Buy now, pay later revolution starts to slow

Buy now, pay later (BNPL) services must have a unique place in the financial sector — there are few services that have been adopted so quickly across so many geographies at the same time. While mobile payments or contactless transitions face sticking points in some jurisdictions, most countries with a strong basis of consumer e-commerce have seen BNPL options emerge. 

There is also a broad spread of providers, depending on the geography. While Klarna, Affirm and Clearpay have a strong presence in Europe and the US, Kredivo, Akulaku and Atome have significant market share in Asia. 

The premise of the service is simple: BNPL allows customers to make payments for their purchases across a set period, normally three or four months, in equal instalments and interest free. With only soft background checks carried out, it is an easy way for customers to obtain credit without incurring additional costs. 

With the likes of Apple Pay looking to enter the space, the management consultant company GlobalData has predicted that the global BNPL market will surpass $1tn by 2030. Juniper Research forecasts a 291% growth over the next five years, to a value of $437bn globally in 2027. Sweden-based Klarna states it has 150 million active consumers and can be used at more than 450,000 merchants in 45 countries.

The widespread arrival of BNPL services coinciding with the Covid-19 pandemic helped to fuel its adoption, as many consumers were unsure of their financial situation and lockdowns forced consumers into e-commerce as an alternative to in-person shopping.

Chris Dinga, payments analyst at GlobalData, says: “BNPL grew during the pandemic, based on convenience and people’s concerns over spending. If they were already planning to make a purchase, they could opt for BNPL rather than their credit card, to avoid the possible interest on making the payments.” 

Tech enabled

The explosion of BNPL has in part been down to the ease of onboarding the technology to points of sale. The use of application programming interfaces (APIs) has allowed merchants to easily plug BNPL services into their checkouts. It is the confluence of several developments in financial technology that allows BNPL to work seamlessly. 

Kanika Hope, chief strategy officer at banking software company Temenos, says: “BNPL is really an example of the API-first, cloud-native composable banking, which is opening up many possibilities in the embedded finance space.” 

Ms Hope explains how the technology breaks down: “At Temenos, we launched a specific BNPL service on our software-as-a-service offering, as our platform enables the embedding of financing in a third-party platform. This means the bank is able to seamlessly provide the financial product through an API from a cloud-native platform on to the merchant’s website, originate the loan and service the loan.

“With artificial intelligence (AI), it is possible to perform credit checks and gain customer insights. Technology is a big part of it and it is here to stay — irrespective of what the future of BNPL as a pure-play product is.” 

The Temenos service has been adopted by payments provider PayPal, which in its most recent earnings call stated 25 million customers globally are now using its BNPL options. 

Financial inclusion 

While BNPL has been eagerly adopted globally, it is helping to fill a financial gap in emerging markets. With sizeable unbanked populations and little access to credit, having an interest-free payments option can facilitate previously unavailable purchases. 

Kenyan fintech DeltaPay has partnered with AI risk decisioning software provider Provenir to bring BNPL to a new consumer base. DeltaPay has plans to expand to Uganda, Tanzania, Rwanda, the Democratic Republic of Congo, Nigeria and Ghana in the next five years.

Adrian Pillay, vice-president of the Middle East and Africa at Provenir, says there is huge potential for growth across the region: “BNPL in the Middle East and Africa is projected to reach $7.2bn this year. Nigeria is poised to grow by 110% and South Africa 70% year-on-year.” 

The arrival of BNPL services in Africa is vital, he says, as there are still around 400 million financially excluded adults across the continent. Even those with bank accounts cannot always access credit. 

“The World Bank reports that less than 50% of countries in Africa have a credit bureau, which would be used by traditional finance organisations to determine credit worthiness,” Mr Pillay explains. “With BNPL we are targeting the underbanked — those with almost no credit file. The ability to do a traditional evaluation of credit risk doesn’t exist. We will use alternative sources to make the decision, such as mobile wallet information or open banking services.” 

There are also considerable opportunities to be found across Asia. Aleksey Kosenko, head of BNPL at Philippines-based UnaCash, says: “The types of service being provided in the US and Europe is completely different to what we see in Asia. Customers in these Western countries already have access to credit services, and their motivation is to consume and find the best discounts. In Asia, what drives customers is credit accessibility. Credit card penetration in the Philippines is only around 8% of the population.” 

The straightforward nature of the product also helps with adoption in less financially literate markets, explains Elaine Koh, senior director, south and south-east Asia non-bank financial institutions at Fitch. “Asia is home to the world’s largest unbanked population, who often lack access to formal credit services. Investors have seen this as an untapped market for simple consumer financial products — BNPL being one example.”

