Regulation is coming for US BNPL companies: Zip and Sezzle shares under pressure

The pain is only adding up for the Buy Now, Pay Later industry, with the US Consumer Financial Protection Bureau (CFPB) issuing a report on Thursday suggesting stricter oversight for installment products before "they create widespread harm".

Beleaguered Zip (ASX: ZIP) and Sezzle (ASX: SZL) shares are down between 2-3% in early trade.

The CFPB first began monitoring it the industry in December 2021 to "gain more insight into the industry."

The agency, which has authority over banks and other financial services in the US, wants to up the regulatory ante for BNPL companies, with the view that they should be subject to the "appropriate supervisory examinations, just as credit companies are."

Here are the report's key findings and next steps.

Bleak insights for BNPL bulls

Key performance indicators getting ugly: "We're already seeing deterioration in credit performance for Buy Now, Pay Later loans In 2020, 2.9 percent of borrowers in our dataset "charged off" on a BNPL loan, which jumped to 3.8% in 2021. And public filings show that this upwards trend is continuing through the first-half of 2022."

"Late fees are becoming more common: 10.5% of unique users were charged at least one late fee in 2021, up from 7.8% in 2020."

"Lenders' profit margins are shrinking: Margins in 2021 were 1.01% of the total amount of loan originated, down from 1.27% in 2020."

Potential consumer risks: Beyond the financials, the report identified several consumer risks that fit into three broad areas of concern. The CFPB views these areas as 'gaps' whereby consumers don't really have any baseline level of protections.

1. Discrete consumer harms: "Undesirable operational hurdles" such as the lack of clear disclosures of loan terms, challenges in resolving disrupts and a requirement to use autopay for all loan payments.

2. Data harvesting: The report observes many BNPL players shifting their business models towards proprietary app usage, which "allows them to build a valuable digital profile of each user's shopping preferences and behaviour." The act of harvesting consumer data may undermine user privacy and autonomy.

3. Overextension: BNPL products aim to encouraging consumers to purchase and borrow more. This can result in either "loan stacking" where the user borrows off several lenders or "sustained usage" which results in a consumers inability to meet non-BNPL obligations.

Next steps

The CFPB said it will pursue a number of additional steps as it tries to flex its authority over the grey BNPL space. This includes:

• Identify potential interpretive guidance or rules to ensure BNPL firms adhere to baseline protections that Congress has already established for credit cards

• Identify data surveillance practices that BNPL providers engage in that may need to be curtailed

• Options on how the industry and consumer reporting companies can development credit reporting practices

• Ensure that BNPL companies are subject to the "appropriate supervisory examinations, just as credit companies are"

The good thing is that nothing material has come out of the CFPB's report. But it does feel like the agency is increasingly closing in the autonomy and freedoms that BNPL companies currently enjoy.