EXCLUSIVE: “The Big BNPL Debate” – James Bryce-Lind, Credit Kudos; Laurel Wolfe, Mambu and Simon Westcott, PwC in ‘The Fintech Magazine’

There’s no denying the success of BNPL (buy now, pay later) in recent years and the biggest BNPL providers – Klarna, Afterpay, Affirm and others – represent a new wave of digital lenders that banks and retailers are still unsure whether to treat as lovers or rivals. Are they either – or both?

Banks and payment providers were barely aware of BNPL’s presence back in 2016. In that year, the new wave of alternative credit lenders collectively gobbled up only one per cent of the entire UK credit market. Fast forward a few years and credit card transaction volumes fell 31 per cent between January 2020 and January 2021. And, while some of that could be explained by lockdown, at the same time BNPL transactions quadrupled to nearly £3 billion.

This explosive growth means BNPL is under increasing pressure from regulators and consumer groups, concerned that this particular form of easy-access credit has – in the Financial Conduct Authority’s words – a ‘significant potential for consumer harm’, traditional financial services began launching ‘me-too’ products. PayPal introduced its own version of BNPL in August 2020, Neobanks Monzo and Curve launched their products, both named Flex and, both curiously, on the same day, in September 2021. Virgin and Barclays are taking an interest – the latter teaming up with Amazon to allow Amazon customers to spread the cost of certain purchases of £100 or more over equal instalments.

However, BNPL providers continue to diversify their offering. One of the most popular, Klarna is already ahead of the game, changing its colours, confusing BNPL predators and appeasing regulators. Most recently, it launched its own version of a credit card and almost simultaneously aimed to reduce regulatory pressure in the UK by getting rid of late payment fees and offering consumers the option of paying off in one go. As with others in this category, Klarna occupies a unique niche – somewhere between the retailer and the bank, posing a potential threat to both by disintermediating the relationship with consumers on the one hand and merchants on the other. So what should banks, and acquirer banks in particular, make of it all?

James Bryce-Lind of the open banking-powered ‘fair credit’ scoring platform Credit Kudos, believes the BNPL category is a triumph of marketing, but nevertheless leaves banks in a Quandary. “It’s such a loud space,” he says, “when, if you look at the US, for example, BNPL actually only makes up a small portion of overall spending: $100 billion in 2021, compared to roughly $8 trillion on payment cards. “For all financial institutions that are current-account-first, it begs the question whether BNPL should be a feature or a product. There’s been an ongoing debate around that, but if you look at the constructs of the first-generation neobanks – your Revoluts, Monzos, Starlings – the ability to monetise that customer base from a current account relies on how many products you can sell them.

“With BNPL, what we’re seeing is that, by offering a value-added product first, like Klarna or Afterpay has done, they’re building meaningful relationships with customers. They’re then able to cross-sell into other aspects of financial life, whether that’s a longer-term product, or offering a personal financial management tool, which Afterpay launched recently in Australia. It’s flipped the concept of a neobank on its head.”

Laurel Wolfe of Mambu believes that for banks imitating BNPL,‘it’s more about keeping the customer in their ecosystem’ and dissuading them from using other payment options from other providers. “I don’t imagine they’re spending too much time thinking about the monetisation of it; rather, it’s a relationship issue,” she says.

From a consumer perspective, however, one of the attractions of BNPL, she argues, is the relationship, in terms of credit provision, is short-lived. “I think that’s exactly the difference; in a BNPL offering you use it at the time you need it, once, and you have a relationship
around that transaction with the BNPL provider until you pay it off. “You don’t have to have a relationship with that BNPL provider again, if you don’t want to, it’s completely your choice.

When you’re in a relationship with other credit providers, then yes, you do have an ongoing relationship with them, with all of the entanglements that may mean.” ‘Entanglement’, of course, includes long-term contracts, interest, late payment or monthly fees and potential impact on a consumer’s credit score.

As Wolfe points out, BNPL providers make the majority of their money from merchant transaction fees. “People often lose sight of that fact,” she says. But it’s particularly relevant in the current debate around consumer debt. With a customer’s upper spending limit ‘pretty restricted’, according to Wolfe, there’s less chance of running up unmanageable borrowing – unless, of course, customers use a multitude of providers.

PwC’s Simon Westcott agrees that, while credit cards will vary slightly across the globe, fundamentally, they’re a product paid for and funded by the customer and – depending on the market – he says that roughly 80-90 percent of providers’ incomes will come from interest payments. “The differences become quite stark when you start to look at the different economic model underpinning each product,” he explains.

