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Inside the explosion of buy now pay later services like Klarna, now facing regulation after worries young people are falling into debt

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Regulation is coming for the burgeoning buy now pay later sector, as usage has exploded during the coronavirus pandemic.

On Tuesday, the UK government has said it will pass new laws to regulate the sector, after a report produced by the financial regulator’s former chief, Christopher Woolard.

In a letter to the government, Woolard argued that buy now pay later products had exploded — and could be “harmful” if left unregulated.

He added that it was possible for more vulnerable users to rack up thousands of pounds in debt and late payment fees, without proper credit checks.

In a press conference on Tuesday, Woolard noted that “firms are flying blind” when it comes to visibility.

He said that if a customer is unable to purchase a product through a preferred provider, many sites offer multiple other buy now pay later options at checkout. That might mean that, without any checks, a customer could feasibly be in arrears with many different companies.  

“Change here can’t come soon enough,” he added. 

Buy now pay later is exploding

Buy now pay later services are a simple, and companies say safer, way for consumers to shop online.

In its simplest form, consumers are offered the opportunity to split up the cost of an item into predominantly interest-free installments over a number of months or weeks, depending on the provider.

Rather than using a credit card, which relies on users being forced to pay high annual rates, buy now pay later is designed to avoid onerous prices.  Yet there are consequences for missed payments which vary across different providers, ranging from freezes on further purchases, to late collection fees, and even debt collection agencies.

Major names in the space include public Australian firm Afterpay (known as Clearpay), Affirm in the US, Swedish decacorn Klarna, and payments giant PayPal.

Klarna is the largest player in Europe, and has been heralded as something of a tech darling. Last year, the Swedish startup raised a massive $650 million round at a $10.65 billion valuation ahead of a potential future IPO.

The growth of Klarna and others is, in recent months, partly down to lockdown measures shutting physical stores and driving a boom in e-commerce.

Record amounts of venture capital funding has poured into the sector. By 2025, buy now pay later volumes in Europe are predicted to hit $357 billion, constituting nearly half of the entire global estimate, and 30% of all estimated e-commerce spend, according to research by Kaleido Intelligence.

Phillip Zilch

Europe as a market is likely to make up as much as 50% of buy now pay later spend in the coming years with the vast majority of users being under the age of 35.

As with all credit-based markets, the risk of debt remains high.

Martin Lewis, the UK consumer finance expert, was early in calling for a crackdown on the sector, saying it targets the under-30s via social media.

In comments to Insider, he also drew a comparison with payday loan providers, which have been accused of pulling consumers into a debt spiral.

“There has been an explosion of buy now, pay later lending over the last few years, often targeted at young people, pushed via Instagram and social media, as if it is a form of lifestyle therapy. It isn’t,” Lewis said told Insider. “It’s debt. In fact, it’s the fastest-growing form of credit in the UK and regulation is crucial.”

“For years, I and others made similar calls about payday loans – they too were purported to be ‘filling a gap’, and about ‘technology, not borrowing’ — and the sloth-like delays to dealing with that led to financial nightmares for millions.”

In late December, the UK’s ad regulator banned four Instagram influencer posts sponsored by Klarna, saying they “irresponsibly” linked its service to happiness.

Yet up until now, buy now pay later lenders have not been regulated by the Financial Conduct Authority (FCA) because they don’t charge interest. That has meant the regulator cannot intervene if customers are treated unfairly, even when the wording around the risks involved is minimal. 

Campaigners such as Lewis grew more alarmed as it became clear users were relying on buy now pay later services to get them through Christmas and the pandemic.

Over Christmas 2020, one in four consumers in the UK used a buy now pay later later credit scheme to pay for their shopping, around 40% of purchases, according to research from credit reporting firm Credit Karma.

A survey by management consultancy firm Capco last November showed that 32% of respondents were using buy now pay later more due to Covid-19 and 62% of respondents said that buy now pay later led them to spend more than they would otherwise.

Most importantly, 50% of respondents aged 18-34 have missed a buy now pay later payment. While buy now pay later lenders don’t charge interest, late payment fees can be steep, as much as £12 ($16.4).

Pressure from lawmakers and campaigners

It has taken some months of public pressure for the government to change its mind on regulation.

Earlier in January, a group of 70 members of the UK parliament, led by Labour MP Stella Creasy, tabled an amendment to the Financial Services Bill in an attempt to have the Treasury introduce stricter regulation. The motion was at the time defeated

But economic secretary to the Treasury John Glen, announcing the plan to regulate, said in a statement on Tuesday: “Many consumers do not view interest-free buy now pay later as a form of credit, so do not apply the same level of scrutiny, and checks undertaken by providers tend to focus on the risk for the firm rather than how affordable it is for the customer.”

Though the government has yet to announce the detail, campaigners are delighted.

In response to the decision, Creasy said: ‘The FCA has confirmed what we have been warning the government of for the past year — that the behavior of the buy now pay later industry presents a clear risk to consumers and needs urgent action.

“The minister’s u-turn on tackling these companies is welcome and now needs to be an urgent government priority — with evidence millions used this form of credit to pay for Christmas, regulation cannot come soon enough.”

Like Lewis, Creasy raised the specter of Wonga, the notorious former payday lender that was held up as the poster child of predatory lending.

Buy now, pay later firms welcome regulation

For all the clamor, buy now pay later companies have consistently stated they are in favor of further regulation, welcoming consistency that would force all providers to give full transparency to users.

In a recent blog post, Klarna UK head Alex Marsh wrote: “We believe that proportionate regulation and consumer protections should be updated for the digital age rather than relying on rules conceived nearly 50 years ago.”

And a Klarna spokesperson added to Insider: “In the buy now, pay later sector there are wide differences between providers, in terms of approach to payment schedules, interest, late fees, eligibility assessments, support for vulnerable consumers and, importantly, protections if something goes wrong.

“That is why it is vital that regulation is updated for the digital age, to ensure that consumers are protected regardless of which provider they choose.”

Philip Belamant, chief executive of British buy now pay later startup Zilch, said his own firm gives users detailed terms of use and details on how its product worked. However, he added, smaller, fast-fashion brands sometimes used buy now pay later as a kind of marketing tactic, offering discounts on top of installments to lure consumers in who may not understand the consequence of missed payments.

“It [buy now pay later] has to move to a position where there is more regulation in the space,” he told Insider. “There is a huge amount of protection built into buy now pay later already but are companies doing everything they can on affordability and visibility?”

Damian Kassabgi, executive vice president of public policy at Clearpay said: “We welcome today’s recommendations and look forward to working with the FCA, the government and stakeholders to build on the consumer protections we already provide to create the right regulation for the sector.

“It has always been Clearpay’s view that consumers will be best served by products designed with strong safeguards and appropriate industry regulation with oversight from the FCA.”

SEE ALSO: We got an exclusive look at the pitch deck deck buy now pay later startup Scalapay used to raise a massive $48 million seed round

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