The product is beneficial and economically rational—but needs some guardrails
Why Buy-Now Pay-Later is Growing so Quickly
Over several years there has been much interest and discussion around Buy Now Pay Later (“BNPL”) and its role within consumer credit. The concept of paying for a purchase in installments is not a new concept at all—in the distant past however, it was incredibly inefficient compared to electronic ways to pay and finance at the point of sale, like credit cards. The use of technology to streamline the customer experience at the point of sale has brought the product back in popularity. While we are several years into its resurgence, there are still developments and shifts in the market that make it important to watch if not participate in.
A BNPL product facilitates a purchase whereby the purchase amount is split into generally four payments over a six-week timeframe without an interest cost during the payment period.[1] The product was already on a growth trajectory, and then COVID propelled its growth as online purchases became more of the norm. The current BNPL market is sizable and will continue to grow significantly. BNPL purchases in the United States totaled nearly $100 billion in 2021, up from $24 billion the prior year.[2] Worldwide BNPL volume in 2021 was $680 billion and is expected to grow to $1.1 trillion in 2025.[3]
Benefits for both sellers and buyers help to drive the strong growth in the market:
- Benefits to Sellers: The strongest benefit is incremental sales. With advanced technology and data, BNPL providers can underwrite and approve more customers. Potential buyers complete their purchases through a compelling user experience along their purchasing journey. Sellers also benefit from fraud protection.
- Benefits to Buyers: BNPL is an economically rational product compared to other forms of financing like credit cards. For users who do not own credit cards, the product enables users to access financing. BNPL financing is more economical compared to higher-cost credit cards[4] since financing is cost-free if all payments are made on time. BNPL has more transparency and predictability with its installments, helping consumers work with their budgets and manage their spending since they have known installment obligations. Perhaps most compelling is that BNPL provides the benefit of credit while using money that consumers have on hand—in fact, many BNPL products in the market have been structured so users cannot go into perpetual debt.[5] Further, BNPL appeals to Gen Z that has fully embraced the smartphone and generally has a lukewarm attitude towards credit.
While pure-play BNPL providers have suffered lower valuations recently (as with many fintech players), their recent top-line performance illustrates the relevance of the BNPL benefits to the market:
Risks, Resiliency, and Regulation
Given the exponential growth in BNPL and the emergence of new entrants, there has been much attention in the market, including that from regulators. The CFPB put forth an inquiry and obtained data from BNPL firms including Affirm, Klarna, and AfterPay, and through their research published a report in September 2022[6] voicing concerns around debt accumulation and overextension, data harvesting and monetization, and inconsistent consumer disclosures and protections (e.g., disclosed fees, dispute protections, customer service for handling returns and refunds, etc.).[7] This investigation was justified since regulators need to understand significant market developments, potential risks created in the market, and their impact on consumers.
Since BNPL transactions and their payments are currently not reported to the credit reporting agencies, there is limited visibility to the true volume of BNPL transactions, the overall market performance of these loans, impacts on consumer debt burden, shift in usage from credit cards to BNPL, and other analytics. This poses a great risk to lenders since they do not have full visibility into a consumer’s financial picture. Each of the credit rating agencies has put initiatives in place to begin the capture of these transactions,[8] and these efforts are still underway.
The rising interest rate environment is also a risk in the industry for pure-play monoline BNPL providers; however, their earnings releases and the growth in volumes will represent growth in top-line revenue. The profitability of these players and their sustainability are significant concerns.
The nature of BNPL requires instant underwriting decisions with the goal of high approval rates. These requirements seem in conflict and could lead to a misperception that the underwriting for risk is not robust. This is an incorrect generalization—many providers, lenders, and banks are using credit information, other sources of data, and proprietary risk models to assess the customer’s ability to pay—the same approach as with other unsecured credit products, except that BNPL typically has smaller sizes.
How the Industry Structure is Changing
Traditional suppliers of consumer credit and other industry leaders have responded to the opportunity (and threat) of installment lending and BNPL:
- Credit card issuers have developed hybrid functionality. Programs like Amex Pay Later, Citi Flex Pay, and Chase My Plan enable cardholders to select specific purchases and pay overtime in fixed installments.
