Where Credit’s Due Ep. 11: Unpacking the CFPB’s BNPL report with Marshall Lux

Today we're having an honest conversation about Buy Now, Pay Later (BNPL). The ease of use of BNPL products has been associated with increased spending and could drive negative consumer consequences, prompting US regulatory agencies to look deeper at this rapidly growing space. 

Last December, the CFPB launched an investigation into the business practices in the buy now, pay later (BNPL) sector due to mounting concerns about  “accumulating debt, regulatory arbitrage, and data harvesting in a consumer credit market already quickly changing with technology.”

Then the bureau issued orders to five BNPL lenders, asking for detailed information on the activities and risks inherent to their lending practices. director Rohit Chopra ordered Affirm, Afterpay, Klarna, PayPal, and Zip to submit information so that the bureau can report to the public about industry practices and risks. Now the report is out, and we're exploring it in today's episode with my guest Marshall Lux.

With a credit risk experience spanning over three decades, including serving as JPMorgan Chase’s Chief Risk Officer of consumer products during the global financial crisis, Marshall supports enhanced regulatory oversight in the BNPL space. He wrote a paper on the risks associated with BNPL, and on what regulation could look like in this space.

More regulatory scrutiny is needed to protect consumers. The way BNPL affects credit scores is still relatively unknown. Credit scores could see damage especially if issuances of BNPL credit are considered single installment loan accounts that are quickly opened and closed, and if consumers aren’t informed over the impact of certain credit behaviors.

On all of this and more, tune in to our conversation. 

Was there anything that surprised you in this report?

There was nothing that surprised me. I thought there was some good data, which was good to see. I think the CFPB did a really thorough job.

The one thing that they didn't do was to ask for risk data. So there's nothing in the report about the fact that these folks are underbanked, near subprime. They talked a lot about the ages of the folks. But one thing that I wish they had cited was the fact that these are generally near prime and subprime individuals. But no, there wasn't anything that was surprising. I think it was fairly comprehensive with that one exception.

You have mentioned in your report that 57% of BNPL consumers earn less than $50,000 annually. Data like that seems pretty important to mention, but maybe it's gonna be in the next CFPB report. I think it's a good starting point.

I agree. My concern is that we're obviously in the middle of a global recession, and with high inflation. They asked for the data nine months ago. I believe the world's changed pretty fundamentally since then. It's a picture that is important, but the world's changed in nine months. The urgency of acting on has accelerated. Now, the debate begins, it's likely that we'll have a divided government and the wheels of government move more slowly than the private sector does. It may take some time before these recommendations get implemented. But best case scenario, people start to see the picture emerge, and will start to self regulate.

We need that in the sector, everybody knows that BNPL met incredible growth. And now we have the numbers to show it. The report shows by adding the five leading BNPL providers that we've mentioned, we see that loan originations increased more than 10 times over the past two years, from $17 million to $180 million in 2021. And the majority of users have been under 33 years old, so we have Gen Z and Millennials. The product is still really geared towards younger generations which can pose serious questions about the risks of BNPL. I know you have a lot of concerns on this front. Could you share with our listeners why this is a dangerously slippery slope?

This product was well suited to help people who would normally not get credit easily, learn how to build their credit, to develop thicker files, to show experience, and to learn how to use credit responsibly. But as the report showed, which was new to me, I think it was 16% have five or more BNPLs, and roughly 5% have ten. And as the numbers of the Bureau have shown, people tend to spend more, so they overspend. And the decisions that are made are ultra quick. In the end, people do believe that it affects their credit ratings. So my concern is that it will have the opposite effect, it will hurt the credit of a generation of consumers, both structurally, it'll make it more difficult for them to borrow, but also it will teach them bad habits. A lot of people saw in the report, they spend too much, there's too much impulse buying that's going on. And technology has enabled something that anyone who's tried to shop online or even physically now can't escape. It's everywhere, right? It's literally everywhere.

Right, it's almost become like a default way to buy, in some sense. And I think in the minds of younger consumers, that effect happens for sure. The credit part of it is very interesting, because debit is the preferred payment method, 90% of payments happen with debit. So that means that probably a lot of folks believe that they're avoiding credit, they're not using their credit card. This BNPL is recurring payments that come off their debit card – they're not getting into the credit territory. But that's not really the case, is it?

I think this stuff is toxic. I really do. And by the way, it's a global problem. I mean, I did an interview yesterday with a French journalist. It originated in Australia, and I think there's 100 community groups that have banded together to protest. It's a UK problem. It's a product that has caught on.

