Buy-Now-Pay-Later: How is this different from consumer lending?

There has been a lot written about the Buy-Now-Pay-Later sector the last few years. It has been growing at 39% per year in the UK, and this form of deferred payment is spreading from its origins in Europe, to the rest of the world now too.

What is Buy Now Pay Later (BNPL)?

Buy Now Pay Later (BNPL) is a way for consumers to make purchases, and defer payments for them to a later period, either through installments or after an interest-free period.

This has been popular with online retailers and catalogs initially, although this is now expanding into high street shops too.

How does BNPL make money? What is its business model?

There are 5 key revenue streams for BNPL firms.

Merchant discount rate (MDR), i.e. fee merchants pay to BNPL firms

Interchange fees, if a credit card is used as part of the transaction

Flat per-transaction fee

Late fees

Interest, if BNPL loan defaults to a traditional installment loan.

Source: The Financial Brand

Without regular interest charges, and all things being equal, BNPL has to manage within finer margins than more traditional lending products.

As a result BNPL firms typically have a focus on keeping costs low, using automated processes, in addition to creating a closed-loop with merchants. This is to drive up the merchant discount rate, based on the extra sales and value they believe they can bring to retailers by offering their brand of BNPL.

What is the difference between BNPL and regulated consumer credit?

BNPL products are currently not regulated lending products*. As such they do not fall under the Consumer Credit Act and do not charge interest. BNPL firms that do not offer consumer credit also do not need to be registered with the Financial Conduct Authority (FCA), although this may change in the future.

Payments. Under a BNPL agreement, balances need to be paid off in less than 12 months and within 12 installments or less. Beyond this and BNPL schemes, become consumer loans and need to be regulated. Most BNPL firms have shorter period and some firms also offer regulated loans too.

Affordability Assessments. BNPL products, are not deemed consumer credit and therefore do not fall under affordability requirement regulations. Whilst some providers do perform some initial credit risk assessment, for others it is limited. Typically there is no hard credit bureau query (soft search only) and limited additional input for other forms of affordability assessment. An arguement is made that the value of these amounts are low, and the focus has been on reducing customer friction at every stage.

the unregulated products, credit bureau, and affordability assessments are limited. This enables fast, digital approvals, a frictionless customer journey, however, has resulted in criticism of the industry over concerns of lending to customers in financial difficulty. This will be a significant change should legislation be enacted to make these regulated products.

Credit risk assessment. In consumer credit, credit risk assessment is carried out at the start of the loan, to assess risk, affordabiliy and the amount that can be borrowed. This becomes the amount leant or in the case of running credit, the credit limit. For BNPL products, this assessment typically needs to be determined on a transaction by transaction basis, taking into account factors such as previous internal payment history. This requires a more dynamic, real time model of assessment and make also pull in additional external data.

Interest. Interest is not charged on BNPL agreement. Late payment fees are however charged, for accounts which miss payments. These are typically flat rate charges, to cover administration fees and not related to balance size. For small balances, these can equate to large equivalant percentages however, and some firms may waive fees as a result.

Credit Bureau Reporting. BNPL is typically not reported to the credit bureau, including no reporting for non payment. For many customers this is seen as a benefit with BNPL products. Creditors however do not have visibility over any BNPL agreements made by their customers thereby limited their ablity to make accurate affordability assessments.

Who are key BNPL providers*

This list is constantly evolving and expanding. A selection is show here

LeadingChallengingNewLaunching
KlarnaZilchTymitMonzo
ClearpayApptoPayFlavaRevolut
LaybuyFlyNowPayLaterZip
Payl8trOpenPayCurvissa
Paypal CreditDivideBuy
Splitit
Currys
Very Pay
LoveHolidays

Why is there controversy?

The BNPL sector has concentrated (at least initially) on marketing this product to younger demographics, with limited experience of consumer credit. Fun lifestyle marketing has been used to promote what critics would say is another form of borrowing, and without regulated requirements for transparency on costs and pricing.

With limited affordability checks, there is a concern in many sectors, that a fast-growing BNPL sector is building problem debt for an increasing part of the population, resulting in repayment issues and later financial difficulty.

Additionally, with the recent regulatory focus and reduction in the size of the High-Cost Short Term Credit Sector, there is a concern some customers, needing credit, and having poor levels of affordability may have migrated BNPL products as an alternative form of credit.

Consumer Credit response

Undoubtedly the growth of the BNPL has been turning heads in more traditional consumer credit businesses. Particularly in the credit card market, BNPL has eroded some of its market share and is now being seen as an emerging competitive threat.

Some banking institutions have responded by launching their own BNPL products or purchasing established firms (PayPal being a good example). Card networks have also been building BNPL into their networks to offer to issuers.

Is regulation on the horizon?*

For UK, it is highly likely that BNPL will be regulated under the FCA and these will become regulated loans. This will include affordability assessments and credit bureau reporting, which will add friction to the onboarding customer experience and likely erode some of the advantages used to build market share. (not to mention the administration cost needed to apply and maintain an FCA license).

Whilst regulation has been discussed since the start of the year, actual change on the ground has been slow, and at the moment we are still status quo.

Some firms, however, have seen the ‘writing on the wall’ and have been quietly gaining licenses in the background to be ready. At this point in time, this does seem like a prudent approach.

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