U.S. consumers are being flooded with offers to “buy now, pay later,” whether it’s a $345 baseball cap from Tom Ford (“starting at $32 a month”) or a $2,199 LG Smart TV from HSN (“3 payments of $733.33”). And just in time for the holiday travel season, American Airlines recently announced that passengers could split the cost of their airfare into $50 monthly payments.
The appeal for the consumer is obvious: unlike credit cards or old-fashioned layaway plans, the buyer pays no interest on the purchase, agrees to a set payback schedule and gets the immediate gratification of ownership. Decisions to use the payment plan can be made instantly, whether at the physical point of sale or during online checkout.
So far, fintechs like Klarna, Affirm and AfterPay are dominating the burgeoning financing business, which disrupts the banking industry’s interchange model and merchant relationships.
As a result, pressure is mounting on financial institutions to offer unsecured lending products. While such products can provide much-needed differentiation among institutions and improve tense merchant relationships, they can also take a bite out of interchange revenue, complicate underwriting and attract regulatory scrutiny.
SECULAR TRENDS PROVIDE A BOOST
Pay found that BNPL is the fastest-growing online payment method in the U.S., Australia, the U.K. and is expected to grow at a 28% compound annual growth rate globally over the next five years. Still, BNPL only accounted for about $100 billion, or 2%, of all global e-commerce transactions in 2020, while global credit-card spending is expected to reach $45 trillion in 2023.
Curinos believes the rise of BNPL can be tied to three global consumer trends that are changing the way people pay for goods and services.
First, regulators and consumer advocates want to see more stable and well-priced credit products for underserved consumers. While regulators have already raised some concerns about BNPL late fees and the chance that customers are biting off more than they can chew, financial institutions are in position to address those issues while they expand lending for consumers who historically have been locked out of credit products.
Secondly, the global financial crisis of 2008 and the COVID-19 pandemic have made younger consumers more hesitant to use traditional credit cards. Many of these consumers saw their parents fall into a debt trap during the financial crisis that they attribute to the convenience of credit cards and the economics that incentivize spending. And in the case of the pandemic, consumers have increasingly turned online for purchases and found BNPL solutions could smooth their payments.
Finally, advancements in BNPL solutions at checkout are now as convenient as using a credit card.
THE CHALLENGE FOR FINANCIAL INSTITUTIONS
BNPL creates a challenge for traditional financial-services providers that are facing yet another round of competition from fintechs and challenger institutions that seek to disrupt consumer and merchant financial services.
BNPL takes aim at the long-fraught relationship between merchants and their banks over interchange fees because the unsecured loans don’t carry interchange. Merchants have long castigated interchange fees, paying more than $50 billion to banks each year for purchases made with credit cards and debit cards. Meanwhile, financial institutions depend on interchange to fund their card programs.
Unlike the new challengers, banks have complicated financial relationships with multiple parties in the payment process – all of which can be disrupted if they start offering new unsecured lending products. Although a growing number of banks have started offering installment loans in the past few years, those products have been slow to gain acceptance, partly because they have a fixed interest rate.
The ultimate decision by a traditional bank to develop a BNPL program or challenger proposition will vary based on its position in each of the underlying markets – from the merchant acquirer relationship to its reliance on interchange.
Things to Consider When Weighing BNPL
As the market grows and more providers look to embed BNPL, banks and other providers that consider it as a strategically attractive option will be weighing its risks and costs.
BNPL is an emerging product for consumers in the U.S. and Europe, so perceptions are still forming. That brings with it reputational risk. From a cost perspective (as with any new offering), the provider needs to evaluate infrastructure investment, as well as marketing, underwriting and servicing costs.
Analysts from Curinos’ Digital Banking Hub have isolated a number of areas in which BNPL providers are attempting to differentiate.
- Brand and positioning. Leading digital players have gone beyond purely point of sale engagement to provide omni-channel experiences and have penetrated the market with destination platforms.
- User experience. Dedicated providers have integrated into retailer sites as well as operating their own apps or sites while positioning BNPL as a valid, trusted payment option.
- Product and pricing. Market leaders now offer users the ability to change the product according to repayment preferences in a single platform. Those providers that are really carving our market share, however, are actively engaging with users after an initial purchase to encourage further transactions.
Routes to entry vary, such as partnerships (Discover and Ally have interests and agreements with Sezzle), point-of-sale propositions (Citizens Pay or Goldman Sachs working with Apple) and installment plans (like My Chase Plan, Synchrony’s Pay in 4 or US Bank’s Extend Pay).
There are many ways to muscle in on the market. From a digital banking perspective, BNPL is part of a wider embedded finance narrative that’s providing food for thought for all.
SHOULD YOU JUMP ON THE BNPL BANDWAGON?
Curinos believes that banks can deepen customer relationships by offering BNPL-like products, but they must carefully consider a number of factors before joining the fray.
- Differentiation. Consumers are eager for their banks to provide new and innovative products. Offering a product like BNPL can deepen relationships with customers and attract new ones. Wrapping a financing product into a checking account, for example, could be appealing for some consumers. Financial institutions could also develop serial installment loans that consumer could access through a separate debit card or within their digital wallet; the bank could then approve each purchase individually. And, of course, they can always buy one or partner with one a BNPL providers.
- Economic implications. Banks with outsized reliance on interchange, overdraft fees or merchant-acquiring businesses must weigh the potential that BNPL will cannibalize those revenues, particularly if the product grows exponentially. That said, it is unlikely that BNPL will have any material impact on volumes in the near term. Banks must weigh the challenges of making a BNPL program profitable with the prospect of being distinctive as noted above.
- Regulatory scrutiny. Institutions that have been in the crosshairs of regulators may want to tread carefully when it comes to BNPL. The Consumer Financial Protection Bureau issued a warning about the products in July, reminding consumers that they carry late fees and don’t offer the same dispute protections as credit cards. Appropriate and transparent disclosure will be essential for banks that want to offer the product.
- Underwriting challenges. Banks have a clear advantage to new entrants when it comes to assessing the creditworthiness of customers. The mountains of data and analytics available to banks can help estimate loss ratios and assess the risk in offering these products.
- Merchant relationships. Many merchants already view banks with suspicion when it comes to customer payments and may be hesitant to engage in a new offering. Banks will need to convince merchants that they have a competitive offer.
The BNPL landscape is evolving quickly and we will likely see announcements of even more creative new offerings in 2022. A few banks have already announced partnerships with fintechs to provide BNPL solutions for their customers. It is also clear the market is rewarding providers of BNPL products; shares of Affirm jumped 6% after it announced its deal with American Airlines.
BNPL represents just the latest challenge to the way that traditional financial-services providers have done business for years. There will be more innovative products on the horizon. While banks don’t necessarily need to create their own version of every new whiz-bang product, BNPL also can’t be ignored.