Buy-now pay-later (BNPL) is an important, digitally enabled method of unsecured consumer lending that is just beginning to appear in Asian markets. Although it is part of the fintech trend of making finance accessible to more people, BNLP could trap consumers in debts they can’t meet.
Regulators, especially in emerging markets where people have the least experience with credit, should ensure BNPL businesses are sound. The best way to do that is to channel those businesses towards developing outstandingly good credit scoring.
One step that regulators should consider is prohibiting BNPL fintech companies from charging consumers a fee for late payments. A late payment is a reflection of a failed credit-risk model. BNPL providers have other, more important ways of generating revenues.
In emerging markets, the bar should be set high enough that providers will double down on getting the credit assessment right – but not so high as to discourage the development of BNPL. Focus the innovation on credit-scoring algorithms and data collection, and the revenues on merchants, not consumers.
From layaway to pay later
When DigFin was a kid and finances were tight, his mom bought things at Sears on layaway: the store would reserve the item for her after she paid off the purchase, plus an administrative fee.
Emerging markets have longstanding versions of this. In India, every local retailer keeps a “khata”, a tab for local consumers who are known to the merchant. It’s a customer-loyalty service, not an interest-bearing loan.
Later, when DigFin‘s parents had a bit more cash, they bought things with a credit card, which was fine as long as they met the monthly payments in full.
Good thing they did: today in the U.S., consumers are being crushed beneath a $1.36 trillion mountain of credit-card debt that’s on a revolver basis, that is, they’re paying off interest but not the principal, says Nitya Sharma, co-founder and CEO of Bangalore-based BNPL startup Simpl. “They’re paying compound interest of 24 percent to 36 percent, which is financial suicide – and it’s all going to the banks,” he said.
This is where BNPL comes in. It was pioneered by Sweden’s Klarna in 2005 as a credit-card killer in online shopping. Users can input just a phone number and email to buy a good, with a commitment to pay Klarna via any payment method. Klarna used cutting-edge algos to assess credit, including mobile phone meta data and purchasing information, and turned this into the sort of one-click experience that Amazon and Alibaba had become known for.
Klarna charges e-commerce merchants a transaction fee, and will charge consumers if they pay late. Consumer payments are via installments over a variety of schedules. Consumers like it because if they’re prompt, they pay no interest. Merchants like it because it helps them move inventory and creates customer loyalty. Klarna is now valued privately at $5.5 billion.
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Australia’s AfterPay and Sezzle and Affirm in the U.S. have developed similar models. And now a variety of fintechs are building BNPL businesses in Southeast Asia, including the Pay arms of Grab, Gojek and Razer; Singapore fintechs Hoolah and OctiFi; Indonesia’s Kredivo; and the Philippines’ Cashalo, a unit of Hong Kong-based Oriente.
India has a multitude of BNPL startups such as Pine Labs, ZestMoney and Simpl – even the post office now offers this.
Most of these companies are targeting Gen Z and millennials, which Southeast Asia and India have in abundance. This is why the established Western players are also coming: Sezzle is looking to enter India, while AfterPay is keen to expand into Southeast Asia, and Klarna has opened in Singapore.
BNPL is for many users a better deal than credit cards. It is touted as making things more affordable, especially for young people lacking traditional credit scores. But the model is coming under fire for unscrupulous behavior.
“Of course exploitation could be a worry, especially in Southeast Asia,” said Geoffrey Prentice, co-founder and CEO at Oriente.
The Australia Securities and Investments Commission (ASIC) released a report in November that highlights what look like abuses. Up to 30 percent of Australian adults have now opened BNPL accounts. Although BNLP has improved consumer choice and payment options, it has also led to financial stress when consumers missed fee payments.
ASIC found in the past 12 months to November, 21 percent of users missed a payment, generating A$43 million in fee revenues, up 38 percent year-on-year. AfterPay, the industry’s giant, generated 20 percent of its revenues from missed-fee payments.
