The Rise and Risks of Buy Now, Pay Later

Thursday, February 10, 2022  |  Caroline Vahrenkamp

Buy now, pay later (BNPL) programs have taken the country and world by storm, with balances expected to top $181 billion globally by 2022. The rapid rise represents both a threat and an opportunity for traditional lending institutions such as banks and credit unions, but moving into this space will bring its own unique set of risks, as well.

Chances are, when you were shopping for holiday gifts for friends and family (and yourself, of course), you encountered companies offering you the chance to buy now and pay later – not with a credit card, but with a third-party company like Afterpay or Klarna.

If you are a millennial, there’s a very good chance you’ve tried one of these programs. Raddon research suggests that 95% of millennials are at least somewhat aware of BNPL, and 61% have used BNPL to purchase something.

If you are a baby boomer, on the other hand, this might be new information to you. So let’s cover the basics. What is BNPL?

Also known as point-of-sale financing, BNPL is at-your-fingers layaway: short-term, small-dollar loans made convenient through mobile and online technology.

In its most popular form, BNPL allows consumers to borrow a specified dollar amount for a purchase in exchange for repaying that amount over four biweekly increments. Unless the borrower misses a payment, there is typically no interest or fees charged.

What makes BNPL appealing is the ease of borrowing, typically done online with a minimum of clicks or time spent and with no credit check.

At its core, however, BNPL is simply a new twist on a very old concept: the short-term consumer loan. Institutions have been lending small dollar amounts on a short-term basis for decades, whether it be a payday loan or an unsecured personal loan. These new programs are very similar to a payday loan or a fixed rate credit card: low fees or interest until you miss a payment, in which case the fees can be staggering.

BNPL services have skyrocketed in popularity over the past two years. According to IDC, by 2023, 65% of consumers globally will have tried a BNPL service, yet Americans are only now starting to embrace a concept that is far more mature in other markets. For example, if Americans were to use it as often as Australians or Britons, yearly BNPL sales in the U.S. would rise from about $20 billion to $100 billion. This is why key BNPL players like Klarna (Sweden) and Afterpay (Australia, but in process of being purchased by Square in the U.S.) come from abroad.

So why would consumers, particularly young consumers, prefer BNPL to existing credit cards they might have? Convenience and price, mostly.

Because BNPL charges no interest and is very simple to use and understand, consumers are gravitating to it, and most have a very positive experience. Of the BNPL users we surveyed, 77% say they are very or extremely likely to use it again.

The risk for banks and credit unions comes from three primary sources:

Credit Card Balances

Only 10% of credit card convenience users – cardholders who use their card for purchases but pay off their balances before incurring finance charges – have tried BNPL. They prefer to use their credit card to earn rewards. On the other hand, 46% of balance rollers – cardholders who do not use their card frequently for purchases but who carry a balance – have tried BNPL. Since the majority of credit card profitability comes from finance charges, BNPL could negatively impact card balances and profitability.

Interchange Income

Of the BNPL users we surveyed, 40% used their checking account to repay their loan, as opposed to their debit or credit card. As a result, their institution saw no interchange income, either from the original purchase or the four subsequent payments. The BNPL providers prefer this situation to reduce their expenses, but it does suppress non-interest income for banks and credit unions.

Market Share

Some of the providers are hoping to use BNPL as a springboard to attract a larger share of a borrowers’ financing and banking business. As such, these entities represent threats to market share, particularly among Gen Z and millennials.

Where Financial Institutions Fit In

On the other hand, there is space for banks and credit unions to enter the fray, should they desire. Of the BNPL users we surveyed, 72% – and 78% of millennial BNPL users – would be extremely or very likely to use BNPL from their primary financial institution (PFI), if their PFI were to offer a program. Even more compelling, when asked whether they would prefer to use BNPL through their PFI or a third party like Klarna, Affirm or Afterpay, 61% of users – and 68% of millennial users – said they would prefer their PFI. Only 7% would prefer a third party.

If a bank or credit union wants to engage in the BNPL space, opportunities exist, either through their existing credit card program (designate a purchase as pay-over-time at a low rate) or through a repackaging of the long-dormant unsecured line of credit. Of course, in both cases, institutions will need to understand how to compete on 0% APR. Impending CFPB interest in BNPL, focused on late fees and other charges, may alleviate that pressure.

The primary challenge is not the product offering or even pricing, but the ease and speed of fulfillment. If loan applications take minutes instead of seconds, borrowers will continue to migrate toward technology companies and neobanks that can offer a product faster, even if they must pay a higher price for that speed.

BNPL is a new version of an old product, but its rapid rise shows intrinsic demand. Banks and credit unions must figure out how to meet the need for inexpensive, easy, short-term financing.

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