The rapid evolution of digital lending has meant that many modern and increasingly popular Buy Now Pay Later (BNPL) products are currently unregulated by the FCA. Updated legislation has not been able to match the pace of innovation, and the Consumer Credit Act 1974 is starting to look a little outdated in 2021. Following publication of the Woolard Review on 2 February 2021 (the Review), which stated that BNPL services can “pose potential consumer harms that need to be addressed as soon as possible”, the Treasury has announced urgent plans for a programme of reform to be set in place.

What does this all mean?

Klarna, the market leader, is a BNPL firm that allows consumers to make credit purchases at the checkouts of thousands of online retailers. It typically offers two payment options: buy now and pay the balance in 30 days; or buy now and pay the balance in 3 instalments. There is significant incentive for the consumer in the short term to check out with Klarna, because the firm does not charge any interest or fees on purchases and undertakes only a soft credit check when assessing the consumer’s eligibility for credit. This means the search has no impact on the consumer’s credit score, nor is it visible to other lenders. Klarna is one of several BNPL banks. Others, such as Clearpay and Laybuy, operate on similar commercial terms.

What’s going to change? And why the need to regulate?

Currently, firms such as Klarna assess the availability of BNPL credit to a particular consumer on a case-by-case basis, founded on a soft credit check and the ongoing relationship with that individual, rather than conducting an affordability check as would typically be the case in the majority of regulated consumer credit purchases. A working example of this practice is that if a customer shows a reliable pattern of repayment, Klarna will continue to make facilities available to that person, with no set credit limit. And comparatively, if a customer misses a repayment instalment, Klarna will reject that person the next time they try to avail of the service at the checkout. This works for Klarna because it is a simple method of risk assessment and works in the customer’s best interest because it should, in theory, hinder their ability to amass unaffordable debts.

However, given that these types of BNPL credit products do not create a financial footprint, other BNPL providers are not made aware when a person has been “blacklisted” and therefore may well authorise the transaction, notwithstanding what would usually be seen as clear evidence of a struggling borrower. In a shift of responsibility, the onus has now fallen on the borrower, rather than the lender, to assess the affordability of the proposed repayment schedule before committing to the purchase. In this way, consumers can easily accumulate thousands of pounds of debt spread across various platforms.

The Review highlighted that there has been a quadrupled increase in the uptake of BNPL products since the outset of the pandemic, despite a decline in financial resilience. Therefore, whilst Klarna express their commitment to being a responsible lender, offering, for example, budgeting and insight tools on their app, there has been significant and urgent call for FCA regulation.

If BNPL companies are to become regulated by the FCA, they will need to comply with ongoing regulatory requirements, which typically include:

  • Affordability checks;
  • Credit limits;
  • Fair treatment for borrowers struggling to repay;
  • The right to complain to the Financial Ombudsman; and
  • A consistent approach to forbearance (i.e. a blanket policy on the recovery action taken against defaulting borrowers).

But will this mean a seismic shift from the existing commercial terms that have made Klarna so popular amongst consumers? And will that, in turn, be prejudicial to their business model?

In fact, Klarna has welcomed the calls for reform, commenting on the Review that it is their “priority” to co-operate in the creation of a new regulatory framework that protects their customers whilst supporting further innovation in payment options. And it is not difficult to see why working hand in hand with the committee will benefit BNPL companies in the long run. The appetite from retailers to offer the service is insatiable, and with 35,000 new retail partners having joined Klarna in 2020, there is a lot on the line.

Next steps

The FCA is said to considering the suggestions made in the Review and it will provide its response to recommendations in its April 2021 business plan. Whilst there are calls for rapid implementation of the recommendations, it is likely to take some time, not only because of the strain on resources caused by the pandemic, but also in the interest of striking a commercial balance. One significant comment from Klarna was that it is essential that the new framework is “modern, proportionate and fit for purpose”, and that it reflects evolving consumer preferences.

If you have any questions on the above article, please contact Lauren McGarry.

This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.