Case scenarios about lending

Publication date: October 2, 2024

The following fictional case scenarios provide examples of payment functions that are, and are not, incidental to a consumer lending business.

Case scenario: Financing company partnering with merchant

Merchant X decides to partner with Company A to provide a financing solution that is offered directly to Merchant X’s customers when they are making purchases. Given that many of the goods that it sells are big-ticket items, Merchant X believes that offering financing as a more convenient in-store option could help to attract new customers and grow its retail business. Company A does not charge any fees to Merchant X as part of this partnership. Rather, Company A generates its revenues from the interest charged to borrowers on issued loans. Company A sees its partnership with Merchant X as an opportunity to more effectively reach potential borrowers.

When using this financing option at a Merchant X store, clients use tablets supplied by Company A to complete the loan application process established by Company A, which includes providing consent for Company A to conduct a soft credit check. In the application, clients provide identifying information and details of their employment and income and select their preferred means of repayment for the loan. The loan application is then submitted virtually to Company A. Once Company A receives the application, an automated process reviews the file and determines whether an instant approval is possible, or if a manual review will be required. Once Merchant X is informed by Company A that the loan is approved, the customer can take possession of the good. Subsequently, Company A transfers funds equal to the purchase amount from its bank account to the account of Merchant X. Borrowers repay the loan through scheduled payments to Company A using one of the accepted payment methods, such as pre-authorized debits or credit card payments.

In this case, Company A stores personal and financial information regarding its borrowers to underwrite the loan and receive future repayments. This means that Company A performs the payment function of providing or maintaining of an account on behalf of an end user in relation to an electronic funds transfer (EFT). However, the performance of this payment function is incidental to Company A’s lending services. The only reason the company maintains an account is because it is necessary to issue a loan to a borrower and to receive repayment. While providing in-store financing and providing funds to the merchant enables a transaction to take place, Company A is not in the business of facilitating payments between merchants and their customers. When it supplies funds to the merchant, Company A is purchasing a future revenue stream that it is entitled to collect from a borrower. Company A does not generate any revenues from facilitating payment—all revenues come directly from its lending business. Furthermore, Company A also does not advertise its services as a payment solution and, consistent with its marketing, borrowers using Company A see it as a loan provider.

As a result, Company A is not considered a payment service provider (PSP) under the Retail Payment Activities Act (RPAA) and does not need to register with the Bank of Canada.

Case scenario: Buy-now-pay-later

Company B is a buy-now-pay-later (BNPL) business that allows consumers to make purchases and defer payment for them over time through four installments. Company B’s solution integrates with the websites of merchants with which it has agreements to offer its BNPL solution as an accepted payment method. To start using this service, individual consumers create an account with Company B and consent to a soft credit check. There are no fees charged to the consumer for the advance of funds to make a purchase, but late repayment fees may apply.

Merchants like Merchant X that wish to offer Company B’s BNPL service as a payment option to their customers also need to sign an agreement and open an account with Company B. As part of this process, the merchant provides information on its business activities and on the details of the bank account where Company B will disburse payouts for the proceeds of sales. Merchants using Company B’s solution are charged a discount rate and a transaction fee for each transaction. Company B promotes its services to merchants as a payment method popular amongst consumers that will increase sales through lower cart abandonment and increased conversion rates.

When a customer wants to make an online purchase from Merchant X using Company B’s BNPL solution solution service as their payment method, they first select Company B at check-out as their means of payment among the different options available. The customer is then directed to a confirmation window controlled by Company B, where they can review the terms and conditions of the loan, choose their means of repayment and agree to proceed with the purchase via BNPL financing.

As part of this process, Company B also assesses the purchase against its credit limit for each specific customer and decides whether to approve the transaction.

Once the loan is approved, Company B’s software transmits some information necessary to process the first installment repayment, such as the customer’s name and amount payable to a third-party company. Next, Company B’s BNPL interface receives a confirmation that the first installment payment has gone through and confirms to the customer that the transaction has been finalized. Later, Company B reconciles all the transactions processed for the merchant during the day and instructs its financial institution to transfer that amount minus the applicable fees to the merchant. In case of chargeback or refunds for the transaction, Company B will net these amounts against any new purchases.

As part of these different steps, Company B performs the following payment functions: the maintenance and provision of an account; the initiation of an EFT; authorization of an EFT and the transmission and reception of a payment instruction; and the provision of clearing or settlement services.

While one or more of these payment functions may be performed to support its lending business, Company B also performs some payment functions as a distinct business activity. Company B’s business offering is twofold and consists of offering both lending services and payment services. In other words, some of the payment functions are not exclusively performed for the purpose of allowing Company B to sell their non-payment related service (lending services). They are instead performed as part of a distinct service that allows other businesses to receive payments for the goods and services they sell to their clients.

As further indication that some payment functions are performed as a distinct service, Company B generates revenues from two distinct business lines:

1. the late penalty fee paid by borrowers on the lending-business side
2. the discount rate and transaction fees on the payment-service side

Additionally, Company B markets and brands its offering as a payment service. It promotes its solution to merchants as a popular payment method and advertises it to consumers as a less expensive, less risky payment method compared to traditional credit cards. Similarly, customers on both the borrowing and the merchant side generally understand that they are using Company B as a payment service.

As a result, some of the payment functions performed by Company B are not incidental to another non-payment related business or service activity. Company B thus meets the definition of a PSP under the RPAA and needs to register with the Bank of Canada, assuming it meets the other registration criteria.