Buy Now Pay Later Chargebacks

A recent development in the payments industry is “Buy Now, Pay Later” (BNPL), a technologically facilitated update to the old concept of the installment plan. Whether run through BNPL apps or retailer-specific BNPL programs, these new payment options for consumers offer interesting benefits and challenges for merchants. In particular, BNPL may present increased risks of fraud but, oddly enough, decreased risks of chargebacks for merchants. However, as a new and largely unregulated payments method, these features will likely be subject to some change in the coming years. Nonetheless, it is valuable to examine what BNPL means from a merchant’s perspective.

What is Buy Now Pay Later?

BNPL is a payments model in which a consumer is allowed to split up the price of a purchase into multiple installments with only the first one due at checkout. It is, in essence, an instant credit, installment loan. Installment plans and loans are not new forms of payment, but BNPL combines them in a new format, often in conjunction with smartphone apps and other tools for ecommerce. There are third party apps that facilitate BNPL such as Afterpay, Klarna, Sezzle, and Affirm. It’s possible that some larger retailers may have their own proprietary BNPL systems, as well.

A BNPL purchase works such that the BNPL provider pays the merchant in full, the consumer pays the BNPL provider a down payment, and the customer agrees to pay the remainder of the purchase price to the BNPL provider in installments—often somewhere between 3 or 12 installments. Some BNPL programs charge interest to the customer, but most do not. Instead, they charge a fee to the merchant, usually between 2% and 8%.

BNPL has become more popular during the more than two years of the COVID-19 pandemic, possibly indicating a consumer need for new forms of credit to offset pandemic-related financial difficulties. The Motley Fool writes about a study in which BNPL use was found to have grown 50% between July 2020 and March 2021. Additionally, BNPL is especially popular with tech-savvy, bank-wary, younger consumers. In the same Motley Fool study, the percentage of respondents who had used BNPL in the age groups of 18-24, 25-34, and 35-44 all surpassed 60%. But only 53% of respondents aged 45-54 and 41% of respondents over 54 had used BNPL.

Risks

Soft Pull Credit Checks

There are a number of aspects of the mostly unregulated BNPL process that make it risky. The most notable is the fact that credit is issued without a full credit check. Instead, BNPL providers perform a “soft pull” of the customer’s credit history during the verification process. BNPL providers are also accused of having poor identity verification features, making their apps a target for fraudulent actors.

Big Ticket Items

Another aspect of BNPL that makes it an enticing space for fraud is the fact that it is often used for expensive, big ticket items. The payoff for fraudsters is larger with BNPL than with some other fraud targets.

Uncertain Future of BNPL

Additionally, BNPL is a new, growing segment of the payments industry and it is not entirely clear that it is financially sustainable in the long term. As BNPL providers scale up their operations and consumers come to expect it from more retailers, merchants may get caught up in the pressure to adopt a payment method that may change significantly or even cease to exist in the near future.

Types of BNPL Fraud

Already, certain fraud patterns are apparent with BNPL apps.

Account Takeover Fraud

One such pattern is the prevalence of account takeover fraud, in which a fraudster accesses a consumer’s BNPL account and uses it to purchase items. This can be a particular issue with BNPL because of its frequent use for purchasing big ticket items and because the delayed payment expectations may prevent the consumer from realizing their account has been compromised in a timely fashion.

Synthetic Fraud

Another form of fraud that is a particular challenge for BNPL is synthetic fraud. In this case, fraudsters use the industry’s lax standards for identity verification and credit checks to create accounts under fake identities. Again, the tendency toward big ticket items and delayed payment makes BNPL an appealing mark for this kind of fraud.

Other Buy Now Pay Later Fraud

BNPL is also at risk for the same sorts of fraud that affect most kinds of card-not-present (CNP) transactions. This includes types of friendly fraud such as family fraud and intentional chargeback fraud such as digital shoplifting.

BNPL Fraud and Chargebacks

The good news, for now, for merchants is that all of these risks and fraud tendencies are unlikely to translate to chargebacks. Because BNPL works in such a manner that the BNPL provider pays the merchant upfront in order to facilitate the installment payment plan with the consumer, any chargeback liability should fall to the BNPL provider rather than the merchant. But the under-regulated and nascent nature of the BNPL industry means that this may not remain the status quo for long.

Additionally, there are other consequences that merchants may have to face in exchange for being inured to chargeback risks. The BNPL provider is an additional layer to the already complex payments process, making such things as refunds more complicated. Customers may not necessarily be aware of the distinction between the BNPL provider from the merchant. Therefore, communications between merchant and customer may be complicated by the role of the BNPL provider. Or the BNPL provider may do something outside of the merchant’s control that upsets the customer but the customer blames the merchant.

What to Do About It

Buy Now Pay Later is risky, fraud-prone, insufficiently regulated, and likely to change significantly in the coming years. But it is also a growing segment of the payments industry and merchants would be well served to understand it. Even though chargeback liability is unlikely to fall to merchants under the current BNPL paradigm, merchants that adopt BNPL should try to strengthen their fraud-detection and identity-verification efforts. BNPL can offer merchants the opportunity to reach new consumers who are unable or unwilling to open traditional credit card accounts but it is important for merchants to not open their businesses up to additional fraud risks as well.