'Buy now, pay later' schemes such as Klarna and Clearpay will face tighter regulation after the UK's financial watchdog raised concerns that their use has ballooned since the start of the pandemic.
On Tuesday, the Treasury announced that it would bring the £.2.7bn sectors under the Financial Conduct Authority (FCA) regulation, forcing firms to carry out affordability checks on consumers and giving borrowers the right to open a case with the Financial Ombudsman if things go wrong.
'Buy now, pay later' (BNPL) firms, including Paypal, Klara, and Clearpay, which are popular with young people, allow shoppers to delay paying for goods and services bought online without undergoing a full credit check.
Between January and December 2020, the use of BNPL services quadrupled, with more than 5 million people employing the schemes since the start of the pandemic. In a review of the sector led by FCA Chief Executive Chris Woolard, it was found that the use of BNPL spiked during the Spring 2020 lockdown.
The Woolard Review also revealed that in November 2020, 1 in 10 BNPL customers were already in arrears with traditional lenders such as banks and credit providers.
Most of us will use credit at some point in our lives. So, it's vital that we have a fair market that works for everyone. New ways of borrowing and the impact of the pandemic are changing the market, with billions of pounds now in unregulated transactions and millions of consumers at greater risk of financial difficulty.said Woolard
In a letter to the Treasury, Woolard highlighted the schemes' 'potential consequences for harm', saying that while an average transaction is worth less than £100, shoppers can make many transactions over a short space of time and hold accounts with several providers, potentially racking up debt totaling thousands, without ever having undergone a credit check.
An array of BNPL options offered at digital checkouts can make it hard for customers to make informed decisions before they borrow.
According to the Woolard review, the presentation of BNPL schemes at digital checkouts can mislead shoppers, making them likely to believe that such systems are simply a type of payment technology (such as Apple Pay) rather than a form of credit.
As with all forms of credit, BNPL must be repaid and can create problem debt if not managed carefully.
While many firms offer low-interest repayment over the short term, problems inevitably arise if shoppers cannot repay their debt on time.
In his letter to the Treasury, the FCA Chief noted that the current lack of affordability assessments on BNPL schemes risked putting customers in a position where they borrowed more than they could afford to repay.
AJ Bell Financial Analyst, Laith Khalaf, seconded this point of view:
Consumer credit can be a blessing or a curse, depending on how it is used. It's a convenient way to make purchases for many people and the debt is routinely paid off in full without incurring any interest. For others, it's a way of making ends meet, and it doesn't take much in the way of unexpected costs to push such consumers into a downward spiral of borrowing.
One feature of BNPL schemes that drew concern in the FCA's review is the financial relationship between such systems and retail companies, where retail sites receive payments from the creditors based on their services' uptake.
As Mr. Khalaf explained:
That leads to the potential for misaligned incentives, where the financial interest of BNPL providers lies in boosting sales with little regard for the consequences for consumers. Regulating BNPL will mitigate this risk, and firms that are behaving responsibly should have nothing to fear from oversight. Regulations should also bring with it the benefit of increased consumer confidence in using such products.
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