The Woolard Review, published on February 2nd, reports on the recent changes and innovation in the unsecured credit markets and describes what regulatory changes we might expect in the coming months and years. The document itself doesn’t set out changes to the regulation but steps out recommendations to the FCA and government. Most notably, the report recommends that Buy Now, Pay Later (BNPL) products - currently outside the regulatory perimeter - are to soon be regulated by the FCA. This change won’t happen overnight, but rather through a transition period. This will be triggered by a consultation paper to be published by HM Treasury in the coming weeks.
Many prominent firms in the BNPL market are already regulated by the FCA, either as providers of consumer credit or other related activities. Many have also publicly encouraged the introduction of regulation in the market, describing the afforded clarity and confidence for their customers as a key benefit.
This article looks at the potential next steps BNPL firms (as well as more traditional lenders) can take to prepare for regulation whilst maintaining rapid growth and lending sustainably.
Affordability answers the question, ‘can a customer afford to repay a loan or credit agreement?’. In simple terms, that means adding up all of an individual's monthly expenditure, discounting non-essential or ‘discretionary’ purchases and deducting from their income. If the monthly repayments for the product can comfortably fit in the gap between the two, then the affordability assessment is passed.
In the past, the quality of these assessments has been called into question by the FCA, leading to stricter guidance on what is proportionate and acceptable. Many critics of BNPL have suggested that despite products often being interest-free, customers are potentially left vulnerable due to the payments not being affordable. Today, these products strictly aren’t defined as credit so there is some ambiguity over what a suitable measurement is.
Interestingly, in recent commentary following the release of his review, Chris Woolard called for BNPL providers to develop “metrics for suitability and vulnerability” to measure the potential impacts of their products and ensure a consistent and objective approach to affordability is applied. Affordability is a moving target -- what’s true today might change tomorrow due to a new financial commitment or other changes in financial circumstances. Most BNPL products are designed to increase merchant retention and encourage loyalty through the ability to “try before you buy”. The continuing engagement with the products opens the opportunity to leverage Open Banking to generate a continuous view of affordability which can track and measure those key metrics of suitability and vulnerability in real-time. This is especially significant, given that at present BNPL products are outside the remit of SCOR rules on reciprocity and so the presence of a BNPL agreement is not necessarily available with legacy CRA data.
Access to Affordable Credit
Whilst BNPL often isn’t presented as a loan, it fulfils the same purpose - providing an advance on a payment for convenience (e.g. trying something before you buy, such as a new pair of trainers) or to break a larger purchase into manageable chunks (e.g. a fancy new internet-connected spin bike). BNPL is a great example of embedded finance - rather than separately searching for a lender, applying for a loan, then using the funds to fund a purchase, I can do this all in one easy step. It’s not just clothes and spin-bikes either; other firms are providing simple ways to purchase flights or hotels using the same mechanism. These are all fantastic and innovative products that are providing value to consumers, a sentiment that is echoed in the Woolard Review, which highlighted BNPL’s ability to provide consumers a significant alternative to higher-cost lending.
One of the challenges facing many BNPL firms is reaching ‘credit invisibles’ -- those applicants who are creditworthy and can afford the product, but have little or no evidence of this held by legacy CRAs. Our recently published Borrowing Index reveals that 71% of BNPL customers are under 44, with almost half (47.4%) under 35. With many BNPL firms competing to win the business of merchants who are selling predominantly to a younger audience, being able to accurately assess those customer profiles is a key differentiating factor. Many have now turned to Open Banking as the solution to this problem.
Participation of mainstream lenders
The review also discusses how participation of mainstream lenders in non-prime markets might be encouraged, citing regulatory and reputational risks as the primary barriers to be overcome. Some would argue that through overdraft products many of the major banks are already (to an extent) operating in this market by providing shorter term credit to their customers. However, it is possible that, with the right regulatory frameworks and perhaps use of the FCA’s Sandbox environment, that high-street lenders would be able to bring new products to market that serve this segment more effectively. It’s no secret that BNPL is perceived as a threat to the credit card market as it offers a similar ability to fund purchases usually at a lower cost. The opportunity to grow retention through BNPL means that many merchants are favouring these options over more traditional credit card routes. There is an opportunity therefore for incumbents to compete through better personalisation.
For mainstream banks, this means more contextual lending, e.g. allowing customers to finance existing purchases on demand, or offering credit repayments that automatically adapt to their monthly cash flow (again, driving better affordability outcomes). These opportunities are enabled only through value exchange with the customer and by leveraging real-time financial insights. It’s worth noting that many of the mainstream banks already operated in the retail finance arena prior to the rise of BNPL and have strong relationships and capabilities which could be leveraged to bring such products to market.
All in all, the Woolard Review is a very positive step for the industry. We’re excited at the prospect of progressive regulation enabling new business models and better products coming to market. We’re especially pleased to see the consideration of new models of credit evaluation and how adoption can drive better outcomes for customers of all types.