The real risk facing Afterpay and its rivals

Afterpay is almost 10 years old as a business, but the very idea of buy now, pay later remains divisive. Is this industry a financial innovation that’s providing much-needed competition to the big banks? Or is it just another way of lending money that exploits regulatory loopholes, potentially leaving vulnerable borrowers at risk?

Financial Services Minister Stephen Jones this week found the middle ground between these opposing views when he unveiled proposed new legislation to bring buy now, pay later (BNPL) – which is particularly popular with Millennials and Generation Z – under the provisions of the Credit Act.

New buy now, pay later users will soon have to undergo a credit check, after the government introduced legislation to regulate the sector.Credit: Marija Ercegovac

However, that has not settled all the questions about how policymakers should deal with Afterpay and its rival buy now pay later providers. There is still a looming debate about whether such firms should also face tighter regulation that would allow retailers to pass on the cost of BNPL loans through surcharges, as they can with credit card transactions.

The regime Jones announced would result in relatively manageable changes for BNPL platforms, which include companies such as Afterpay (part of US fintech giant Block), ASX-listed Zip and Swedish firm Klarna. All these businesses compete with credit cards by providing short-term interest-free loans, typically for online shopping, which are repaid through instalments.

Under Jones’ plan, new users would have to undergo a credit check, and BNPL firms would need to hold a credit licence, among other changes aimed at protecting consumers who use the platforms.

In one sense, this is a major milestone. The laws would mean BNPL firms are captured by the Credit Act – something much of the industry had previously avoided because BNPL loans do not charge interest. Most agree there should be some common standards for the industry through regulation, and those standards now appear on the way.

BNPL firms probably breathed a sigh of relief this week because they’ll be subject to lighter-touch regulation than what is applied to credit cards. Even so, it’s hardly time for them to crack out the champagne because BNPL firms are also gearing up for another debate about a different part of their business model: how they deal with merchant surcharging.

What’s the concern? BNPL loans appear “free” to a consumer, but of course, someone is paying, and it’s the retailer.

When retailers make a sale through a BNPL platform such as Afterpay, they pay a fee of about 4 per cent of the purchase price to the BNPL firm – significantly more than what retailers are charged for receiving credit card payments. As part of their contract with the BNPL firm, the merchant cannot add a surcharge on top of the retail price paid by their customer.

For years, groups including retailers, the Reserve Bank and some consumer groups have raised concerns about this ban on surcharging. They worry that forcing retailers to absorb BNPL firms’ chunky fees simply prompts the retailers to build these costs into their prices. Banks – which compete with Afterpay by issuing credit cards – have also grumbled about an uneven playing field.

BNPL loans appear “free” to a consumer, but of course, someone is paying, and it’s the retailer.

This long-running debate looks set to rear its head again soon because of proposed legislation before parliament that would give the Reserve Bank new powers to regulate new forms of digital payments, including digital wallets such as Apple Pay, and BNPL firms. The central bank has said that if the bill passes, it will launch a review of retail payments, including BNPL and surcharging.

When the Reserve Bank last looked at the question of BNPL surcharging in 2021, it sided with retailers, concluding that they should have the right to add a surcharge on to the price of products sold via a BNPL platform.

Will it reach the same conclusion when it consults on the issue again – expected in the second half of this year? That will be a key question for BNPL firms, the retailers that use these platforms, and their customers.

Afterpay co-founder Nick Molnar this week played down the potential impact of any potential changes to the rules on surcharging, saying it would not have a “material impact” on the business. He argued retailers would be attuned to the wants of their younger customers, who dislike credit cards and value things such as free returns (which, like BNPL, also costs retailers money).

“Retailers are going to meet the consumers where the consumers are, and when 50 per cent of retail spend in Australia in 2030 comes from this debit card consumer and the Millennial and Gen Z demographic, they’re going to optimise to the absolute best experience for that debit card customer,” Molnar said.

Even so, the risk for Afterpay and its rivals is that the Reserve Bank could give retailers the ability to charge more for goods they sell via a BNPL platform – as retailers often do for credit card transactions. If some retailers chose to surcharge BNPL sales, it would remove the appearance of BNPL loans being free to the consumer.

Against this, there is also a chance that BNPL firms may get a reprieve from the Reserve Bank because of more important changes in the world of payments than the rise of BNPL. For example, the practice of surcharging by retailers will also be considered in the Reserve’s retail payments review because, increasingly, cashless consumers are becoming frustrated by retailers adding on charges for paying by card.

The Reserve Bank will also need to consider arguments from Afterpay and its rivals that they are putting competitive pressure on the traditional credit card market, which is dominated by big banks known for charging consumers hefty interest rates.

It is worth noting that the BNPL industry is still relatively small. Afterpay says BNPL is still only about 3 per cent of all consumer credit payments, and its role overall is tiny compared with digital wallets such as Apple Pay and Google Pay.

As consumers increasingly ditch cash for digital payments, it is throwing up all sorts of tricky questions about how these new payment methods should be regulated and how to keep costs contained. BNPL is just one area where these questions are still being debated, almost a decade after Afterpay came onto the scene.

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