Considerations for the regulatory framework of Buy Now Pay Later

The rapid rise of BNPL arrangements has created a need for new regulatory frameworks, and the Australian Government is taking notice. Treasury is currently exploring a new regulatory framework which is expected to bring BNPL services more in line with existing consumer protection laws. They are exploring 3 regulatory options.

In this newsletter edition we consider the 3 options and explain the reasons behind our recommendations in our submission to treasury.

The first option would see an improvement on the BNPL Industry Code, which already exists to protect consumers. This would include a bespoke affordability assessment that BNPL providers must adhere to before granting credit. BNPL is not currently regulated under the National Consumer Credit Protection Act 2009 (the Credit Act), because it typically falls under the exemptions available to certain types of credit in Schedule 1 of the Credit Act.

Having dealt with many FinTech and lending start-ups in Australia, we believe that BNPL can operate under the existing Credit Act as a licensed entity providing there is clarity about the definition of scalability (a concept that currently allows lenders to determine what is reasonable in terms of the inquiries and steps taken to assess a customer’s financial situation) and that all lenders can obtain reliable information about the level of a consumer’s indebtedness.

In our view, accepting the BNPL Industry Code and allowing an exemption to the Credit Act will set a precedent for continuous regulatory arbitrage in cases relating to innovative credit products. The nature of a self-regulated Industry Code means that BNPL, and potential future innovative credit providers, would not be subject to the same level of public scrutiny, monitoring and enforcement as other credit providers that operate under the Credit Act.

The second option is to bring BNPL within the Credit Act with a tailored version of Responsible Lending Obligations. This would create a more comprehensive framework for BNPL arrangements and offer better protections to consumers.

However, we don’t see this working well either. In our view, adding more “carve outs” like those for SACC, MACC and Reverse Mortgage loans will further complicate regulations for existing lenders and create additional uncertainty for credit providers that are considering new and innovative products. This option would set a precedent for each new market entrant to seek ‘their own rules’ claiming their product is ‘unique’ and should be treated differently based on a technicality, such as in the case of BNPL, rather than on the core premise of the product.

The third option and the one we support in our submission to Treasury, is for BNPL providers to be required to hold an Australian Credit License. This would bring BNPL into line with other credit providers in the industry and ensure a consistent regulatory approach across all credit services.

But our support is dependent upon there being a clearer definition of scalability for the benefit of all lenders. Clearly defining scalability in relation to reasonable inquiries about, and verification of, the customer’s financial position will provide a strong framework for ensuring lenders balance a low cost, efficient and streamlined process against avoiding reasonably foreseeable consumer financial harm.

Defining Scalability

Even before it was introduced, the definition of “scalability” has been a point of contention among consumer lenders. When introduced for consultation in 2010, there was little definitive explanation of scalability leaving each lender to interpret thresholds for reasonable inquiries about, and verification of, the customer’s financial position. Competitive pressures and product economics led to a wide range of interpretations, resulting in an equally inconsistent level of consumer protection.

Many lenders implemented Income Validation Models and Expense Benchmarks for credit facilities that had combinations of low value and low risk so they could maintain efficient, low cost and streamlined processes.

Over the subsequent few years, ASIC took action against a number of lenders for failing to comply with responsible lending obligations and additional requirements were added to regulations for SACC and MACC loans. The perceived compliance requirements and threat of regulator action meant that many lenders took a conservative approach to credit assessment resulting in more complex processes, greater customer friction and higher costs.

At Kadre we have worked with many consumer lenders across the industry and have a deep knowledge of credit policies and credit assessment processes including the way in which they assess and verify a customer’s financial position. We are currently working with organizations such as the Sydney University Business School to determine appropriate empirical methods for defining scalability.

We will discuss our scalability hypothesis in further detail in our next edition. Make sure you subscribe to get this directly into your inbox.

But for now, in summary, our Kadre team believes that the Government has a great opportunity to address the increasing potential of consumer financial harm from BNPL’s and to reduce the cost of credit while continuing to promote innovation that will emerge from technology advancements. In our opinion, the existing requirements in the Credit Act are sufficient to apply to all lenders providing there is a clarity about the definition of scalability. We believe that scalability principles should apply to the full breadth of credit providers, not just BNPL. It should provide consistency and certainty as to what is, and is not, acceptable, without the risk of impeding innovation.

Our commentary recently featured in an article for the Australian Financial Review written by James Eyers. You can read it here AFR published article: BNPL regulation perfect opportunity to clean up credit law mess. - Kadre

The Kadre community includes former CROs of major banks and other financial institutions including fintechs, former senior executives of Credit Reporting Bodies, founding members and former directors of ARCA and subject matter experts who have been involved in ASIC investigations, helping lenders deal with enforceable undertakings and remediation programs. The community also includes leading data scientists who have a deep understanding of how to use data to achieve successful business outcomes.

If you are a lender and would like further information and assistance with affordability assessment, please contact [email protected] or [email protected].