Fintech firms are targeting consumer financing with buy now, pay later or BNPL products, also known as point-of-sale financing. The simple idea is that when you purchase anything, you do not pay the full price immediately, but in instalments usually over six to eight weeks.
It is an adaptation of layaways where you made a series of payments to cover the purchase price. The difference is, under BNPL, you get the item today, rather than having to wait until you have paid in full. It is similar to purchases using a credit card or loan allowing payments to be spread over time.
The largest segment is integrated BNPL shopping apps like Klarna, LazyPay, Simpl and Amazon Pay Later that cater to low-value purchases, usually of groceries, meals and clothes. There are equivalents that focus on larger items, typically electronics, furniture, home goods, sports equipment and travel, repayable over eight to nine months.
BNPL now accounts for over $300 billion globally, against around $2 billion a decade ago. It’s growing fast in India too, partially driven by the growth in online shopping during the pandemic.
The attractions include availability at point of purchase, ease-of-use via apps, product-independent financing, credit with limited checks and seemingly no interest charges. The cost is covered by the seller, who pays a merchant fee plus a discount on the sale value.
In effect, the seller has a receivable which is being factored to the BNPL firm at an annualised funding cost of around 30 percent. These charges reduce merchant profit margins significantly. As BNPL encourages impulse purchases, the seller may face extra costs of higher rates of return.
The only way the costs can be recovered is increasing the price of the items where the conditions permit. As you cannot specifically target BNPL buyers—all customers, including those who don’t use the financing service, must pay, effectively subsidising the buyers on credit. BNPL firms also charge late payment fees, which can be a large penalty.
The economics are attractive for fin-tech entrepreneurs and venture capitalists providing capital. High effective interest income and fees funded by borrowed money, typically from banks or securitising the receivables, at rates of around 6-7 percent generates generous margins. In theory, costs of the platform are fixed with modest ongoing costs providing significant operating leverage.
There are low regulatory costs. While BNPL firms essentially are money lenders like banks, they have, to date, been largely unregulated. The labelling of what are economically interest payments as fees under the guise of fin-tech, which regulators are keen to encourage, has allowed avoidance of rigorous requirements imposed on traditional consumer lenders.
The major potential risk is credit losses. Assessment of individual ability to repay is far from demanding. Unlike traditional time-consuming credit processes, it is generally automated, increasingly relying on artificial intelligence engines, based on public information and even social media. Claims of advanced technological capabilities, distinctive merchant underwriting and consumer-fraud models is marketing puffery.
While data is scarce, available information suggests that most BNPL borrowers are riskier. They tend to have lower credit scores, lower savings and significant levels of other unsecured debts like credit cards and consumer debt. The industry argues that defaults have been low and less than other similar forms such as credit cards or unsecured personal finance. One possible explanation for low losses is a favourable business cycle. In essence, the true level of defaults will become apparent only in a major downturn.
A subtler reason for low losses to date is the structural arrangements. Most BNPL providers require that customers establish authorities for automatic deduction of payments from available cash sources such bank account or other credit cards. This means that BNPL lenders gain de facto priority access to the borrower’s available funds or credit card limits. That creates the potential for BNPL repayments to transfer the default risk to other lenders.
The industry now faces headwinds. Governments may establish a regulatory framework like that applicable to other lenders to increase transparency over costs, protect consumers and prevent misuse of private data collected. At the same time, credit bureaus are increasingly including BNPL borrowing in individual credit assessment. Facing loss of income to newer forms of borrowing, credit card companies, banks, payment firms and merchants are launching competing instalment credit products.
Ironically, it is forcing BNPL firms to move in the opposite direction, converting themselves into banks losing some of their cost advantage. The new disingenuous claim is their competitive advantage comes from accelerated customer acquisition at low cost because the expense is partially borne by the merchant.
None of this addresses the underlying societal cost of excessive borrowing, which is also increasingly hidden and difficult to quantify. The frictionless interface, speed and ease of obtaining credit may encourage ‘loan stacking’. The absence of borrowing limits customary in other consumer credit means that individuals can incur large amounts of BNPL debt with overlapping loans from a range of providers alongside other borrowings increasing the risk of financial distress.
This makes it more likely that borrowers will default on their BNPL loans or on other credit. American BNPL users had an overall credit delinquency of close to 18 percent, compared with about 7 percent for non-BNPL users. As BNPL companies are funded by banks or investors, any problem will leach into the broader financial system.
Fintech promoters argue they are democratising credit and encouraging greater competition. But the approach is poor, predatory and risky. BNPL may well come to mean ‘buy now, pain later’ for all parties involved.
Satyajit Das
Former banker and author of A Banquet of Consequences
(Views are personal)
Full article on newindianexpress.com