Buy Now Pay Later - A Case for Increased Regulation?

Introduction

The e-commerce industry in India has grown exponentially in the last decade and is expected to maintain the same moving forward (see here). This has created a competitive marketplace with online business platforms, offering a plethora of goods and services, competing to acquire and retain customers. To do so, it is imperative for businesses to provide flexibility through payment options and expedite the online checkout process. Therefore, buy now pay later (“BNPL”) schemes, which are being offered as an alternate payment mechanism by the fintech companies, have become increasingly popular. According to estimates, the BNPL market in India will increase to $35-40 billion by 2026 from $3-3.5 billion presently (see here).

BNPL involves advancing a short-term credit to the consumer which can be paid within a period between: (i) 15 to 45 days with zero percent interest; or (ii) 3 to 12 months through EMIs with an additional interest charged (see here). The revenue model for BNPL companies involves the following components: (i) following a default on payment, the company will charge a late fee which is, for example, ₹250 per cycle default in case of Simpl (see here); (ii) the company can charge an interest rate between 10% and 30% if the consumer opts for a longer repayment plan (see here); and (iii) the company receives a share of the transaction amount from their retail partners, which can be between 2% and 8%, when a consumer uses BNPL for making any purchase with them (see here).

Companies which offer BNPL schemes tie up with multiple online retailers who offer the BNPL option in their checkout page. Availing this option allows consumers to make the purchase without paying first since the BNPL operator pays on their behalf. Presently, BNPL as a payment option is restricted to transactions in the e-commerce space. However, companies like Pine Labs are making innovations in order to extend credit to consumers through cards at physical checkout points (see here). Examples of BNPL players in the Indian market include ZestMoney, LazyPay, Simpl, Amazon, etc.

The articles aims at scrutinizing the regulations, or its lack thereof. I, in the BNPL space. The key question is whether these companies should be classified as non-banking financial companies (“NBFC”) and/or payment system operators (“PSO”) and thus regulated by the RBI in either case. This article would like to argue that BNPL operators need to be regulated by the RBI by bringing them under the scope of PSOs. The article shall also highlight the impact BNPL schemes can have on consumer debt which will justify my stance for greater regulation in this space.

Legal Framework

The BNPL operators could potentially be regulated by the Reserve Bank of India (“RBI”) under the RBI Act, 1934 and the Payment and Settlement Systems Act, 2007 (“PSSA”). However, the RBI has not taken any concrete steps towards the same.

The RBI Act defines NBFCs as companies which carry on their business or a part of it through activities which include,inter alia, financing, through loans or advances or otherwise, of any activity other than its own (see here). Examples of NBFCs in India include Bajaj Finance Ltd, Muthoot Finance Ltd, Tata Capital Financial Services Ltd, etc. (see here).

The companies which offer BNPL schemes could possibly need to be registered as NBFCs under the RBI Act (see here). This is because, they help facilitate payment between a consumer and a retailer by extending a short-term credit to the former. However, BNPL operators avoid the same by tying up with NBFCs which extend credit to consumers and settle transactions between buyers and sellers. In such a scenario, the BNPL operator purely provides tech-enabled services to facilitate the transaction which actually takes place between their partner NBFC and the seller (see here).

The PSSA regulates payment systems which enable payments to be effected between a payer and a beneficiary, for example, credit and debit cards (see here). Presently, BNPL operators do not come within the scope of payment system operators (“PSOs”) and are not regulated under the PSSA. This is established by the fact that the RBI did not recognise any company which solely offers BNPL services in its list of authorised PSOs (see here). This is likely because the partner NBFC handles all payments or settlements for a BNPL operator when a consumer makes use of their service.

Impact Of BNPL Schemes on Consumer Debt

There are parallels which one can draw between making purchases using the BNPL option vis-à-vis a credit card. This is because, both options involve advancing a short-term credit to the consumer which can be repaid at a later date or over a period of time. However, using the BNPL option increases the likelihood of a consumer entering into debt. This is because, as opposed to banks and NBFCs, BNPL operators conduct a limited credit worthiness assessment before allowing consumers to register with them (see here). While doing so, they rely on the past purchase behaviour of the customer with the merchant (see here). This could lead to a scenario where consumers with pre-existing debt are allowed to take on additional debt by using the BNPL option.

Further, failure to repay their debt could lead to consumers being charged with a late fees and the possibility of their credit score being downgraded (see here). Moreover, BNPL schemes are misrepresented as payment options, as opposed to their true nature of a short-term credit, in advertisements. This coupled with the easy accessibility and flexible repayment schedule of BNPL schemes leads consumers to splurge on products beyond their means, which adds to the consumer debt. The RBI has taken note of the same and in its Report on Digital Lending, it has recommended that BNPL products needs to be classified as a loan and regulated accordingly (see here).

In fact, reference needs to be drawn to a survey conducted by the Australian Securities and Investment Commission which found that 21% of BNPL users who were surveyed had missed a payment in the last 12 months as of November, 2020 (see here). In the absence of any corresponding studies done in India, the above survey goes on to highlight the impact BNPL services can have on consumer debt in society.

Regulating The Buy Now Pay Later Space

As discussed previously, there is little scope for regulating BNPL operators by classifying them as NBFCs. However, BNPL operators can still be classified as a NBFCs if they are involved in any other forms of financial activity such as writing off any debt owed by a consumer to them. Nevertheless, the above determination needs to be made on a case-to-case basis.

On the contrary, there is greater scope for regulating BNPL operators by classifying them as PSOs. This is because BNPL operators perform a function which is similar to credit card operators, the latter requiring authorization from the RBI under the PSSA, wherein it allows consumers to make purchases by extending a short-term credit to them. The difference between the two lies in the fact that credit card operators handle all payments or settlements for the consumers themselves, whereas the same is done by a partner NBFC for the BNPL operator.

However, this should not per se bring BNPL operators outside the scope of the PSSA. This is because, the PSSA did not originally envisage payment mechanisms like BNPL where the digital platform to facilitate online transactions and the transactions are being handled by separate entities. Therefore, the PSSA needs to be interpreted considering recent technological advances which have allowed such a distinction to exist. Further, the involvement of a partner NBFC does not change the fact that BNPL operators are the ultimate beneficiary of the services which they provide. Hence, they cannot escape regulation by simply partnering with a NBFC.

To illustrate, the RBI has clarified that Google Pay does not require authorization under the PSSA since it uses the unified payment interface network of the National Payment Corporation of India, the latter being a registered PSO (see here). However, BNPL operators need to be distinguished from platforms like Google Pay for regulatory purposes from a policy perspective. This is because, Google Pay and other similar platforms do not extend credit to consumers as opposed to BNPL schemes which could potentially add to the consumer debt in India.

Concluding Remarks

The growth of BNPL as an alternative to traditional modes of online payment is a natural outcome of innovations carried out by fintech companies. This has been supported by the Central Government’s emphasis on the ‘Digital India’ movement (see here).

However, any innovation in this space needs to adhere to the existing regulatory norms. Further, in the absence of such norms, the Central Government needs to suitable amend the regulatory framework to bring BNPL operators within its scope. In this article, I have argued that BNPL operators should be deemed as PSOs and regulated under the PSSA accordingly. BNPL operators could also be regulated under the RBI Act potentially. However, the same is unlikely, due to reasons highlighted above, unless a BNPL operator is involved in writing off any debt owed by a consumer to them Nevertheless, the extent to which BNPL operators need to be regulated remains open for future deliberation, since it would involve a careful balancing act between encouraging innovation and protecting consumers.