Providers of buy-now-pay-later finance achieved blockbuster valuations on a wave of pandemic-fuelled hype last year, sending everyone from high-street banks to tech giants scrambling to launch their own BNPL products. But growing regulatory pressure and soaring inflation in the UK are starting to pose serious problems for the sector. Could it be the service providers, rather than the users, who will ultimately pay later?
The surge in ecommerce prompted by 2020’s Covid lockdowns helped the BNPL market to gain serious momentum. It doubled in value to £5.7bn in 2020-21, according to estimates by the Financial Conduct Authority, as more and more enticing buttons appeared on etailers’ checkout pages inviting customers to pay for their purchases by interest-free instalments.
Stagnating wages and the return of high inflation have since caused a cost-of-living crisis that’s forced millions of British consumers to tighten their belts this year. In April, the Office for National Statistics recorded the first monthly decline in retail sales for 15 months.
“People are spending less on items such as clothing, which has been a big driver of BNPL profitability,” notes Benedict Guttman-Kenney, a PhD student at the University of Chicago who has been studying the industry for his doctorate in economics.
As well as limiting the retail activity that’s the lifeblood of the BNPL sector, the cost-of-living crisis has caused concern that a wave of defaults is approaching as growing numbers of consumers find themselves unable to make repayments. At the same time, rising interest rates are pushing up providers’ operating costs, while the sector attracts greater regulatory attention amid claims that it ensnares young people in debt.
Last June, Klarna was valued at $46bn (£39bn), making it Europe’s most valuable private fintech firm, but the Swedish company is now seeking new finance at less than half that valuation, having recently announced its intention to lay off 10% of its workforce. Meanwhile, the share price of rival Affirm tumbled 80% this year.
The cost-of-living crisis could boost demand for BNPL services, but uptake may be more focused on essential, rather than discretionary, spending. Some providers have steered away from this category, but firms such as Zilch enable customers to spread payments for groceries and even energy bills. Indeed, Zilch was recently criticised for encouraging consumers to pay for basics such as supermarket pizza over several weeks.
Retailers’ appetite for BNPL is based on the promise of better sales figures. Providers argue that they help consumers manage their spending more effectively and offer better terms than credit cards (several of which have been charging interest rates exceeding 20%). But critics say that they can still trap customers in a debt spiral, and that BNPL’s sheer ease of use means that many people don’t even realise they’re becoming indebted.
“This trend gets worrying when you see reports that increasing numbers of customers are using BNPL to cover essential purchases,” notes Hannah Hilali, industry strategist at fintech consultancy 11:FS.
A YouGov poll of BNPL customers for debt advice charity StepChange last October found that 49% of respondents were struggling to keep up with household bills and other debt repayments.
And research published by Citizens Advice this June found that more than 20% of recent BNPL customers had been obliged to borrow money to make their repayments. There are concerns that the situation will worsen in the coming months as the financial pressure on consumers shows little sign of easing.
A surge in defaults would be painful for BNPL providers, given that most of them don’t charge interest or late-payment fees that they could use to offset the damage. They make their money by charging retailers a fee for each transaction.
A lot of fintech companies are altering their business models or exploring new ones to stay afloat
And then there is regulatory uncertainty. Westminster is planning to require lenders to perform affordability checks on BNPL applicants, but such legislation is unlikely to be enacted until next year. In the US, meanwhile, the Consumer Financial Protection Bureau has ordered, Affirm, Afterpay, Klarna, PayPal and Zip to share information about their commercial practices.
“The longer this goes on, the more uncertainty there will be about what the rules are going to be and how they will affect businesses,” Guttman-Kenney says.
Yet the gathering storm clouds haven’t dissuaded new players from entering the market. Apple recently became a notable challenger in this sector, alongside an increasing number of retail banks. Barclays, Monzo, NatWest, Revolut and Virgin Money are among those offering, or planning to offer, new products featuring instalment repayments. How can these companies avoid the worst effects of the looming default crisis?
“One approach could be to stop giving credit to really high-risk people, because they’re too risky to lend to in this environment,” Guttman-Kenney says.
Klarna, which decided to strengthen its credit checks in the UK at the end of last year, intends to share information with reference agencies Experian and TransUnion.
Such moves won’t mitigate the effects of inflation and recent increases in the Bank of England’s base rate on BNPL providers’ operating costs, of course.
“One option for them would be to pass their extra costs on by increasing the cut they take from retailers,” says Hilali.
But, while BNPL providers have typically charged merchants between 3% and 6% commission on each transaction, Klarna’s CEO, Sebastian Siemiatkowski, told Bloomberg in January that intensifying competition in the sector meant that retailers were no longer agreeing to pay the top rate.
Because most BNPL firms don’t charge customers interest, a fresh approach may be warranted, according to Hilali.
“One of the wider trends we’re seeing is that a lot of fintech companies are altering their business models or exploring new ones to stay afloat,” she says.
A study published last October by equity research house Redbu indicated that profit margins in the BNPL sector were wafer-thin or non-existent even while the market was booming. The researchers suggested that providers would have to expand into all-purpose digital wallets to ensure their survival.
Hilali notes that she has seen many players, including Klarna and Afterpay “evolving to focus on solving adjacent customer needs, such as building shopping experiences around their products”.
Highlighting the importance of Mastercard’s and Visa’s instalment products in enabling firms to launch their own BNPL offerings, she adds: “I think we’re about to see a lot of companies enter such partnerships across the world.”
Notwithstanding the prospect of more stringent regulation, the BNPL revolution could still be in its infancy, according to Guttman-Kenney.
“I’m pretty confident that it’s going to survive this crisis,” he says. “The sector has very attractive economic and psychological factors – to both consumers and retailers.”
