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Fintech Buy Now Pay Later has a great future as old-fashioned consumer credit

With last week’s news that Klarna is cutting 10% of its global workforce, and valuations of listed fintech Buy Now Pay Later companies falling, some may now be doubting the long-term viability of Buy Now Pay Later (BNPL). But given the inherent benefits of BNPL to consumers, the product seems unlikely to disappear. Instead, expect a shift towards old-fashioned interest-charged consumer credit.

It's clear that consumers see BNPL as a convenient way of buying goods and services, even if it’s often seen 'merely' as a form of payment rather than as credit. It’s fast and simple to apply for, and likely to be offered. Unlike a standard credit card, the repayments are straightforward and transparent as each transaction is presented separately. With no or low fees, and being interest-free, it’s less likely to become an unmanageable debt than most types of non-prime credit.

Higher interest rates, increasing the cost of subsidising interest-free credit, are blamed for Klarna’s decision to cut costs. But it is a total coincidence that the UK’s HM Treasury department is about to publish its decisions on how BNPL in the UK will be regulated?

UK regulation of BNPL

Considering the political pressure on the UK Government to regulate BNPL, it is odd it has taken so long to finalise this matter. It’s now 16 months since the Economic Secretary to the Treasury, John Glen, wrote to the Financial Conduct Authority following the Woolard Review of the UK’s unsecured credit market, agreeing that the Government should take ‘swift action to bring these products into regulation before potential detriment is able to occur’.

The FCA has tightened some rules already, but the effects of this are marginal, as most BNPL remains unregulated. On May 7, the Times reported that the Government planned to publish a further consultation within ‘a few weeks’, presumably based on information from the Treasury.

The new regulation is widely expected to require BNPL providers to do more to confirm that new lending is affordable for consumers. It’s likely that will involve extending existing FCA consumer credit rules to BNPL, whether by amending the current regulatory exemption for interest-free credit up to 12 months, or (as I have suggested previously) clarifying that the current exemption doesn’t apply to most BNPL. Either way, we should expect the BNPL application process to become slower and more likely to lead to declines.

‘Over the top’ solutions

BNPL providers have an answer to that, being ‘over the top’ solutions, such as the Klarna Card, Zilch virtual Mastercard and Butter. These allow consumers to open a BNPL account, providing details of their finances once, and then use the facility at any retailer that accepts Visa or Mastercard without having to make a new application every time they checkout. It’s a strong solution to the regulatory problem but it comes with a problem for the provider. ‘Over the top’ means that there’s no retailer involvement, so there’s usually no retailer subsidy.

What’s still in it for the BNPL provider? They will take a cut from the payment processor, and there’s talk about other services they can offer to retailers - for example to promote a retailer, making their business model more like the cashback apps such as Quidco or Top Cashback. There may also be cross-selling of interest-charged loans or other products. But it’s difficult to see these making up for the loss of subsidy payments to allow interest-free repayments, particularly as interest rates rise.

Future for BNPL

How can BNPL survive? Paradoxically, the solution for these fintech providers could well be a step back in time to old-fashioned consumer credit, where the consumer pays interest to borrow money.

Not a lot of interest, it must be said, but on these very small short-term loans (at best, they are not so far removed from microloans in developing countries, helping consumers to even out expenditure) a small absolute charge for interest - just a pound or two - could translate into quite a strong return for the lenders. Consumers are more likely to focus on the actual cost of the loan than the very theoretical APR rate that lenders are required to show.

Profitability would rest heavily on a high number of transactions or loans per customer per year, both to reduce origination costs and bad debts, but there’s every sign the BNPL providers will achieve that with their ‘over the top’ products. Some consumers will stop using BNPL, so growth rates will be lower, but if consumers don’t value the benefit of the product, perhaps that’s not such a bad outcome for retailers?

An extra twist to regulation?

Given the time the Government is taking over its regulation, it does seem possible there’s going to be a more to it than affordability.

One possibility is that the Government caps the size of each BNPL transaction unless it is assessed separately for affordability. A cap at, say, £100 seems to fit the Conservative Party’s ideas of market interventions, as they don’t prevent individuals from borrowing (that would be ‘unconservative’) but just make it slightly more difficult for consumers to become overindebted. The £2 restriction per bet on gambling machines in UK bookmakers, that may now be extended to online bingo and other games, is an example of such an approach.

If that option forms part of policy (it doesn’t seem probable, but still worth considering), it might mean that smaller loans can be automatically approved, but larger ones may require a reassessment of affordability - as already happens with longer-term retail Point of Sale finance.

Global impact

Finally, could the UK Government’s actions on BNPL affect the firms globally? The international financial services regulators collaborate on BNPL policy and there’s a long tradition of other international regulators taking a lead form the UK. It doesn’t seem unreasonable to say, therefore, that the future of BNPL could well depend on the UK Government report due out soon.

For more information on the UK BNPL sector, see the recently updated report from Apex Insight.

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