This past holiday season, consumers unknowingly took part in a mass economic experiment. Unable to hit the malls, they turned to shopping online, where at checkout, many were met with a tempting offer — buy now, pay later (BNPL). Estimates are that 1 in 3 Americans have now used BNPL credit and that number spikes to over half in the 34 to 44 age group.
The premise of BNPL is simple; consumers get a short, interest-free loan to stretch out payments on big (or even small) ticket items. But the fallout of this mass experiment could be painful for consumers and lenders alike. The unsecured loans made in the weeks between Thanksgiving and Christmas are now coming due, and because of the short lending cycle, lenders already know the answer to a question that the world’s bankers have been nervously asking one another: Is BNPL a clever way for younger borrowers to take on sensible credit, or did lenders just give billions of dollars of loans to a bunch of subprime borrowers in the checkout aisle?
The answer matters. Investors love that the fintech firms doing the lending — Klarna, Affirm, Afterpay and others — are disrupting the traditional credit card business. Consumers, not known for restraint, love being offered a 0% line of credit without a complicated application process. Retailers love that BNPL borrowers increase their spending and besides, they’re not on the hook for collecting (retailers pay the lender a fee for the service, typically between 2.5% and 4% of the purchase). This combination of drivers has led to a surge in BNPL credit to hundreds of billions of dollars outstanding – and has also caught the attention of some regulators, with the U.K. Treasury placing BNPL firms under the supervision of the Financial Conduct Authority. Still, BNPL is a small fraction of the trillions of dollars of credit card spending, but with a high enough growth rate that banks and major credit card issuers are scrambling to respond with their own services.
There is an optimist’s case for BNPL. Younger consumers who saw what debt did to their families’ finances a decade ago could be using BNPL as a responsible way to bring forward consumption rather than racking up big, high-interest revolving credit lines. Most BNPL services require equal payments made over, say, just two months. The amounts are typically small, and payments are charged directly to a borrower’s credit or debit card. In this optimistic scenario, borrowers are budgeting better, being wary of high-cost revolving debt, and avoiding the credit sins of the past.
Borrowers who can’t pay could well see their credit shredded. For example, Capital One COF +0.5% was sufficiently alarmed by the patterns they were seeing that they essentially banned cardholders from paying BNPL loan instalments with their cards, avoiding the risk of credit ‘stacking’ where one credit line is used to finance additional loans. And then there’s the fact that BNPL firms typically securitize and sell the loans to investors, so it’s an open question who will be left holding the bag if the holiday shopping wave turns into a wave of delinquent or defaulted debt.
BNPL isn’t new. Klarna may have made a big splash with its commercial at this year’s Super Bowl, but the company was founded in Sweden back in 2005 (that’s a year after Facebook). In markets like Brazil, shoppers have been splitting their purchases up into four equal payments for years. But the pandemic super-charged the practice in the U.S. and Europe and we don’t yet know how that will turn out.
Investors have been betting on the optimistic scenario for BNPL. Affirm, led by PayPal PYPL +4.7% co-founder Max Levchin, raised $1.2 billion in an IPO in January, nearly doubling its stock price on its first day of trading, and now sports a market cap of $29 billion. And several banks have launched BNPL services, sometimes called “POS credit” for point-of-sale. These offerings may end up being much less profitable than the credit cards that form the firms’ bread and butter but BNPL may be a smart way to play defense and diversify their consumer credit business model.
BNPL will be part of the consumer finance landscape going forward as it fills a specific need. But the question that will be answered shortly is whether on its way to “business as usual” the industry will see a messy deflating of a short-term credit bubble, “drains-up” investigations by regulators, and a bunch of overly optimistic investors nursing serious losses.
