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| Buy-now, pay-later providers have been criticized for carrying out minimal credit checks and not doing enough to protect consumers. Source: Klarna |
U.K. banks are pushing into the buy-now, pay-later market in the hope that upcoming regulatory developments will curb the sector's worst excesses and provide opportunities for new entrants.
Major lenders like Barclays PLC and NatWest Group PLC have recently launched buy-now, pay-later, or BNPL, services, while financial technology challenger bank Zopa Bank Ltd. has also moved into the market.
The U.K. BNPL market is growing at a 60% to 70% annual rate and accounts for 5% of e-commerce transactions, according to a 2021 Bain & Company report. According to the report, BNPL transaction value in the U.K. reached £6.4 billion in 2020, while a May 2022 report from Global Data said the global market reached $120 billion in 2021.
Banks are keen to capitalize on this growth opportunity but have been reluctant to do so until effective regulation is in place. A recent U.K. Financial Conduct Authority review and subsequent announcement of new regulations for the sector mean that banks are increasingly keen to get involved.
Urgent change
Incumbent BNPL operators have been criticized for carrying out no, or minimal, credit checks and for doing little to educate customers on the nature of the product and the risks of using it. The Financial Conduct Authority review that preceded the regulation announcement said change was urgently needed to protect consumers.
"For banks, the introduction of regulation will create opportunity rather than risk because it levels the playing field for everyone that is participating," said Tim Waterman, Zopa's chief commercial officer.
The U.K. government acted after the regulatory review revealed the potential for high levels of indebtedness and the absence of any requirement on behalf of BNPL firms to undertake consumer creditworthiness assessments. BNPL providers often apply a "soft" credit check that is faster for customers but would not meet existing regulatory requirements.
Debt advice charity StepChange said the ease with which BNPL was offered to consumers was a concern.
"There is often considerably less friction at the check-out when someone uses BNPL than when they use a debit card," said Richard Lane, director of external affairs at StepChange. "Overwhelmingly, too, most people don't recognize that they have taken out credit when using BNPL."
Unmanageable debt
A StepChange survey showed that 31% of current and former users said BNPL had got them into unmanageable debt. A survey from the charity Citizen's Advice showed that more than 40% of users had borrowed money to make BNPL payments, with 26% using credit cards to pay. The survey also showed that 8% used BNPL to pay for essentials such as groceries.
Regulation will see affordability checks introduced, and BNPL providers will need to be approved by the Financial Conduct Authority. But this is not likely to be introduced until the start of 2024.
Barclays urged existing providers to act ahead of the imposition of the regulations. "There is nothing to stop the sector from adopting more forward-thinking policies such as more robust credit checks and reporting lending to the credit reference agencies," said Antony Stephen, CEO of Barclays Partner Finance, via email.
BNPL operators can generate income from commission fees charged to shops and late payment fees from consumers. Management consultancy Accenture has estimated that on average 25% of BNPL providers' revenue comes from such methods.
BNPL provider Clearpay charges £6 after a seven-day delay in payment for products under £24, and 25% for products over £24, capped at £36. Its peers Laybuy Group Holdings Ltd. and Openpay Group Ltd. charge late payment fees after 24 or 48 hours of due payment date.
All of these companies changed the terms of their contracts to make them fairer and easier after a review by the Financial Conduct Authority.
This wave of new entrants comes as one of the sector's biggest incumbents faces mounting challenges. Sweden-based Klarna Holding AB (publ) carried a $45.6 billion post-money valuation after a June 2021 funding round, making it Europe's most valuable fintech. A July 2022 investment round saw that value plummet to $6.7 billion.
The company reported a loss of 7.1 billion Swedish kronor for 2021, up from 1.4 billion kronor in 2020. Credit defaults accounted for a high proportion of those losses in 2021, at 4.6 billion kronor, compared with 2.5 billion kronor in 2020.
Klarna said the losses were explained by its rapid expansion into new markets and a massive influx of new customers. The company had 150 million active users in the first quarter, up 60% year over year.
Klarna drew up its business plan for 2022 in the fall of 2021 but the world had changed dramatically since then, CEO and co-founder Sebastian Siemiatkowski told his staff. There had been a steep increase in inflation, a highly volatile stock market and there was likely to be a recession. It has said it plans to lay off 10% of its 6,500-strong workforce.
Klarna's business model, too, has come under attack, with Barclays highlighting the firm's high level of delinquencies and losses, The Daily Telegraph reported.
"They're not acting with due care for their customers after they've booked these loans, but we believe regulation will change that for everyone," said Zopa's Waterman.
Klarna has denied the accusations and criticized Barclays for its BNPL deal with Amazon, which allows users to spread the cost of their purchases but also charges 10.9% interest. It says its way of working compares well with banks and credit card providers.
"Unlike traditional banks, who profit when people can't meet repayments, our business loses when people can't repay so we provide the guardrails to enable responsible spending with protections built into our products," said a Klarna spokesperson via email. Klarna does not charge late fees, but debt could be passed to debt collection agencies.
Card competition
Indeed, credit card providers are likely to be threatened by BNPL. A Bain & Company survey found that 49% of U.K. respondents in the 25-34 age category used BNPL, while 51% used credit cards. BNPL also has a significantly superior net promoter score than credit, meaning people are more likely to recommend it to others, Bain & Company found.
A survey by The Ascent, a unit of the Motley Fool financial website, showed 67% of users thought BNPL could replace their credit cards, although only about a third would want that to happen.
Banks can compete by enhancing existing credit card options to offer some of the flexible type of financing that makes BNPL attractive, said Accenture. It noted that Citigroup Inc. in the U.S. launched Citi Flex Pay, which allows credit card customers to make monthly fixed payments for a set duration.
"Banks need to give customers the choice to pay through whatever means they prefer — whether that's credit card, debit card, mobile wallets or point-of-sale lending — and [ensure] that those payment methods are accepted wherever customers like to shop," said Barclays' Stephen.
Yet new entrants may need to heed the challenges noted by Klarna and the worsening economic environment. Waterman said the rise in interest rates aimed at tackling soaring inflation would affect the BNPL market this winter as consumer purchasing power suffers.
"There's been a race to the bottom in the BNPL market because providers have been focused on growth rather than margin," Waterman said. "As interest rates go up, the cost of funding goes up and margins are further compressed."
As of Aug. 5, US$1 was equivalent to 10.23 Swedish kronor.