The tug of war over embedded financing. Who will win?

Ranking Republican Patrick J. Toomey, R-Pa., recently had this to say about embedded financing: “Regulating these products too quickly or stringently would stifle innovation and hurt consumers. This is a reminder that market competition is typically better at helping consumers than the government — whether the product or service is in the financial sector or another category.” 

Toomey went on to applaud Buy Now Pay Later (BNPL) products “for providing credit to people often left behind by traditional lenders, including low-income and young people.” Interestingly, he closed with this cautionary caveat: “…as long as consumers have truthful and accurate information about financial products."

On the other side of the political aisle, we have Sen. Mark Warner, D-Va., who gave us this warning in a recent Senate Banking hearing. “We're now seeing a migration in the non-regulated part of the financial industry. I think we focus sometimes almost exclusively on the benefits and not on some of the challenges. There are reasons that we have regulated financial institutions.”  Warner wrapped up his POV by likening the coming BNPL storm of “emerging technology-based lending products that lack consumer protections” to the 2008 financial crisis.

Embedded financing, as we all know now, allows consumers to pay for a product, often bought online, in a set number of installment payments over a predetermined period; usually four payments over six to eight weeks. And the appeal is obvious. For the consumer, embedded financing provides a “one-stop shop” that makes it easier to access goods and services when and where they’re needed. For the business, embedded financing not only generates more sales but also provides consumer data than can later be used to drive future business.

Embedded financing rose in popularity during the pandemic as lockdowns drove consumers to online shopping. According to a study from Juniper Research, the value of the embedded finance market was $ 43 billion in 2021 and is highly likely to exceed $ 138 billion. According to Oracle’s estimates, the value of the market is expected to exceed $7 trillion in the next 10 years, making it worth double the combined value of the world’s top 30 banks today.

All of this growth depends, of course, on guys like Warner and Toomey, doesn’t it? But, what will drive the decisions around embedded financing and determine the industry’s future?  Will it be the CFPB? The Consumer Federation of America? The Financial Technology Association?  Sorry about all of the questions, but I seem to see lots of questions with very different — even conflicting — answers to them.  And I’m hoping that our legislators are getting better, more consistent data. One thing we do know for certain: The structure of these services has so far allowed many providers to avoid requirements that apply to traditional lending products, including credit cards… or can we even be certain of that?

On the one hand, for instance, just this past month the Consumer Financial Protection Bureau released an 82-page report that will help develop "interpretive guidance or rules" to cover gaps and consumer risks in the booming BNPL niche. The CFPB's market-monitoring exercise began early this year when it surveyed five top BNPL providers — PayPal, Affirm, Afterpay, Klarna, and Zip — and focused specifically on the "Pay in 4" style of loans that are spread over four equal segments, bypassing traditional lending regulations. Skeptical about the real benefits, the agency highlighted questions about whether consumers are accumulating an unsustainable amount of debt, and whether companies are skirting regulations or engaging in unfair data collection. Their three primary concerns are around discrete harms to consumers, data harvesting, and overextension.  Also this past month, the FTC reminded businesses that if they offer embedded financing that they must comply with “the three basic consumer protection ground rules of the FTC Act: 1) Claims must be true for the typical consumer, 2) Consider consumer understanding, not just conversion, and 3) If things go wrong, companies can’t disclaim liability by pointing to others in the ecosystem.”

According to a September article, Rachel Gittleman, financial services outreach manager for the Consumer Federation of America, expressed similar concerns: “We would argue that most consumer protection laws should apply to buy now, pay later, as it's being structured more and more like open-end credit,” she said. “Federal regulators should supervise buy now, pay later providers and ensure that they're not engaging in unfair, deceptive or abusive acts and practices, or unlawful discrimination.”

While there seems to be considerable momentum behind taking significant steps toward regulations, there are certainly opposing points of view that support Rep. Toomey’s. In the same article, Penny Lee, CEO of the Financial Technology Association, supported Rep. Toomey’s POV with this: “Only 4 percent of buy now, pay later users missed at least a payment,” she said, citing a March study by the Financial Health Network. A September poll — not surprisingly commissioned by Lee’s association — found that “94 percent of users said they easily understood the terms and conditions of buy now, pay later services,” Lee said.

Lee went on to say that “BNPL products are also subject to consumer protection regulations, including anti-money laundering, fair-lending, debt collection, privacy, fair treatment of consumers and electronic fund transfers. They are also subject to similar state consumer protection laws.” Admittedly, she said afterward, “in some cases the products may not be considered loans if they’re structured as credit sales or retail installment sales through agreements with merchants selling the goods or services.”

I’m not a betting man, but if I were, I’d be putting my money on a much-transformed, much more highly regulated embedded financing industry in the coming year(s). There seems to be mounting evidence, to me anyway, to support this. I would also bet against Oracle’s prediction of a $7 trillion industry 10 years from now. And I’d place that bet using cash… not a Pay-in-Four loan.

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