However, she says there is still a long way to go for BNPL providers, as the take up of products accounts for around 1% of transaction volume in the south-east Asia region. One reason for this is the comfort some consumers have with using other forms for financing when making purchases from physical stores. 

“In many parts of emerging Asia, there is already a presence for point-of-sale financing,” Ms Koh says. “At a physical retailer, the customer will be able to purchase consumer products on credit via a product similar to BNPL, offering payments across six or eight monthly instalments. When it comes to moving to BNPL, however, the providers may still find they need to gain the trust of consumers in shifting to online rather than in-store transactions and familiarising themselves with new BNPL brands.” 

Retailers need to weigh up if offering BNPL will bring a high enough volume of transactions to cover the additional costs of use, with BNPL providers known to charge from 2% to 8% of the purchase price, compared with the 1% to 3% seen from credit and debit cards. 

Business opportunities 

An untapped area of BNPL is the business-to-business (B2B) space, especially among small and medium-sized enterprises (SMEs) that struggle to get access to financing. With the consumer space saturated with products, venture capital firms have been looking at these opportunities. UK-based lender Funding Circle has expanded its FlexiPay offering, explaining to customers they can use the solution to pay for services including value-added tax and business bills. Meanwhile, Banking Circle acquired Netherlands-based Biller in February 2022. 

Ryan Glancy, UK country manager at Biller, says: “Typically we cover orders of around £5000, but we can go up to £20,000. Normally we see orders of around £300. This shows how these businesses are using it for smaller items they need to make their business run, like laptops or office supplies.”

Unlike consumer-focused BNPL, Biller conducts checks on its customers before the financing is permitted. “With business buyers, we run a quick background check using machine learning leveraging over 100 data points to identify possible fraud and creditworthiness,” says Mr Glancy. “The only caveat is if we work with sole trader buyers, we treat them more like an individual. In these cases, we will put in a limit of £500 or up to £1000 if they are happy for us to use open banking to make a lending decision.”

There are also different penalties in the B2B space for missed payments. “We will notify a customer when their payments are due with a payment request. Following the due date, we send a free reminder after two days and then another reminder with a small charge after 10 further days. After a further 14 days there is another charge and a last notice 14 days after that. A very small amount of interest is applied from the second reminder. If the amount has not been paid following the final notice, the debt is passed to a third-party collection agency,” Mr Glancy adds.

Consumer risk

While the boom in BNPL has provided financing options to millions of consumers, there are concerns about what all of this will mean for individual consumers. 

Research conducted by the UK-based Centre for Financial Capability in December 2021 found 63% for 18–34-year-olds had used BNPL. Of all adults, 23% said they had been charged late fees, rising to 35% in the 18–34 years category. Adobe Analytics reported seeing an 85% increase week-on-week in BNPL spending among online shoppers in the US over the period comprising Black Friday and Cyber Monday. 

Carol Knight, trustee of the Centre for Financial Capability, says better financial education is vital. “The BNPL adverts show no interest rates applied and it is very easy for consumers to think that’s a great deal. But they don’t go into depth on the cost of missing a payment. Communication needs to be more transparent, so people are aware of the risks.” 

Maddy Irwin, analyst of thematic intelligence at GlobalData, says among the younger demographic it can be easy to overspend without understanding the risks. “After this period the debt collectors from the companies will get in touch, which can come about very quickly. People can easily get into this hole of not really thinking about the repercussions when they feel they’ve effectively ordered all the products for free.” 

These issues can be compounded in regions with lower levels of financial literacy. Tengfu Li, assistant vice-president and analyst at Moody’s, says: “There is risk of overleveraging among consumers, particularly given the accessibility, convenience and weaker underwriting standards of BNPL services. Adding to this risk is the modest financial literacy among south-east Asian consumers. Further, fintech companies that offer BNPL services do not report to any national credit bureaus, while credit information is generally not shared among industry players.” 

The Financial Times’s in-house charity Financial Literacy and Inclusion Campaign (FT FLIC) is focused on improving financial education in the UK. Claer Barrett, consumer editor at the FT and FLIC trustee, notes that shoppers who spent during Black Friday sales and for Christmas will be paying off their purchases until early spring.

“The concern is through the lack of checks it is the customers with the poorest credit history who will use it,” Ms Barrett adds. “It is possible for them to make purchases from multiple BNPL providers and there is no cross-referencing on the amounts. Unlike credit cards, there is not a credit ceiling and levels of debt can mount up.” 

Under the current regulatory structure, responsible BNPL borrowers do not benefit from making their repayments in time. “Although BNPL providers don’t technically have to report to credit agencies, many do so, which will affect credit scores. On the flip side, using BNPL doesn’t benefit your credit score,” says Mat Megens, CEO of HyperJar, a money-management service. 

