The rapid evolution of buy now, pay later is attracting regulators as market forces continue to shift practices.

Buy now, pay later, or BNPL, typically refers to short-term, small-size, interest-free installment financing. Consumers make a down payment plus three installments over four to six weeks, so it is often described as a "pay-in-4" product. The product variety on major BNPL platforms has grown rapidly to include larger, longer-term point-of-sale loans with interest to extend their relationships with customers. Credit card issuers have also borrowed this popular term to appeal to merchants and consumers.

A fluid definition of BNPL is likely to cause regulatory arbitrage. In December 2021, the Consumer Financial Protection Bureau opened an inquiry into such credit and warned that "some BNPL companies may not be adequately evaluating what consumer protection laws apply to their products." For instance, consumers may feel like BNPL works similar to a standard checkout with a credit card, even though they are not protected by the same legal standards.

"The regulatory environment is going to change, and I think we certainly as a financial institution are welcoming that," said Brett Worick, vice president of BNPL and point-of-sale lending at First National Bank of Omaha. "I think as long as there's a little bit of level setting and everyone's playing by the same rules, then I think that'll help the industry overall."

Rules of the road

As a bank player in the sector, First National Bank of Omaha leverages its strength in point-of-sale financing to approach BNPL and designs it as a purely digitized experience, Worick said. While it comprehends BNPL as a low-dollar, short-term retail financing product, a specific definition is "still an outstanding question" in its conversations with regulators and credit bureaus, Worick said.

"Regularly, slight changes in these products come up," either from new product launches or from small tweaks, making it challenging for definition, said Mark Luber, chief product officer for the U.S. Information Solutions division at Equifax. Equifax enables companies to report pay-in-4 loans to help consumers build credit.

The fast pace of innovation will only continue as BNPL platforms seek to diversify and differentiate their products. With the current ambiguity in the definition, it is increasingly important for these players to make clear the loan terms and fees of each offering in order to help clarify impressions left on consumers by different interpretations of BNPL.

As the Financial Technology Association recognized in a comment letter to the CFPB, "FTA members are committed to continuing to advance customer education and industry standards that safeguard consumers, including transparent and consistent disclosures." The trade group represents several BNPL platforms, including Afterpay Ltd., now part of Block Inc., Klarna BV, as well as Zip Co Ltd. and Sezzle Inc., the pair currently undergoing a merger.

BNPL universality

In practice, there do not appear to be clear-cut lines to distinct key industry terms. Despite the notion of BNPL being short-term financing, Affirm Holdings Inc. offers a 43-month repayment plan with zero interest for a treadmill at Peloton.

Fees also vary under different brands. While Affirm and PayPal Holdings Inc. said they do not charge late fees for pay-in-4, Klarna, Afterpay, Zip and Sezzle charge late fees. Klarna also charges fees for returned payments due to insufficient funds, while Zip charges fixed installment fees per order and monthly account fees, and Sezzle charges fees to extend the term lengths.

The CFPB has "signaled that they do have some concerns about the product and in particular ... around the cost that may not be so clear to consumers," said Allen Denson, a partner at Stroock & Stroock & Lavan LLP.

Meanwhile, Affirm, Klarna, PayPal and Sezzle have partnered with banks to offer traditional unsecured personal loans or revolving credit products. Sezzle partners with Ally Financial Inc.'s Ally Lending to finance purchases of up to $40,000 at an annual percentage rate of 9.99% to 26.99% with the lengths are up to 60 months. In the BNPL applications, traditional financing products are often blended with the pay-in-4 option and presented to consumers altogether at the checkout.

"I've seen BNPL type of programs going all the way up to $50,000 for home improvement, then [it] ends up becoming actually a form of traditional unsecured personal lending," said Ruby Walia, senior adviser for digital banking at Mobiquity. "What you're seeing now is that the BNPL players are bundling that in. ... [T]hey often skew towards a longer-term relationship."

Product innovation at banks also broadened the scope of BNPL. Banks such as American Express Co. and JPMorgan Chase & Co.incorporated this concept in credit card repayments. Similar to pay-in-4, those plans allow cardholders to split payments of certain big-ticket items in their credit card bills into monthly installments over three months up to two years, without interest but sometimes with a fixed fee. But the credit decision-making and underwriting procedures are very different.

Regulatory frameworks being discussed

Currently, this continuously changing market does not have a single regulatory framework. Compared to those that can be clearly defined as point-of-sale loans or credit cards, pay-in-4 is particularly under the spotlight due to its popularity, ease of use and different regulatory structures.

Comment letters in response to the CFPB's inquiry in BNPL shed light on the different positions among stakeholders. The Financial Technology Association wrote that "some BNPL products may not qualify as a loan when they are structured as 'credit sales' or 'retail installment sales.'" Those fall into states' supervisory of retail installment contracts.

Others argued that there can be no doubt that providers of the pay-in-4 model are extending credit and should be regulated by the Truth in Lending Act as credit card issuers, according to the comment letter of the Center for Responsible Lending, the National Consumer Law Center and the Consumer Federation of America.

Following this inquiry, the CFPB would ultimately be inclined to advance a larger participant rulemaking for BNPL, which may not be finalized until mid-2023, according to a research note by Isaac Boltansky, director of policy research at BTIG.

"This is really just kind of a prelude to the Bureau being more active in this space," Stroock & Stroock & Lavan's Denson said.