BNPL Credit Risk
As fintech companies continue to disrupt the banking landscape, the credit card lending industry is now seeing challenges from a new kind of credit decisioning model. Buy Now, Pay Later (BNPL), often known as Pay-in-4, allows merchants to bear the cost of financing a purchase, while their chosen BNPL provider assumes the risk.
While most BNPL systems are currently tied to specific merchants, there are a few working to elevate the option into the mainstream. The focus is on what consumers want and need from financing options, and the no- or low-interest option coupled with instant decisioning is a large part of the reason BNPL is making inroads in the lending market against traditional credit cards.
Banks and credit unions are lagging behind the fintech apps when it comes to BNPL, but that could be about to change. Having an in-house offering tied to a customer instead of a merchant can redirect lending back to bank control and improve customer retention rates.
The Current BNPL Market
There are numerous BNPL options available currently, Of these, four stand out:
Klarna is currently one of the largest international BNPL entities. It allows customers to connect a valid credit or debit card, and charges the first of four installments when your item ships. Buyers can shop directly from the app and each purchase is evaluated and approved or denied instantly.
Klarna only does a soft credit pull for Pay in 4 transactions and charges no interest. If a payment isn’t completed, they will try one more time before charging a $7 late fee. Cumulative fees can’t amount to more than 25% of the total purchase.
A 30-day no-interest option and 6-36 month financing at 19.99% APR are also available through Klarna. A default on any payment results in a ban on using the service again. Klarna also reserves the right to report late payments and defaulted financing to credit bureaus.
Sezzle only does a soft credit check, charges no interest and splits all purchases into four equal payments. The app allows for larger purchases over time as history is built. Sezzle also allows rescheduling of payments if needed with no charge for the first reschedule (which can be used to push all payments out by two weeks) and only a nominal fee for up to two more rescheduled payments.
Affirm does a soft credit pull to prequalify users for an amount up to $5,000 and issues a virtual credit card number valid for use with partnered merchants. Most of the current spend through Affirm is at Walmart or for Peloton exercise bikes.
Depending on the merchant, amount of purchase and credit, the APR may be 0% or between 10%-20%. Payments can be spread out over 3-12 months. Affirm only charges simple interest, not compounded interest, and no other fees. Affirm also reports payment history, credit used and length of history to credit bureaus.
PayPal Pay in 4
PayPal now provides Pay in 4 as an option at checkout at most of the millions of stores that accept PayPal. Purchases between $30 and $1500 may qualify, and the decisioning process takes seconds.
No interest is charged and there are no late fees although abuse of the program will result in discontinuation of access to Pay in 4. An advantage of PayPal’s BNPL offering is that purchases are covered by the online payment processor’s protection plan.
Credit Card Companies Exploring BNPL
Visa has rolled out Visa Installments, which allows consumers to use their existing line of credit without a new credit check. Payments can be spread over several installments and no interest is accrued. Visa’s program currently only works with select cards from certain issuers, at specific merchants.
Mastercard has a more robust offering. Instead of being restricted by participating merchants, Mastercard provides a bank-driven experience, working with most bank-issued cards. The app creates a virtual card number for the transaction, pays the merchant directly and allows users to split their payment into the now-familiar four equal installments.
The Future of BNPL for Banks
Individual banks are beginning to look into how to create their own BNPL offerings with the goal of recouping the merchant fees currently being paid to fintech companies for BNPL transactions. McKinsey points to estimates that fintech is currently diverting $8 billion to $10 billion in annual revenues away from banks.
Mckinsey also notes that, given the shorter duration of financing, receivables turn over eight to ten times a year. This results in a return on assets (ROA) of 30% to 35%, with a loss rate comparable to those of credit cards at only 6% to 8%.
However, to effectively manage a BNPL option, banks and credit unions must let go of some of their risk-averse tenets. The no-interest, no late-fee model that most successful BNPL apps offer is a difficult one for banks to match under traditional lending models.
The consumers who seek BNPL options are also less likely to meet parameters for traditional credit decisioning, meaning a new way to validate and qualify candidates must be embraced if banks are to effectively leverage BNPL.
Traditional credit products are already blurring lines. Banks are currently offering loans against open credit card lines. Fintechs are dipping into the arena of installment-based credit cards and debit cards that have Pay in 4 features.
Underwriting must be product agnostic for banks to succeed in a BNPL marketplace. The ability to manage economics and maintain strong risk management will be a major determinant of success. Broader visibility into consumers’ finances can expand the prospective base of users by tapping into demographics that may have been underserved and restricted by traditional credit-scoring models.
Improving the technology stack and using consumer-provided data beyond a credit score is key to bringing banks into the BNPL market and creating strong relationships with customers. GDS Link delivers automated credit decisioning models to power instant, digital loan application experiences and help banks, credit unions and fintechs meet modern lending challenges.