The year closes with three crucial credit card business issues at hand:
- In the modern history of credit, never has every lending facet been disrupted by a public health issue, which spans the globe. Business models that predict business revenue, cardholder default, and merchant acceptance functions found new highs and lows as sheltering-down and isolation became the new way of life.
- Regulatory stop gaps in the U.S. with Current Expected Credit Losses (CECL) and International Financial Reporting (IFRS-9) went into effect weeks before the March 2020 crisis-point. They coincidently ensured that credit markets adequately reserved against the potential of surging credit losses.
- Unexpectedly, a fintech lending solution, known as Buy Now Pay Later (BNPL), sometimes referred to as “Pay-in Four,” gained traction across the globe.
The first issue will have a lasting impact and will likely carry through until 2023. With a vaccination on hand, the global challenges to inoculate every person on earth will ultimately eradicate the viral risk, but the delinquency wave remains artificially suppressed. With erratic unemployment and massive small business losses, it is likely to expect a surge in charge-offs as the economy recovers. With adequate reserves on hand, the industry will withstand the problem, but several quarters of weak performance are likely.
The second issue is often understated, but it is essential to note. Dodd-Frank, the wide-reaching set of regulatory reforms resulting from the Great Recession, and similar goals required by global accounting standards, caused financial institutions to prepare for stressed financial markets. One component of Dodd-Frank, which required financial firms to shift loss recognition from historical, batch performance to individual lifetime account risk, required the industry to move tens of billions of dollars into their loan loss reserves. Talk about being at the right place, at the right time- the trigger date was less than 90 days before the COVID-19 March 2020 surge.
The third 2020 event is new product development. New products and enhancements are natural in consumer credit. Some old innovations trigger late, as we saw with surges in contactless payments; other forces naturally develop, as experienced with the general rise in e-commerce during the COVID crisis. Yet, one item that sticks out is the growth of BNPL lending. This installment lending reprise uses a fixed term on a low-ticket purchase to extinguish a debt. In contrast to the open line of credit associated with a card, this short term loan engineers a quick payment term, usually associated with four payments over two months.
The success of the BNPL product comes as credit card balances decline, a function of conservative borrowing and prudent credit control. Seeking Alpha notes that BNPL Klarna, a fintech, had 11 million users as of October. Instead of interchange, merchants pay an above-market discount of between 2.5% to 4%, but regulatory compliance is uneven. One issue is that fintech lenders are not typically regulated for prudential standards, though they are subject to fairness.
From a credit card risk standard, it is good to see 2020 close. Looking into 2021, expect the industry to be sensitive to unemployment and merchant disruption. But for BNPL, this early stage product needs to be engineered in a way that keeps borrowers, and lenders, out of trouble.
Overview provided by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
