Embedded finance
Embedded finance

Embedded finance regulation - a look into BNPL

BNPL is a mature market in embedded finance, and worth keeping an eye out in order to better prepare for B2B embedded finance regulation.

Embedded finance is present in many shapes or forms, one of them being buy-now-pay-later (BNPL). BNPL has transformed the way people buy from retailers. In fact, to say BNPL has boomed would be an understatement. Growing at a rate of 39% per year, the BNPL market is expected to exceed $260 billion by 2025.

As a quick overview, BNPL removes the typical challenges of applying for credit and allows consumers to instantly purchase an item and spread the cost over a few payments. Its seamless and quick processes means consumers are more inclined to buy again. For instance, people that use BNPL have a 36% higher purchase frequency than regular shoppers. Its popularity has even taken over credit card usage.

However, missing a payment or spreading the cost over a longer period of time could result in late fees, penalties, or high interest rates - which have been called into question and resulted in the tightening of rules and regulations.

In this article, we look at how BNPL has become the embedded finance poster child, and what regulatory trends might be gaining momentum within the embedded finance ecosystem.

A spotlight on BNPL regulation

Despite its popularity, BNPL has been met with mixed reviews by all parties involved with this form of embedded finance - including credit providers, consumers, and regulators.

  • Credit providers - Lenders are concerned that without consumer usage data for BNPL, a whole level of consumer spending is missing from credit risk assessments - which means they can’t run thorough affordability assessments.
  • Consumers - For some, BNPL isn’t suitable. According to research by Barclays, 30% of shoppers regret using BNPL. These shoppers are overwhelmed by repaying.
  • Regulators - The FCA has focused on bringing BNPL within regulatory perimeters like all other financial products so that consumers can be better protected through more rigorous checks.

Regulatory concerns

In recent reviews by the Financial Conduct Authority (FCA), affordability was highlighted as a key concern. While some BNPL firms have taken steps to integrate affordability, more needs to be done to assess risk and better inform consumers on interest rates before they buy.

The regulatory focus on BNPL embedded finance is a hot topic both in the UK and overseas. The BNPL market has grown internationally and many other countries are taking a close look at providers too. For example, in the US, the Consumer Financial Protection Bureau (CFPB) issued orders in late 2021, to several BNPL companies, asking them to collect data on customers for use in risk scoring.

How embedded finance regulation might impact the future of the industry

These concerns are clearly important within the embedded finance industry too.

We recently spoke at the FTT’s panel on BNPL and heard from fellow panellists about the
industry giving us a good sense of where regulation might impact the industry in the near future.

There were three main takeaways:

  • Collaboration will be key: Regulators and providers should both be collaborating to find ways to protect consumers' interests with BNPL products.
  • Moving from online to offline: BNPL will soon be expanding outside of online to transactions in brick-and-mortar stores too.
  • Is B2B BNPL coming soon? Small and Medium businesses are the next logical target for BNPL products and can benefit greatly from them.

More importantly, although it started being adopted by millennials and Gen Z, it’s becoming more widely adopted, and regulators are interested in protecting everyone. Just because as a consumer you don’t pay fees for BNPL doesn’t mean you are able to spend that money, so you might end up in more debt that you can afford.

Given the above, it’s no surprise that regulators are looking into this more.

The building blocks of a future proof embedded finance solution

If we can learn anything from the regulation of BNPL, it’s clear that those that put the right foundations in place from the start drew attention for the right reasons. That’s why starting with the right building blocks is so important.

To future proof an embedded finance business model, you’ll need to get the right foundations in place. There are three places to start:

  • Licences - To cover regulatory requirements, businesses need to be or work with licensed businesses. Those that already carry out financial activities will have the necessary licences and infrastructure in place.
  • Access to sensitive data - To provide embedded finance offerings that meet regulatory requirements, embedded finance providers require access to significant amounts of sensitive data. This powers identity/anti-fraud and affordability checks. Managing this data accurately is critical.
  • The right technology - As much as expertise and capabilities are going to define embedded finance solutions, technology is what really makes embedded finance solutions successful. This is because an always-on approach is expected with embedded finance. The end user wants quick payments - they don’t want to find the tech behind it causing payment failure hours later.

Because these core building blocks are critical, many companies will prefer to work with an external provider to enable them to go to market quickly and effectively with an inclusive, tried and tested model.

💡 📕Further reading: Embedded finance products: Risks and rewards
💡 Embedded finance introduces distance between the end-user of a financial product and the provider. Therefore working with an embedded finance provider with the appropriate legal and compliance frameworks to manage risk - without introducing friction - will be one of the most important requirements for success.

How embedded finance regulation is likely to evolve

BNPL is likely to be where any extensive regulation of embedded finance products will start, mainly due to the affordability issue. This type of embedded finance regulation hinges on the fact that consumers need protection. Historically, the BNPL offerings are not necessarily incentivised to make sure consumers are able to afford the spending that BNPL allows them to do. We expect this to change with the regulatory clamp down.

A natural extension of this might be other consumer embedded finance products, such as insurance or instant checkouts.

B2B embedded finance products, however, are often different so the specific points of entry for regulators might be different.

Some obvious starting points might be the regulation of B2B financing products that are not flexible enough, or that require interest-based payments or significant collateral. The most optimistic actors in the space are hoping to see a regulatory push towards more inclusive solutions for SMEs as well.

💡 As an interesting side note: Revenue-based financing takes off some of the repayment burden, and cash flow constraints, and makes it easier for the SMEs to manage their cash flows - only accepting offers they can afford. For example charging a flat fee at the start instead of spreading it out over interest payments.

We’re also seeing regulatory requirements change across geographies. For example, embedded finance is also popular in Sweden and Australia, which are home to two of the biggest providers: Klarna and Clearpay (aka Afterpay) respectively. Both of these countries have also recently tightened restrictions in relation to BNPL.

What’s next for embedded finance regulation?

By imposing new rules on BNPL, the regulators have taken a first step forward to regulate this evolving market.

Regulation creates a win-win for both customers and providers as it ensures customers can pay back and protects loyal customers. So it’s important to develop products and solutions that grow in that same direction in order to not become irrelevant.

While difficult to predict what might come next for embedded finance regulation, the regulators must ensure that any regulation is carefully considered to balance the need to protect consumers, without stifling innovation, choice, and competition in the market.

The adoption of embedded finance strives to delight customers, but incorporated into this must be the development of the right embedded finance solution and a focus on sustainable growth for both the SMEs and the organisations offering them embedded finance solutions.

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