There is no question about the popularity of Buy Now Pay Later Lending (BNPL). If you did your holiday shopping online this year, you would have encountered BNPL at major retailers. But as a payment option, is BNPL a viable, sustainable offering?
Although BNPL provides easy lending options, we see credit quality issues brewing. Our view, expressed in Mercator’s most recent Viewpoint, draws data from the Australian Securities and Investment Commission. Aggressive lending is generating very high default rates.
- The AISC supported its findings of aggressive lending in BNPL with a survey that found high delinquency rates compared with other loan instruments, suggesting that lending standards were too loose for the consumer’s credit qualifications.
- With fully 20% of consumers in a delinquent status, many seem to fall into the category of those who cannot pay or lack the experience and commitment to manage household budgets.
There is an essential calculus to lending. Based on the loan type, you attract customers who pay for their borrowing needs. The loan principle plus the incurred interest becomes the total cost of the loan. Additional revenue comes from the merchant who pays interchange or discounts the goods and services.
Revenue offset lender costs. The costs cover marketing, acquisition, funding costs, credit risk, and servicing. The remainder is profit. Before those profits are realized, the lender must pay the expenses for bad credits–those customers who do not repay. In typical cases, one bad debt can negate the profit generated from 25 accounts.
That is the concern of AISC. If delinquencies run high, losses will be linear. Creditors will assume risks that they will not be able to cover or have to generate high fees to cover the risk.
Now, consider today’s read, which comes from The (Canadian) Chronicle Herald. The article announces, “Capital One Stops’ Risky’ Buy-Now Pay Later Credit Card Transactions. Bankers, take note!
- Capital One Financial Corp (CapOne) has barred customers from using its credit cards to clear buy-now-pay-later (BNPL) debt as the transactions bear unacceptable risk, it told Reuters, making it the first to distance itself from the finance alternative.
- The third-largest U.S. card firm with 62 million accounts, plus more in Canada and Britain, said it would no longer allow “transactions identified as point of sale loans charged on its credit cards, regardless of the point of sale lender.”
- “These kinds of transactions can be risky for customers and the banks that serve them,” a spokeswoman said in an email.
- The move makes CapOne the first major financial firm to push back against the quick-growing BNPL segment, which has seen startups such as Australia’s Afterpay Ltd make inroads offering interest-free shopping with no credit history required.
Several top U.S. banks built their versions of BNPL Lending. Instead of aggressive lending, credit card companies such as American Express (Plan It, Pay It), Chase (My Chase Plan), and Citi (Flex Pay) use a model described in this Harvard Business School Study, titled ‘”Repayment-by-Purchase” Helps Consumers Reduce Credit Card Debt.’
The model is different than BNPL because it works within the consumer’s credit card account and allows cardholders to isolate a transaction and achieve the same result as BNPL. The difference is that these consumers are credit qualified.
The BNPL space is exciting because it brings easy credit for consumers. But for banks, there is a need to be prudent about lending. And, with this comes structure and ensuring the consumer has the ability to repay.
Overview provided by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
