Kadre Article Series – Perspectives on Credit and Risk in Australian Financial Services
Welcome to Kadre’s – article series ‘Perspective on Credit and Risk in Australian Financial Services’ where, the Kadre team will provide leading commentary, reflecting on their collective experience, to help Chief Risk Officers navigate the permanent white water of the Australian Financial Services environment.
Buy Now, Pay Later: What Australia Needs to Consider for BNPL Regulation
As an increasingly popular payment method, with RBA’s data showing roughly 7 million active accounts recorded in FY22, Buy Now Pay Later (BNPL) arrangements are coming under closer scrutiny in Australia. This is good news for retailers who received $1.5 billion in net benefits from BNPL operators but with this rapid expansion of the BNPL market, comes greater responsibility for the Government and Regulators to ensure that consumers are protected and given access to responsible credit arrangements.
Consequently, the Treasury is currently exploring a new regulatory framework which is expected to bring BNPL services more in line with existing consumer protection laws.
As part of this they have recently gone out to market to gain feedback on three potential options for regulating BNPL arrangements.
- The first option is to strengthen the existing BNPL Industry Code to include a bespoke affordability assessment that BNPL providers must adhere to before granting credit.
- The second option is to bring BNPL within the Credit Act with a tailored version of Responsible Lending Obligations. This would create a more comprehensive framework for BNPL arrangements and offer better protections to consumers.
- The third option is for BNPL providers to be required to hold an Australian Credit License. This would bring BNPL into line with other credit providers in the industry and ensure a consistent regulatory approach across all credit services.
At Kadre, drawing on our extensive experience in the consumer lending sector – with many of our executives being at the forefront of the development and implementation of major initiatives such as Comprehensive Credit Reporting and Responsible Lending Obligations – we are particularly focussed on the two below regulatory concerns outlined in the treasury’s options paper:
- the definition of scalability in regulatory guidance (RG209)
- deficiencies in the way comprehensive credit reporting has been implemented
What is our recommendation?
- To require BNPL providers to hold an Australian Credit License (option 3)
Having dealt with many Fintechs and lending start-ups in Australia, Kadre is of the view that BNPL can operate under the existing Credit Act as a licensed entity providing there is clarity about the definition of scalability in relation to assessing a customer’s financial situation, and that all lenders can obtain reliable information about the level of a consumer’s indebtedness through the credit reporting regime.
Our take is that BNPL products are credit and should be regulated consistently with other credit providers within the existing Credit Act. Why should a $1,000 BNPL credit line require no credit assessment while a $1,000 overdraft or credit card, which can have a materially lower impact on the cash flow of a consumer, requires substantial effort by the lender to assess the customer’s financial position?
In our experience, the principles of the Australian Credit License process are sound and reflect society’s expectation of providers of credit in areas such as:
- Fit and proper person to engage in credit activities.
- Adequate compliance arrangements.
- Supervising and training representatives.
- Adequacy of resources.
- Dispute resolution and hardship processes.
- Sound risk management practices.
- Appropriate and defined compensation arrangements.
An issue however that does need to be addressed is the time required to process an ACL application. Working with many start-ups, we have found this to be a challenge for fintechs seeking to enter the market with innovative ideas related to provision of credit. In our view, the government should consider rectifying this situation with an appropriate flexible resourcing mechanism for ASIC in this area.
What are the issues with option 1 or 2?
We believe that going with the alternative, of accepting the BNPL Industry Code and allowing an exemption to the Credit Act (option 1), will set a precedent for continuous regulatory arbitrage in cases relating to innovative credit products. The nature of self-regulated Industry Code means that BNPL, and potential future innovative credit providers, would not be subject to the same level of public scrutiny, monitoring and enforcement as other credit providers that operate under the Credit Act.
Similarly, we don’t see option 2 described by Treasury proposes to bring BNPL within the Credit Act with a tailored version of Responsible Lending Obligations working well either. In our view, adding more “carve outs” like those for SACC, MACC and Reverse Mortgage loans will further complicate regulations for existing lenders and create additional uncertainty for credit providers that are considering new and innovative products. Option 2 would set a precedent for each new market entrant to seek ‘their own rules’ claiming their product is ‘unique’ and should be treated differently based on a technicality, such as in the case of BNPL, rather than on the core premise of the product.
The Credit Act and Regulatory Guidance (RG209) already contains provision for dealing with variations on Responsible Lending Obligations. For example, Regulatory Guidance (RG209.81) states that:
“The process of determining the kinds of inquiries and steps that are reasonable has been described as ‘scalability’. You need to apply your own judgment in determining what is reasonable in the individual circumstances”.
Clearly defining scalability in relation to reasonable inquiries about, and verification of, the customer’s financial position will provide a strong framework for ensuring lenders balance a low cost, efficient and streamlined process against avoiding reasonably foreseeable consumer financial harm.
- To clarify what is meant by scalability
Our support for option 3 proposed by Treasury that BNPL be required to hold an Australian Credit License and be regulated under the Credit Act is dependent upon there being a clearer definition of scalability for the benefit of all lenders.
Even before it was introduced, the definition of “scalability” has been a point of contention among consumer lenders. When introduced for consultation in 2010, there was little definitive explanation of scalability leaving each lender to interpret thresholds for reasonable inquiries about, and verification of, the customer’s financial position. Competitive pressures and product economics led to a wide range of interpretations, resulting in an equally inconsistent level of consumer protection.
Many lenders implemented Income Validation Models and Expense Benchmarks for credit facilities that had combinations of low value and low risk so they could maintain efficient, low cost and streamlined processes.
Over the subsequent few years, ASIC took action against a number of lenders for failing to comply with responsible lending obligations and additional requirements were added to regulations for SACC and MACC loans. The perceived compliance requirements and threat of regulator action meant that many lenders took a conservative approach to credit assessment resulting in more complex processes, greater customer friction and higher costs.
Kadre has worked with many consumer lenders across the industry and has a deep knowledge of credit policies and credit assessment processes including the way in which they assess and verify a customer’s financial position. We are currently working with organisations such as the Sydney University Business School to determine appropriate empirical methods for defining scalability.
In summary, our Kadre community believes that the Government has a great opportunity to address the increasing potential of consumer financial harm from BNPL’s and to reduce the cost of credit while continuing to promote innovation that will emerge from technology advancements. In our opinion, the existing requirements in the Credit Act are sufficient to apply to all lenders providing there is a clarity about the definition of scalability. We believe that scalability principles should apply to the full breadth of credit providers, not just BNPL. It should provide consistency and certainty as to what is, and is not, acceptable, without the risk of impeding innovation.
You can view the full submission to treasury here – Kadre’s full submission to Treasury on BNPL
The Kadre community includes former CROs of major banks and other financial institutions including fintechs, former senior executives of Credit Reporting Bodies, founding members and former directors of ARCA and subject matter experts who have been involved in ASIC investigations, helping lenders deal with enforceable undertakings and remediation programs. The community also includes leading data scientists who have a deep understanding of how to use data to achieve successful business outcomes.
If you are a lender and would like further information and assistance with affordability assessment please contact t@kadre.com.au or steve@kadre.com.au.
