Lending, also acknowledges some potential advantages of BNPL products vs. traditional credit cards, but notes significant gaps in the data to understand outcomes for consumers who use the product.
Torres argues that federal and state regulators should collect and analyze more robust data on the sector and that, at a minimum, consumer protections around unfair, deceptive, and abusive practices and unlawful discrimination should be enforce, stating in her written testimony:
CFPB should use its market monitoring authority to collect, analyze, and publish data from the largest providers (anonymized) to better identify risks within the market.
CFPB should also issue a larger participant rule to define the market and then actively supervise large BNPL lenders to ensure, at a minimum, that they are not engaged in unfair, deceptive, or abusive acts or practices or unlawful discrimination.
CFPB should ultimately ensure that BNPL lenders make loans only after determining the borrower’s ability to repay, considering both income and expenses or obligations, and that these lenders are not charging unfair fees.
States should require BNPL lenders to obtain state licenses and consider collecting data to better illuminate the risks involved in these programs.
BNPL Is Here to Stay, But May Evolve Under Regulatory Scrutiny
Reflecting on the 57+ pages of written testimony and 90 minutes or so of the hearing itself, I found the discussion of the opportunities and risks of buy now, pay later to actually be reasonably balanced.
It’s undeniable that emerging fintech products, including BNPL, have expanded the types and formats of products consumers have access to. That said, novel product formulations do seem to be exploiting gaps in existing regulations; this hearing and recent statements and activity from the CFPB and state regulators are logical responses to the explosive growth in the category.
If I were on the committee or in the CFPB, what areas would I be paying the most attention to?
Ability to pay. This was addressed in the hearing, but, generally, focused narrowly on how (or if) BNPL are assessing consumers’ ability to repay the debt they’re taking on in the form of these products.
While necessary, that scope is not sufficient. Regulators should also be looking more holistically at consumers’ finances; for instance, if they’re managing to stay current on BNPL plans, but doing so is causing them to fall behind on other debts or overdraft their accounts. There is evidence in the UK and Australian markets that such outcomes are not uncommon.
There’s a reason why BNPL companies have avoided ability to pay underwriting common in most credit products. Collecting and verifying the necessary data to do so inevitably will introduce friction into the process of using BNPL and reduce approval rates — something that would erode the appeal to consumers, add costs, and depress conversion rates and revenue.
Structure of BNPL products. At present, most of the revenue for BNPL companies is derived from merchants, rather than consumers. However, as increased competition compresses the merchant discount rates BNPL providers can charge merchants, this may change.
This may tempt BNPL companies to look to consumers, rather than merchants, to preserve margins. I would keep a close eye on revenue derived from consumer usage, especially late, NSF, or other punitive fees (especially if they’re not made clear upfront).
Consumer protection supervision. Though industry advocates suggest BNPL providers are “already highly regulated,” I’m sure that traditional lenders would disagree.
Just because these products are “free” / 0% APR, doesn’t mean that there isn’t UDAAP, ECOA, and FCRA risk to consumers. BNPL providers should be subject to the same kinds of consumer protection supervisory exams and, if necessary, enforcement actions as other consumer credit products.
Credit reporting. This came up in various ways throughout the hearing. Reporting BNPL usage, in theory, could give consumers an opportunity to build credit history; though it’s not clear how this type of tradeline data would impact traditional credit scores (Vantage/FICO).
Perhaps more importantly, real-time reporting of BNPL usage would enable all potential creditors (including BNPL providers) to have a more accurate picture of an applicant’s debt obligations and ability to repay.
There’s a variety of reasons why most BNPL may be avoiding furnishing data to credit bureaus. Under FCRA, there are a variety of requirements, including around ensuring data accuracy and processes for handling customer disputes, that can be complex and costly to implement. Avoiding furnishing this data (which isn’t legally required) could be a competitive advantage vs. traditional lenders.
On the “overdraft avoidance” front:
While increased competition and novel product formats have increased consumer choice, this also has made it harder for consumers to compare products and their costs. Despite referring to themselves as “transparent,” reliance on so-called “tipping” models and expedited funding fees is anything but — especially where consumers are defaulted into or otherwise steered into incurring these fees.
The regulatory oversight and risk to consumers varies considerably by provider. Some are explicitly structured and regulated as lending products (Varo offers a line of credit), some fall into a grey area (Chime offers a “fee-free” overdraft, though it accepts tips, through its supervised bank partners Bancorp and Stride).
