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Few things unite popular opinion quite like the subject of indebtedness. Consumers have always received the notion of credit rather flinchingly, and the extent of stringent regulatory oversight in the space is well known.
So, each time a financial product is introduced that does not fit neatly into the existing regulatory framework, stakeholders are predisposed to track responses from government, incumbent players and consumers with bated breath.
Cryptocurrency is one example. More recently, BNPL – a challenger credit offering that is redefining how we spend money – has come under the scanner. Countless arguments have been made against its use, here I sum up a few:
It pushes people to spend unnecessarily or beyond than their means
The bulk of BNPL users being young people, non-payment places them at higher risk
It is not entirely economical since interest is accrued in case of missed payments
I disagree with this stance. But for the sake of a measured response, I’ll play the devil’s advocate.
Is BNPL a bubble, not a boom?
The economic conditions created by a global pandemic created fertile ground for BNPL to flourish – a) it offered credit to those left out of the formal credit ecosystem; b) it is usually interest-free, so it basically functions as free financing; and c) it gave an added to boost to e-commerce which was already thriving due to movement restrictions.
Customers, retailers, lenders – all were happy. But what’s to come after the pandemic, especially with warning bells of an impending recession ringing incessantly?
Customers are grappling with inflation and inclined to use BNPL for necessities like food and utilities. (I previously wrote about the nature of unproductive debt here.)
With rising inflation, BNPL providers were unable to absorb risk from a large subprime customer base like before.
Several early players in BNPL reported losses while trying to acquire more customers.
Faced with a reckoning of their existing business models, BNPLs resorted to more stringent underwriting, which has led to a dip in approval rates.
There is also an argument that customers may charge their BNPL dues to their credit cards.
Regulators in India as well as across the US, UK, EU and Australia have started drawing up policies to bring BNPL under their purview
The assumption here is that BNPL players can only thrive in a low-interest rate regime. The bulk of their revenue is made up of fees paid by merchants and charges on late payments. So when interest rates are hiked, they face thinning margins. Another threat is the steady decline in consumer spending. This would pump the brakes on the overall BNPL uptake, while also increasing defaults on existing accounts.
The impact of inflation and growing scrutiny cannot be neglected. But that doesn’t mean BNPL is past its prime.
Customers and merchants love BNPL
First, let me get something out of the way – yes, BNPL has serviced a vast cohort of new-to-credit customers who had little to no prior access to formal credit due to poor credit histories.
However, research suggests that around 65% of receivables originated by PoS lenders go to customers with credit scores of 700 or more. For instance, Affirm originated loans amounting to over $1 billion annually at the exercise equipment giant Peloton. The average credit score of this portfolio was 740.
Even in cases of smaller ticket sizes, the customers serviced have lower credit scores. However, this is the result of thinner credit files and not poor credit utilization. Moreover, a Bain & Co. study found that 63% of BNPL users surveyed had full-time jobs and 40% had higher levels of college education.
Thanks to such a diverse customer base, BNPL providers can rest assured that their portfolios will remain balanced.
(Sidenote: You can read this myth-buster about BNPL’s impact on credit scores in this piece.)
Most BNPL business models require partner-retailers or merchants to pay a fee for their integration (not unlike MDR charged by credit card providers). The value created from this fee is enormous. Merchants have reported sharp increases in sales, customer acquisition, customer loyalty and higher value purchases.
In this graphic, ‘second chances’ refers to second-chance customers. These are customers who use BNPL to build their credit scores. Merchants can tap into this highly motivated customer base to lift their sales metrics.
Customer experience is no longer confined to the B2C space. BNPL for businesses has proven to improve a number of metrics by offering a better checkout experience. It lowers cart abandonment rates and improves the overall customer experience.
Small, thin file retailers can access financing right at the point of demand creation, within a user journey. As for B2B platforms offering BNPL, they can improve their average order value (AOV) since retailers are empowered to spend more. As customers return for repeat purchases, the platform’s customer lifetime value (CLTV) also improves.
Larger businesses, on the other hand, can leverage BNPL to build an ecosystem. They can offer varied products and services on a single platform, with PoS tying them all together, possibly even paving the way for a super app . Read more about it here.
BNPL models are in flux
BNPL providers were in no way blindsided by the present economic conditions or regulatory onslaught. Even if the core BNPL product becomes less viable, most companies have built robust business defenses by diversifying their offering. Thus, unlocking other revenue streams.
Klarna, for instance, offers retail bank accounts, B2B lending as well as a shopping app. It has also mitigated its interest rate risk through retail deposits, debt instruments and bonds.
FinTechs that fashioned themselves as pure play BNPL providers are now building entire ecosystems around their core product. There is massive potential for these companies to leverage their existing customer base for other financial products. They can also act as consultants to e-commerce and other platforms by mining this rich trove of data to better brand and market financial products.
Regulation will end uncertainty
Regulation has been touted as a threat to innovative FinTech products like BNPL. But, as I have argued before, the RBI has a history of encouraging financial ingenuity. Moreover, concrete directives around the distribution of BNPL will free entrepreneurs from uncertainty and make room for bold, sure-footed business decisions.
Trends have a fleeting nature. As our attention spans shrink, we discard one fad and flit on to the next. BNPL - a product that has expanded in usage 4x within three years and clocked revenue of $120 billion from sales in 2021 alone – is not a trend.
It is a sizeable industry that will leave an enduring impact in more ways than one – financial empowerment for millions, an overhaul of traditional banking and creating a credit product truly worthy of the digital age.