Buy now, pay later firms will now be regulated amid fears young shoppers are falling into huge debts

Buy now, pay later schemes will face tighter regulation from the City watchdog to stop millions of young shoppers racking up huge hidden debts.

The Financial Conduct Authority (FCA) today said bringing the sector under stricter control was a ‘matter of urgency’ after a review of the unsecured credit market found the scheme could ’cause harm to consumers’. 

Many high-street retailers including Marks & Spencer and H&M, and online shops such as Asos, offer the services, which let customers pay for their shopping in monthly instalments interest-free in order to spread the cost.

Though they stop shoppers from turning to expensive borrowing, the schemes potentially encourage people to spend more than they had planned and accruing debts that they cannot pay back.  

The use of buy now, pay later schemes, provided by firms like Klarna and Clearpay, nearly quadrupled in 2020 as the pandemic drove online shopping. At Christmas, one in four shoppers used £2.3billion of buy now, pay later credit to pay for their festive shopping. 

However, a review of the market by Christopher Woolard recommended bringing interest-free buy now pay later into FCA supervision after finding it was ‘relatively easy’ for shoppers to accrue debts of around £1,000 that credit reference agencies and mainstream lenders cannot see.

Today the government announced that providers will need to undertake affordability checks before lending and ensure customers are treated fairly, particularly those who are vulnerable or struggling with repayments.   

The move, which has been recommended by Labour MP Stella Creasey and MoneySavingExpert’s Martin Lewis, was praised by groups including Which?, Citizens Advice and Step Change. 

John Glen, Economic Secretary to the Treasury, said: ‘Buy now pay later can be a helpful way to manage your finances but it’s important that consumers are protected as these agreements become more popular.

‘By stepping in and regulating, we’re making sure people are treated fairly and only offered agreements they can afford – the same protections you’d expect with other loans.’

The Woolard Review, chaired by the former interim chief executive of the FCA Christopher Woolard, found that though the schemes give consumers a significant alternative to more expensive credit, it puts them at risk of getting into debt.   

For example, more than one in 10 customers of a major bank using buy now, pay later were already in arrears. 

The Review found several potential harms which can be mitigated by bringing these agreements into regulation.

Many consumers do not view interest-free buy now, pay later as a form of credit, so do not apply the same level of scrutiny, and checks undertaken by providers tend to focus on the risk for the firm rather than how affordable it is for the customer.

Although the average transaction tends to be relatively low, shoppers can take out multiple agreements with different providers – and the review found it would be relatively easy to accrue around £1,000 of debt that credit reference agencies and mainstream lenders cannot see.

With several providers planning to expand to higher-value retailers, or offer their products in-store, the risk that consumers could take on unaffordable levels of debt is increasing, the government said. 

Regulation will offer customers a level of protection, such as being able to report the scheme to the Financial Ombudsman if something goes wrong. 

A consultation will take place before legislation is brought forward to ensure the approach to regulating buy now pay later firms is proportionate. 

Mr Woolard said: ‘New ways of borrowing and the impact of the pandemic are changing the market, with billions of pounds now in unregulated transactions and millions of consumers at greater risk of financial difficulty.’ 

Reality stars and Instagram celebrities have been blasted for plugging the schemes to their young followers on social media without outlining the risks, while parents were warned not to use the service to buy Christmas presents over fears they would not be able to repay the costs. 

A spokesperson for Klarna said that as a licensed bank, it was ‘very comfortable operating in a regulated environment and wholeheartedly supports further regulation of the buy now pay later sector in the UK’. 

‘We agree that regulation has not kept pace with new products and changes in consumer behaviour and it is now essential that regulation is modern, proportionate and fit for purpose, reflecting both the digital nature of transactions and evolving consumer preferences,’ it said.

‘This is why we welcomed Woolard Review into change and innovation in the unsecured credit market, we have fully engaged in this process and we now look forward to working together with the FCA, government and the wider sector to build a modern regulatory and supervisory framework that delivers the best outcomes for customers.’

Damian Kassabgi, EVP Public Policy at Clearpay, said: ‘We welcome today’s recommendations and look forward to working with the FCA, the government and stakeholders to build on the consumer protections we already provide to create the right regulation for the sector.

‘It has always been Clearpay’s view that consumers will be best served by products designed with strong safeguards and appropriate industry regulation with oversight from the FCA.

‘We are pleased that many of the suggestions we put forward in our submission to the Woolard review have been acknowledged and that the review has recognised the diverse nature of the industry.’

Martin Lewis, founder of MoneySavingExpert.com, told MailOnline: ‘There has been an explosion of buy now, pay later (BNPL) lending over the last few years, often targeted at young people, pushed via Instagram and social media, as if it is a form of lifestyle therapy. It isn’t. It’s debt. 

‘In fact, it’s the fastest-growing form of credit in the UK and regulation is crucial.

‘For years, I and others made similar calls about payday loans – they too were purported to be ‘filling a gap’, and about ‘technology, not borrowing’ – and the sloth-like delays to dealing with that led to financial nightmares for millions.

‘That’s why I strongly support regulation, and regulation at speed. BNPL isn’t as bad as payday lending – done right, used right, it’s interest-free. Indeed, it can be a useful tool. 

‘However, it’s been sold to retailers as an easy way to get people to spend more – this, combined with the younger demographic who use BNPL, is a massive red flag.

‘Regulation isn’t about killing the industry, it’s about putting controls on product design and marketing, to ensure that over-borrowing doesn’t ruin lives, and that consumers are treated fairly. 

‘And most importantly for me, it means people would have a right to take any complaints to the free and independent Financial Ombudsman Service.’

Gareth Shaw, Head of Money at Which?, said: ‘We’ve highlighted how the Buy Now, Pay Later market can encourage some people to spend more than they can afford, so regulation to protect consumers from building up large debts that they will struggle to pay off is clearly required.

‘As Buy Now, Pay Later services continue to surge in popularity at a time when people’s finances are under significant pressure, there is no time to lose. 

‘New rules covering this type of lending must be introduced as soon as possible to ensure action can be taken if firms are treating customers unfairly.’

StepChange’s Director of External Affairs Richard Lane told MailOnline: ‘This report identifies multiple ways that the regulator can help the credit market to improve to benefit consumers, and we’re particularly pleased to see a focus on how debt problems should be addressed – and avoided.

‘If the pandemic has shown us anything, it’s revealed that it’s not only our health that is vulnerable to sudden shocks – our finances are too. 

‘Chris Woolard’s recommendations on how the FCA should reflect the lessons learned from this period and apply them to future consumer protections show insight and clarity.

‘We very much look forward to working with the FCA to act on these recommendations, and especially to improve the practical steps that can be taken to reduce debt problems in the UK.’

It follows research which found that one in four shoppers used firms such as Klarna, which has formed partnerships with hundreds of household name retailers, in the run up to Christmas. 

Shoppers spent an average of £170, which it is claimed represented nearly 40 per cent of all Christmas shopping. The research, by credit reporting firm Credit Karma, also found that young people were the most common users of buy now, pay later. 

The firms have been accused of tempting people – especially younger adults – into getting into debt by spending money they don’t have. 

Figures previously released by debt solution provider Financial Wellness Group said it was increasingly common for people in debt to such schemes to come to it for help.