Yesterday, the Office of the Comptroller of the Currency (OCC) issued guidance to banks on managing the risks associated with “buy now, pay later” (BNPL) lending. Specifically, the bulletin addresses BNPL loans that are payable in four or fewer installments and carry no finance charges. The stated aim of the OCC’s guidance is to ensure that these loans are offered in a manner that is safe, sound, and compliant with applicable laws and regulations.
BNPL loans, also known as “point-of-sale installment loans” or “pay-in-4” loans, have seen a rapid increase in recent years. These loans have gained popularity, especially among tech-savvy, younger generations and consumers with limited or no credit history.
In a typical BNPL transaction, the lender pays the merchant for the good or service and takes on the responsibility of collecting payments from the borrower. To compensate for the credit risk, merchants pay a “merchant discount” to the lender. The lender then collects the full purchase price through installment payments from the borrower. If the borrower does not pay on time, the lender may, at times, charge late fees and refuse to make additional BNPL loans to the borrower until the borrower brings the account current.
While the OCC acknowledges that BNPL loans can provide consumers with a convenient and relatively low-cost financing alternative, it also believes they carry potential risks for both banks and consumers. These risks, according to the OCC, include the potential for borrowers to overextend themselves or not fully understand the repayment terms and underwriting challenges for banks due to a borrower’s limited or no credit history. The OCC also warns that the lack of clear, standardized disclosures may obscure the transaction terms, result in consumer harm, or result in potential unfair, deceptive, or abusive acts or practices (UDAAPs). The bulletin also points out the OCC’s belief that there are potential issues related to fraud, merchandise returns and merchant disputes not being fully resolved because of the brief term of the loan, as well as increased exposure to operational and compliance risks due to third parties. The bulletin further notes that returns and disputes are common concerns in Consumer Financial Protection Bureau consumer complaints. Lenders also may not have visibility into an applicant’s borrowing activity on BNPL platforms given the limited capture of BNPL activity by traditional consumer reporting agencies.
To mitigate these risks, the OCC advises banks engaged in BNPL lending to operate within a risk management system that is commensurate with the associated risks and designed to capture the unique characteristics of BNPL loans. This includes maintaining prudent underwriting, repayment terms, pricing, and safeguards that minimize adverse customer outcomes. Specifically, banks should establish policies and procedures for BNPL lending that address loan terms, underwriting criteria, methodologies to assess repayment capacity, fees, charge-offs, and credit loss allowance considerations. Repayment assessment methodologies may include assessing debt-to-income, debt-to-assets, or residual income; using deposit account information; or using alternative data. Banks should also ensure that marketing materials and disclosures are clear and conspicuous. The OCC further notes that consumer reporting that complies with the requirements of the Fair Credit Reporting Act and helps banks manage credit risk would also allow borrowers who make on-time payments to demonstrate positive credit behavior and build credit history.
The OCC’s bulletin serves as a valuable guide for banks and their fintech partners to navigate the risks in offering BNPL loans in what the OCC believes is a responsible manner. As the BNPL market continues to evolve, it will be crucial for banks and their fintech partners to stay informed and adapt their risk management strategies accordingly.