- Banks are introducing BNPL quickly with technology partnerships. While banks have a long history of underwriting, they traditionally have lacked the ability to leverage technology to provide products to consumers that are accessible when it matters the most. Technology providers such as Jifiti, LiftForward, and others provide the technology infrastructure linking banks to merchants and enabling embedded finance solutions including BNPL.
- MasterCard and Visa have each launched their own programs that enable lenders the ability to offer BNPL at checkout across their merchant networks.
- Big Tech is getting into the game in a big way. Apple Pay Later was launched in March 2023[9] to select users. The service will enable users to split purchases into four installments, and users can manage these loans in their Apple Wallet. This is particularly interesting in that Apple already has a wide reach into the iPhone customer base and is integrated into Apple Wallet—customer acquisition will be inherently easier for them compared to other providers, and authentication of the borrower is already built into the device.
A big question remains about the quantified impact of BNPL on other consumer credit products. Consumer attitude is compelling towards BNPL in that the product is more flexible and better aligned with the customer’s financial needs and interests compared to credit cards.
The growth of the market and the economic benefit of BNPL does indicate there this likely some displacement of credit card volumes to that of BNPL. This could be better quantified once BNPL transaction activity is fully reported to the credit rating agencies.
Looking Ahead and Implications
BNPL is young in its life stage and the market has been evolving rapidly. This is what we can expect to see going forward:
1. There will be more regulation with clearer requirements for treating BNPL as credit—the industry will need to work with regulators during this journey. The regulators need to spend time having conversations and working with data so they can figure out how the industry works and where the true risks lie. It is imperative for the industry to work with the regulators during this journey. Expect more regulation, guidance, and rules for BNPL like that of credit cards (note: a similar move was just enacted in Australia[10]). This will include consumer protections, bureau reporting, supervisory examinations, disclosures, data privacy, etc. Regulatory pressure will create a rougher period in the near term, but the industry will be stronger on the back end.
2. BNPL will be included within credit bureau reporting—providing more visibility into BNPL and adding information to borrower credit reports. Each of the credit rating agencies is building infrastructure for BNPL reporting, which will take time for completion and use by lenders and furnishers. In the interim, some lenders will use alternative sources of data (e.g., cash flow data) to provide a clearer picture of the credit risk of their customers/applicants. Once BNPL is fully integrated into the reporting, there will be more transparency on the BNPL performance, impact on other credit products (e.g., credit cards), and quantified impact on consumer debt burdens. From a borrower’s perspective, BNPL could be a path to establish a credit file, and these tradelines will add more information to existing credit files.
3. Consumer adoption will surge—keep your eyes on Apple Pay Later. JD Powers estimates that the percentage of U.S. consumers with a BNPL account was 22% in January 2023, up from 18% in October 2022 and 14% in July 2021.[11] Strong adoption will continue as more users become familiar with the economic benefits of the product. Apple Pay Later will help to raise awareness of BNPL with its iPhone users, who will likely have delightful user experiences with the product.
4. Additional use cases and merchant categories will expand. BNPL will continue to go upscale with larger purchases such as travel. We will likely see BNPL that combines multiple purchases into an “experience” bundle—such as trip expenses (airfare, hotel, car, meals, event ticketing), back-to-school shopping across several retailers, holiday shopping, etc. BNPL products will be developed for B2B purchases, freeing up the cost of financings and improving cash flow for suppliers. B2B BNPL is already happening in international markets and is estimated to be a $200B opportunity in Europe and the U.S.[12]
5. BNPL providers will diversify or be acquired. BNPL as a stand-alone product is not a sustainable model since it is difficult to own a customer relationship or address their broader financial service needs. Pureplay BNPL providers will need to diversify their product offerings to enhance their revenue streams and build customer loyalty. They need to drive to become profitable or will continue to suffer from low valuations and represent bargains for potential acquirers.
6. There will be more BNPL participation coming from traditional banks, including incumbents with existing merchant relationships. Technology providers are building programs and solutions to make it easier for banks of all sizes to participate. Larger institutions with existing merchant relationships (e.g., issuers with retail relationships for private label and/or cobrand portfolios), banks with merchant acquiring services) are likely to capitalize on these relationships and find more opportunities to serve them with their credit capabilities including BNPL.