And in this environment, it's very difficult. The most shocking new statistic I've seen is that 50 of the top 100 categories are now food. So people are putting cheese, bread, milk on BNPL. Now imagine if you don't pay for your milk on time. Let's say you pay $3 for a quart of milk. And then you have a $7 fee and interest on that sort of milk. I mean, it gets kind of absurd, and it shows the desperation this economy presents. It's a bad picture.

There's a lot of features of the product that bypass the user awareness and feed into the dopamine hit-inducing society that we're that we're living in.

I think that's exactly right. I mean, it's sort of human nature. I never used BNPL, but when buying something, I've been tempted to say, 'Hey, look, why should I spend X now when I can pay it over four payments on an interest rate loan, or paid over a year and pay interest?' Try, it feels better. And you have literally seconds to make a decision.

But is this even a viable business model? Because you did mention before that you know, at this low transaction, transaction value and of the Buy Now pay later market, the unit economics have a harder time demonstrating the potential for profitability as standalone products. So BNPL companies struggled to charge the fees high enough to cover the cost of services and customer acquisition costs, and most of them are yet to prove profitability. Yes, it's bad for the consumers, but isn't it also bad for the company?

Well, I mean, personally, I wouldn't invest in one of the companies. But they're obviously worth something. We've seen the decline in their market caps, but markets declined a lot for FinTech companies. If investors are comfortable with it, I think that they're seeing something I'm not.

Over time, merchants will negotiate lower fees. Obviously, interest rates are rising. But at the same time, the cost of acquisition goes up. And delinquencies are rising in this segment, which the CFPB cites, but so do others, you can look in these securitizations and the earnings reports for these companies. So the way at least I thought about it is there's only like two ways to make these profitable or maybe three. 

One is to slow growth. And, I don't know, to be honest, how much that'll help but that's one option. That will make them more profitable, or cut costs. And usually people cut marketing costs before they cut anything. 

Two is to sell the data. And the CFPB cited that as a risk. And hopefully they'll act on that quickly. But it is interesting to make sure that that doesn't happen. And the third is to try to cross sell, right, which has always been the Holy Grail. And in my experience, it's very hard, I think near impossible, to convince people that they should open a deposit account, or some other account on the back of a credit product. A lot of these people lived paycheck to paycheck. But even if they didn't, there's something in the consumer psyche, which says, 'Well, if I don't pay, are you gonna withdraw money from my account?' And you saw the news when PayPal announced that they were going to penalize people for certain transactions, and there was an uproar. I think it's a quandary. Someone smarter than me will figure out how these people make money.

What could be the first steps the CFPB takes on BNPL?

My guess is the two most important areas where they'll start will be on data privacy, and on and on credit ad tracks for the bureaus – those two will be the areas where they'll start. Now, the bureaus have been working on this for a while. It's complicated. Let's use an example – over 12 months, each of those payments is considered a specific transaction. So instead of it appearing once, it will appear 12 times. Also, the one Bureau, I believe it's Equifax, has a BNPL bureau that's been launched, and isn't linked to the other bureau. So as far as their other bureau, like the credit card bureau or the mortgage bureau, they don't have a complete picture of the consumer. 

I've talked to a number of risk managers who will say, 'Look, I don't know how much risk this person has. I know, there's someone who is using BNPL, and I know there's someone who has a credit card, but I just don't know if it's the same person'. And so it's complicated. I suspect over time, their bureaus will get it right. But it's going to take time, and it's gonna take work. And it's not for lack of trying. I think they know that this is a priority that they need to show work on. But technically, it's also difficult.

If you read one of the major suppliers of the BNPL providers, it literally says on the website, 'we may or may not report you'. We may or may not. To be honest, that's just not very helpful. We'd be better if it's, 'we will, or we won't'.

Being upfront, making the rules clear, making it a little bit harder, linking it up, just kind of institutionalizing and professionalizing it is the right thing to do. Because look, consumers love this product, merchants love it even more, because they sell more stuff. And that's not going away. I personally think that it's a very healthy sign that regulated banks are getting into it and linking it up with your lines and saying, look, here's a different way to pay, right? So if you have a credit card, here's a different way to pay and you may like this better – that's okay. They're regulated and someone's looking at the models and understanding it. But those typically are our prime and super prime consumers. So it's a different product for different customer segments.