“BNPL customers receive the service for free, in the sense that it’s interest-free; and it’s a much smaller transaction size, over a much shorter period of time. From a customer’s perspective, that feels more manageable, more contained. A model that doesn’t rely on customers paying interest, or tricks and traps, or making mistakes, has to be a better direction of travel, in terms of how the providers are making money. The onboarding around BNPL is also very slick – although there is also some scrutiny from the regulators and others about the extent of checks up front.”

The income split, says Westcott, is the almost exact reverse of the card model ‘with probably something in the region of 70-80 per cent coming from the merchant’, although providers will no doubt have to work harder to justify that, he adds. Again Klarna has looked to diversify to accelerate growth: last year it launched its Comparison Shopping Service (CSS) into 21 European markets, offering Klarna’s partner retailers increased customer reach and budget savings, as well as driving traffic from internet consumers. It’s something the company’s competitors will already have taken onboard, too. “While there’s increasing price competition between BNPL providers, it’s still a significantly more expensive transaction cost for retailers than other types of payment,” says Westcott. “That’s predicated on BNPL driving incremental sales, but if I’m a retailer seeing the growth in this transaction type, I’m looking down the barrel at margin erosion on a bigger and bigger scale.

So, from the retailers’ perspective, how are they going to drive down the cost of these transactions over time?” What’s evident is that the volume of BNPL spending, as an element of embedded finance, is potentially eye- watering. A December 2021 report, Embedded Finance: Who Will Win The Battle For The Next Digital Revolution?, from Mambu and Amazon Web Services, estimates that embedded finance will hit $7trillion by 2030, globally, with retail lending (including BNPL) set to account for 29 per cent ($2.1trillion) of that.

Across Europe, today, BNPL is already worth about £90 billion by Westcott’s reckoning and, crucially, is the only unsecured lending category witnessing double-digit growth. Looking out to 2025, CAGRs (compound annual growth rates) of 25-27 percent are being forecast, depending on who you believe, he says. “There’s a really important play for the banks here, in terms of protecting their customer relationships and conserving value, rather than leaking it to competitors, hence BNPL is impossible to ignore. The key question, for the banks, is how can they run this sort of product in a differentiated and sustainable way for them; one that also plays to their capabilities and their ability to do this differently? I think just going in a straight head-to-head with some of the big, established providers, is going to be a very challenging route.”

Yet, on the basis that BNPL providers are moving up the value chain, banks have reason to feel optimistic, adds Westcott “With the regulatory focus on the market and increased focus on affordability and harder credit checks, you could argue that plays into the banks’ established capabilities in those areas. They would need recalibrating to be able to deal with the speed and the ticket size. But, potentially, the banks have access to much cheaper funding, and, for those that have broader payments businesses, particularly where they’ve got merchant acquiring in their stable, there are readymade opportunities for them, to partner with an existing base of merchants and existing infrastructure.”

Banks will have to up their game, though, if they’re to compete with chameleons like Klarna, though, says Wolfe. “Retailers’ margins are already under significant pressure, and they’re definitely looking for ways to find new shoppers,” she says. In her opinion, BNPL providers, in particular Klarna and Afterpay, can easily drive an affiliate network where they can promote their merchants in their channels – although, the corollary of that, of course, is that a merchant might choose to have multiple BNPL providers at the checkout, leaving the consumer to choose. And that takes us right back to responsible lending: a customer might end up using five or six providers and running up debt with each.

James Bryce-Lind concurs, arguing that there needs to be transparency around true debt levels, including BNPL debt. “We can talk about the risks facing merchants and BNPL providers, but the number one risk, and what we really care about at Credit Kudos, is consumers,”he says. “This is a credit-orientated product which, if not executed correctly, can land people in trouble. At Credit Kudos, with a mission of trying to provide fairer, better credit, we think it’s imperative that initiatives like the Woolard Review (published by the UK Financial Conduct Authority in February 2021) allows the filling of gaps currently left by the unregulated BNPL proposition.”

The UK Government’s consultation document on proposals to regulate BNPL, closed for comments in January this year. So it’s not if but when BNPL is regulated.
Bryce-Lind adds: “The companies we’re working with want to build deeper, meaningful relationships with customers, and the first step in that is managing credit levels and providing the financial insight and tooling to help them, so that they’re not lending to someone who might be overleveraged. It’s something we’re extremely passionate about and working closely with a number of players to achieve.”

BNPL operators have proved tricky for the rest of the industry to grapple with: a triumph of marketing and utility, they have brought consumers onside in a big way and are unlikely to leave the scene, but they might just morph into something even more powerful. Perhaps banks need to decide sooner rather than later if BNPL providers are ‘my lover, or my rival’.

This article was published in The Fintech Magazine #23, Page 34-35