7. Meet your customers where they are – evolve from product-centric strategies to customer-centric strategies based on customer needs. Think about customer needs and their journey along the purchase process and how they prefer to pay. If you are not already offering BNPL, you should research what your customers need to determine if you should participate. Determine how important the Gen Z customer base is for your business and understand their payment preferences. Offering more choices to customers can support their acquisition, loyalty, and retention.
8. Lenders, tech providers, and sellers will need to increase their focus on implementing strong risk management and compliance programs over their partner relationships. On June 9, 2023, the Fed, OCC, and FDIC issued inter-agency guidance on the risk management of third-party relationships and includes discussions on governance, oversight, accountability, independent reviews, documentation, and reporting[13]. BNPL depends on connections between lenders, sellers, and in many cases technology providers. Expect heightened focus from regulators in the risk management program, governance, and monitoring of these relationships.
Continuing the Conversation
BNPL is an economically rational product that provides many benefits to buyers and sellers. BNPL is in a resurgence and is young in its life stage compared to other more mature credit products such as credit cards. Governance over BNPL—such as credit bureau reporting and regulation of BNPL as a form of credit—has not caught up to the popularity of the product. This will happen in the near term.
Despite the regulatory uncertainty as the product matures, the supplier landscape is responding rapidly, including traditional banks which are able to participate quickly by partnering. Consumer adoption will accelerate, and Gen Z will represent a key market segment. While BNPL is relatively new in its evolution and guardrails still need to be put in place, current data does not clearly indicate that the product is inherently bad for the industry or for consumers. More will be proven over time, but in the meantime, we can fully expect the market to continue to grow and represent great opportunities to meet customers where they are.
Please contact me if you found this of interest and would like to continue the discussion!
[1] Other payment and financing mechanisms at the point of sale include installment loan financing (at an interest rate over a term), private label credit cards, other credit cards, etc., and are excluded from the definition of BNPL.
[2] Source: Cornerstone Advisors, https://www.forbes.com/sites/ronshevlin/2021/09/07/buy-now-pay-later-the-new-payments-trend-generating-100-billion-in-sales/?sh=7f96781e2ffe
[3] Source: CB Insights, https://www.cbinsights.com/research/report/buy-now-pay-later-outlook/
[4] A recent CFPB study estimates that a majority of BNPL borrowers would face credit card interest rates between 19 and 23 percent annually if they had chosen to make their purchase using a credit card. Source: Consumer Use of Buy Now, Pay Later: Insights from the CFPB Making Ends Meet Survey | Consumer Financial Protection Bureau (consumerfinance.gov)
[5] For example, the AfterPay product has been structured with responsible spending rules and consumer protections built into the service (e.g., payments via debit, late payment fees fixed/capped and suspended service, rewards for responsible spending).
[6] CFPB Study Details the Rapid Growth of “Buy Now, Pay Later” Lending | Consumer Financial Protection Bureau (consumerfinance.gov)
[7] Director Chopra’s prepared remarks on the release of the CFPB’s Buy Now, Pay Later report | Consumer Financial Protection Bureau (consumerfinance.gov)
[8] Everything You Need to Know about BNPL Credit Reporting (jifiti.com)
[9] https://www.apple.com/newsroom/2023/03/apple-introduces-apple-pay-later/
[10] https://amp-abc-net-au.cdn.ampproject.org/c/s/amp.abc.net.au/article/102368810
[11] https://www.jdpower.com/business/resources/battle-buy-now-pay-later-customers-being-won-point-sale#:~:text=According%20to%20our%20data%2C%20the%20total%20percentage%20of,in%20October%202022%20and%2014%25%20in%20July%202021.
[12] https://www.pymnts.com/bnpl/2023/demand-for-flexible-b2b-payments-fuels-eu-bnpl-growth/
[13] https://www.federalregister.gov/documents/2023/06/09/2023-12340/interagency-guidance-on-third-party-relationships-risk-management