Regulatory interest 

The growth of BNPL has not gone unnoticed by regulators, but few have made decisive steps to rein in the expansion of the sector. 

“There needs to be a broader definition of what comprises responsible embedded consumer lending,” says Temenos’s Ms Hope. “The regulators need to ensure BNPL providers go beyond soft credit checks; there cannot be an algorithm that allows everyone to get the credit they applied for. Many regulators are already looking into BNPL, but the key steps that most seem to want to take include mandatory credit reporting, transparent contractual terms, and a limit on fees and penalties.” 

Daniel Yu, vice-president and senior credit officer at Moody’s, says some financial authorities are taking steps to reduce the risks. “BNPL providers in Singapore abide by an industry code of conduct, which includes rules for the sharing of information among providers and no compound interest for loans. Australian BNPL providers must also adhere to an industry code of conduct, which requires companies to conduct detailed checks into a borrower’s financial profile.” 

The Australian Treasury is in the process of obtaining feedback on the future regulatory framework of BNPL, as it notes the “unintended regulatory gap” that has been created as BNPL falls under the exceptions available to some types of credit as part of the Credit Act.

In the UK, the Financial Conduct Authority does not regulate BNPL, but intends to do so in the future. Meanwhile, firms must comply with consumer protection legislation. In the US, the Consumer Financial Protection Bureau has outlined plans to introduce greater consumer protections. 

Other countries are slower to act as they do not see BNPL as a significant problem. Mr Yu adds that the penetration of BNPL is so low that it does not represent a systemic risk to economies. 

Economic crisis

With the slowing global economy, rising interest rates and a cost of living crisis being felt globally, this may well mean more consumers turning to BNPL to spread the cost of their spending. While this should be good news for the providers, it may impact the core of their operating model. 

BNPL is largely dependent on financing to support its lending. In its most recent funding round in July 2022, Klarna received $800m, from a range of sources. American venture capital (VC) firm Sequoia, Silver Lake and Commonwealth Bank of Australia all contributed, with UAE-based Mubadala Investment Company and Canada Pension Plan Investment Board investing for the first time. With so many investors involved, there are expectations on returns. 

“BNPL is actively funded by VC, and they have credit lines to provide loans. It is the credit facility with a low interest rate that’s financing the service,” says Mr Megens. “At present, they might not be too concerned with chasing customers for low-value payments, but as the cost of the credit facility rises, it will put them under pressure. The VC investors are expecting great returns, and there is a risk the maths won’t add up.” 

Rising default rates could lay bare the structural problems of the BNPL system. Dominique Tetnowski, research analyst at Juniper, says: “As BNPL providers absorb all risk associated with the issuance of loans, they are completely exposed to the impact of defaulting payments. With rising economic strains, it is expected that BNPL providers may suffer additional losses due to defaulting payments. To continue operations, providers are likely to rely on capital injections.” 

Research by Fitch found that when consumer asset quality starts to deteriorate, BNPL consumers deteriorate faster than the average unsecured consumer borrower. 

“The risk to the BNPL companies could come from delinquencies getting out of hand, which are not adequately compensated by the offsetting fees,” Ms Koh says. “This will reduce their cash collections and cash flow, and may call into question their consumer targeting and underwriting models. Ultimately, this could dent investor confidence.” 

“The underwriting of the loans has been very poor,” Mr Megens adds. “Fintechs have not shown to have any advantage in underwriting. In fact, the opposite seems to be true with default rates at venture-funded BNPL businesses rising sharply compared with traditional banks consumer credit loan books.

“Banks have rigorous underwriting standards that have been tested over decades and through economic cycles. The issues may not be in BNPL as a product itself, but rather who is actually providing this product and what their experience and incentives are.”

Even the largest BNPL providers are facing financial hardships. Klarna reported a net loss of SKr6.2bn ($608m) for the first half of 2022, compared with SKr1.4bn the previous year. The company also announced two rounds of job cuts during 2022, reducing its global workforce by 10% in May 2022, before a second round in September 2022. 

“If you look at the reports of the likes of Klarna, Afterpay and Affirm, you see the reason they do not make profits is their expenses,” Mr Dinga says. “A big chunk of revenue is eaten up by the operating costs.

“Secondly, there is the cost of credit losses. As they gain market share, the losses also increase. And now we have the issues around inflation. If a provider is financing their operations through loans, when interest rates are low it is easy to finance as they borrow for very little, give the funds to customers, and charge a fee to merchants which should cover the costs. But if there are defaults or the losses increase, it becomes more difficult to generate profit. The revenue model is under pressure due to inflation.”