“BNPL” has become this magical wordGeoffrey Prentice, Oriente
More than half of people missing fees are under the age of 35, and 45 percent miss multiple payments. ASIC found many of these consumers then had to cut back on essentials like buying food, or enter additional loans, to repay the BNPL providers. Most of these people also have already maxed out their credit cards – which should clearly be a factor in supposedly whiz-bank fintech risk models.
Not all BNPL providers in Australia charge late fees, but AfterPay accounts for 73 percent of the domestic industry. And these players are now teaming up with banks such as NAB, CBA and Citi, as well as with Visa, Mastercard, and eBay, whose own models are all based on banks getting middleman fees – the sort of arrangement that BNPL was supposed to dodge. (Klarna, Affirm and AfterPay have evolved what they call “virtual credit cards” and may one day issue actual plastic.)
The real revenue model
Australian BNPLs aren’t the only ones coming under fire. DigFin happened upon this tweet in December:
It’s a good question. Does Affirm want this customer to max out the credit line it just extended to her? Because this behavior goes against what BNPL fintechs say is their mission, which is all about choice and affordability. (Affirm’s CEO responded to the tweet saying he’d look into it.)
Regulators in Australia, the U.K. and New Zealand are evaluating BNPL and how the industry can self-regulate along clearer principles and suitability tests.
But suitability is not difficult to figure out. That’s the point of using data to assess and price credit risk.
There’s no need for BNPLs to charge late fees.
“Our revenue is just from merchants,” said Arvin Singh, co-founder at Hoolah. “Late payments are bad. We’ve seen other providers generate a proportion of their revenues from late payments, and we do not want that model.” (Hoolah is partnering with Mastercard to expand into new markets.)
The credit-card model is predicated on a desire for some people to default, in order to enter a never-ending world of revolving debt at usurious fees. Buy-now pay-later was conceived to favor merchants and users by eliminating interest from consumer payments and make consumption a little more affordable.
If BNPL fintechs are making so much money off of late fees, then their credit assessments are not working – and that may be deliberate.
“It’s a problem if a BNPL provider can’t underwrite properly,” said Prentice. “BNPL has become this magical word, but it’s still just a loan, whether it’s the store that pays or the customer.”
The good news
It would be a mistake to dismiss the industry as bad for consumers. Run properly it’s great for consumers and merchants. It makes payments and shopping super convenient.
“Our mission is to create a new platform – build the next Visa – that’s better for merchants and consumers,” said Sharma at Simpl. “Credit cards just benefit the value chain. They’ve become predatory.”
Late payments are bad…we don’t want that modelArvin Singh, Hoolah
Also, while the ASIC report is unsettling, it begs the question of whether BNPL loans default more than, say, loans from banks or virtual banks. The big BNPL players have created their own online shopping websites, which is useful competition to giants like Amazon.
They are amalgamating buying, payments and credit in one place, centered around mobile phones.
The startups in Asia hope to replicate this success in what are big, young populations that don’t need to transition from credit cards. It should be easier, although Asia is fragmented and BNPL and other financial tools are still unknown by hundreds of millions of people.
Most BNPL players entering Asia are concentrating on building relationships with merchants, both online and offline, who are also new to these payment trends. “We look at what merchants are investing in to improve a business outcome, and whether we can outperform if we work together,” said Singh from Hoolah.
The model could eventually become even bigger in emerging markets than in the West. South and Southeast Asians, particularly the younger generations, are already mobile-native and haven’t developed a habit for credit cards – and maybe they never will.
“Making the bank the customer is the original sin of credit-card payments,” said Sharma.
But for BNPL to realize its potential, it needs to operate ethically. Self-regulation for such a nascent industry is a risk, especially in markets lacking in traditional regulatory oversight, and among young populations new to credit.
Our mission is to create a platform that’s better for merchants and consumersNitya Sharma, Simpl
Many of these fintechs are already operating models that avoid charging for late fees, and just focus on charging merchants at rates that beat the 3 percent for a credit card, and that actively help them sell.
But if one bad operator gains big market share in a given market and young people fall into debts they can’t pay – on top of the misery already caused by COVID-19 – then it could scar the industry. BNPL players in emerging markets should welcome their regulators to lay out a few hard ground rules now.