Sample SoLo Funds Truth in Lending Disclosure Showing 0% APR / $0 Finance Charge Others would appear to fall quite egregiously afoul of regulation; SoLo Funds, which I’ve written about before and which came up in the hearing, purports to be a platform matching borrowers with unlicensed, individual persons acting as peer-to-peer lenders; it claims such loans have no finance charge and thus a 0% APR, but does require a “platform fee” and “lender appreciation tip,” which amount to $10.50 on a $50 loan, equivalent to 546% APR if repaid in two weeks.
It’s unclear how or if the company complies with consumer protection regulation like ECOA and FCRA, given it claims not to be the lender but just an intermediary.
Industry Response: Klarna & Sezzle
Given there were no direct representatives from BNPL companies at the hearing, I reached out to two leading companies in the space — Sezzle and Klarna — to ask some questions.
Asked about how it determines users’ ability to repay purchases financed with Klarna while also meeting other debt obligations (including to other BNPL providers), a Klarna spokesperson had this to say:
“As a matter of practice, we conduct robust eligibility assessments on each and every transaction a consumer attempts to make, including a soft credit check, so using Klarna is not guaranteed. Klarna offers short-term credit linked to a specific purchase. This is very different from credit cards, which, after a few initial checks, issue a large credit limit, all of which you can spend immediately. We restrict the use of our services if a customer misses a payment to stop debt from building up.”
On the same question, Charlie Youakim, CEO of Sezzle, had this to say:
“Sezzle uses alternative data to determine what consumers’ spending limits should be, but does not conduct a traditional credit check. We analyze an individual’s income and spending data - without reporting it to credit bureaus - and assign a spending limit for them that they can safely pay back. Their repayment behavior is used to increase or decrease their spending limit. For those who do want to build credit, we’ve got Sezzle Up, which reports your transactions to credit agencies. This provides Sezzle users with a new way to build their credit file and improve their credit score. We don't charge interest, and we only charge fees if a payment fails or you need to adjust the date of your payments more than once per order.”
Neither response satisfactorily answers the question of how these companies determine if users can afford to repay their buy now, pay later plan and other debt and payment obligations (mortgage/rent, car payment, other debts, living expenses) — the reality is, without pulling bureau data and collecting and verifying users’ income, this just isn’t possible.
Further, the fact that BNPL providers don’t report consumers’ usage back to CRAs means this debt is invisible to other creditors, potentially allowing BNPL users to take on unsustainably high levels of debt.
Asked about if BNPL can remain “more transparent” and “easier to manage” as consumers scale their use by using BNPL to finance multiple purchases (especially if using more than one BNPL provider), the Klarna spokesperson had the following to say:
“Klarna customers get a full overview of their payments online or in our app. Also, each purchase with Klarna is a new decision based on a soft credit check. Unlike with credit cards, our business model relies on people paying us back on time and in full because we don’t charge interest. If a customer misses a payment, we restrict the use of our services, which limits their ability to build up additional debt with Klarna.”
And Sezzle’s Charlie Youakim answered the same inquiry as follows:
“In Sezzle’s case we are helping shoppers by providing them with guardrails so they don’t overextend themselves beyond their means. Users are unable to make another purchase if you have a failed payment on the last one. We also send reminders for every payment that is due. We’re aligned 100% with responsible lending and consider the risk and loss for Sezzle, unlike credit cards.”
These answers make sense — if a user misses payments with Klarna or Sezzle, the companies don’t enable them to take on additional debt.
The challenge is, consumers aren’t restricted to using a single service. Consumers who use BNPL often use more than one service — debt which, by design, is invisible to bureaus and other BNPL providers, potentially enabling users to take on an unsustainable amount of debt.
Is Additional Regulatory Scrutiny of BNPL Inevitable?
The final takeaway? Perhaps best summarized by committee Chairperson Maxine Waters suggesting that the CFPB should be “looking deeply” at buy now, pay later. With CFPB head Rohit Chopra now confirmed, agency inquiries into the sector would seem to be a question of when, not if.
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Other Good Reads This Week
What Do Customers Actually Want Out of Fintech? (Fintech Takes)
A Nu Dawn, A Nu Day (Net Interest)
Credit Karma and Rapper IDK Team Up To Help Gen Z Manage Money (Fintech Snark Tank)
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