If you purchased something online this holiday season, you were likely given multiple payment options at checkout, including an option to “buy now, pay later (BNPL)”. A BNPL loan allows borrowers to defer payment on purchased items. Borrowers pay little to nothing at checkout but then make repayments over time, typically in four or fewer installments.
While BNPL loans appear similar to traditional installment loans, there are distinct differences between the loan programs. Installment loans often require hard credit inquiries before approval, which can negatively affect applicants’ credit scores. BNPL loans, however, typically only require soft credit inquiries, which do not affect credit scores. Most installment loans also impose finance charges (e.g., interest) on purchases but don’t require repayment in four or fewer installments. BNPL loans, on the other hand, generally do not charge interest on purchases but do require borrowers to repay according to an established payment schedule in four or fewer installments.
Because BNPL programs don’t impose finance charges or permit repayment in more than four installments, BNPL lenders are generally not defined as “creditors” under Regulation Z. This means that BNPL lenders would not be subject to the requirements of Regulation Z, and the consumer protections set forth in Regulation Z would not apply to BNPL loans.
So, what federal guidance does apply to BNPL loans?
On December 6, 2023, the Office of the Comptroller of the Currency (“OCC”) issued Bulletin 2023-37, which provides guidance for banks regarding BNPL loan risk management (“Guidance”). Banks may contract directly with merchants to offer BNPL loans or go through a third-party BNPL provider (e.g., Klarna, Affirm) that acts as an intermediary between merchants and lenders. Banks acting as BNPL lenders will typically reimburse merchants less than the full purchase price of the goods or services, but then collect the full purchase price through installment payments from the borrower.
According to the OCC, BNPL loans pose various risks to both banks and consumers, including:
- Lack of clear, standardized disclosure language, which may lead to consumer confusion and create risk of unfair, deceptive, or abusive acts or practices.
- Problematic merchandise returns and merchant disputes when repayments are owed to BNPL lenders rather than the merchant.
- Operational and compliance risk created by third party relationships (merchants or BNPL providers) and from the highly automated nature of BNPL loans.
- Underwriting and fraud risk due to obtaining limited credit history from applicants and lack of visibility into applicants’ BNPL borrowing history.
To manage these risks, the OCC Guidance urges banks to maintain a risk management system that is designed to accommodate the unique characteristics of BNPL loans. Appropriate risk management includes:
- Managing credit risk. To manage credit risk, the OCC recommends BNPL lenders adopt robust repayment methodologies that give BNPL lenders reasonable assurance that the borrower can repay the debt. These methodologies may include assessing debt-to-income or using deposit account information. Regardless, the methodology used by BNPL lenders should contain safeguards that minimize adverse borrower outcomes. For example, repayment plans dependent on a borrower incurring additional debt to make payments should be avoided as such plans result in a cycle of debt for the borrower.
- Tailored charge-off practices. BNPL lenders should tailor their charge-off practices to the short-term nature of BNPL loans. If information is available that a BNPL loan will not be repaid, the bank’s charge-off policy should go into effect, regardless of whether the BNPL loan would otherwise be deemed past-due under the bank’s standard charge-off policy (e.g., after 120 days).
- Timely reporting to credit bureaus. The OCC Guidance highlighted that failing to timely report BNPL loans to credit bureaus hinders banks’ ability to identify borrowers’ total debt obligations when evaluating repayment ability. Thus, the OCC urges BNPL lenders to furnish relevant BNPL loan information to credit bureaus in a timely manner.
- Operational risk management strategies and fraud prevention. Consumer complaints involving BNPL loans often center around purchase disputes, including a borrower’s obligation to continue making payments on disputed or returned purchases. Consequently, BNPL lenders should implement processes for handling merchandise returns and disputes, and such processes should be fully explained and disclosed to borrowers. In addition, since many BNPL loans require little to no up-front payment, BNPL loans present enhanced risk of first payment default. BNPL lenders should therefore have in place procedures to address first payment default and controls that timely identify suspected fraud.
- Addressing third party and compliance risk. Banks that engage merchants or BNPL providers in connection with a BNPL loan program should ensure all third-party risk management processes are applied to the third parties engaged in providing BNPL services. All marketing, advertising, and consumer disclosures should also clearly state the terms of the loan, including the borrower’s obligations and applicable fees. While the Regulation Z disclosure requirements may not be applicable to BNPL loans, BNPL lenders should still adhere to the requirements of other applicable regulations, including regulations governing billing disputes and error resolution rights.
Notably, the OCC Guidance applies specifically to BNPL loans that are payable in four or fewer installments and carry no finance charges. Loans with payment terms greater than four installments or that impose finance charges are treated as traditional installment loans subject to Regulation Z.
The OCC Guidance is one example of how closely regulators are scrutinizing alternative credit programs, particularly those programs that are likely to involve non-bank third parties. Banks should closely review the OCC Guidance before implementing (or continuing) a BNPL loan program.
 Regulation Z defines a creditor as “a person who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments.”
 While the Guidance is issued by the OCC and is directly applicable to national banks, the principles and commentary on BNPL loans set forth in the Guidance seem applicable to any bank offering a BNPL loan product.