Buy Now, Pay Later (BNPL) programs were quickly adopted by consumers due to their ease of access, low or no interest, and other benefits.
For several fintech start-ups, BNPL has become a lifeline, allowing them to generate significant income for the company. The trend has become popular around the world, aided by the pandemic, as more people shop for food online.
BNPL is not new, as it has existed as a point-of-sale credit from companies like Bajaj Finance. However, with the advent of e-commerce stores, a large number of new BNPL companies have started funding transactions through online channels.
However, despite the growing frenzy around BNPL among lenders and consumers, the segment carries several risks.
Do BNPL companies lend to subprime audiences?
Unlike traditional lenders such as banks, which are highly regulated and to whom they particularly lend, BNPL players generally have a fairly lenient approach to lending. Documentation required for BNPL loans is quite low, with lenders claiming to use data collected from users to make lending decisions.
Investors were impressed with the BNPL product, with financial technology companies raising more money to expand BNPL’s business. Market participants expect the market to expand several times over the next five years.
Currently around 10-15 million customers use BNPL.
A risk from a lender’s perspective has been the possibility of defaults due to heavy lending to consumers who might overtake themselves. These loans are generally used to finance consumption, rather than productive activity.
In the United States, some analysts have commented on the delinquency rates of the BNPL markets. According to these analysts, some of these companies have extremely high delinquency rates compared to traditional players operating in the unsecured lending segment, preventing them from surviving downturns.
For example, Oppenheimer’s Chris Kotowski pointed out that BNPL is “subprime in a new dress”. These companies are mainly aimed at people who are not well off financially and who cannot access credit from traditional lenders.
Comparing established lenders who had a 2.6 percent loss rate on their loan portfolios to BNPL lenders such as Klarna who had 8 percent losses on their loan portfolios, a report showed default rates high of the business.
And these losses occurred while they were operating during the best lending period in history, indicating that these companies may not be lending to the best borrowers.
Another hallmark of subprime loans is the general high cost imposed when payments are delayed. In India, these fees vary between 2-10% of the loan amount, which is a high fee in the event of late payment.
According to Kotowski, in a Fed stress test scenario, Klarna could see its losses increase to almost 52% while traditional lenders would see only 16% of the loss rates.
The situation could be even worse in reality, as lower quality borrowers usually experience the highest stress in distress scenarios. Australia has seen the shares of several of its BNPL players fall by nearly 90% after these companies saw their losses rise and regulations in the space increase, leading investors to worry about viability. of the business model.
RBI’s concerns about the digital lending space
Usually, for digital loans, including BNPL, non-bank financial corporations (NBFCs) partner with fintech companies that act as the front-end for the business.
Fintech companies are generally not allowed to lend on their own account, which makes the partnership legally necessary. These companies sometimes sign agreements with NBFCs, where they guarantee part of the loan in the event of customer default – effectively lending on their own behalf.
These are first fault guarantee contracts (FLDG). A Reserve Bank of India report had pointed out that the industry’s rapid growth and lack of regulation can pose a risk, especially as fintech companies continue to take much of the lending risk without explicitly being regulated.
“The loan portfolio supported by FLDG is akin to the lending service provider’s off-balance sheet portfolio in which nominal loans are entered on the lender’s books without having to participate in a lending process,” the central bank said in a report.
Will BNPL kill credit cards?
While some investors believe that credit cards may see their market share shrink due to the rise of BNPL, others believe that the markets in which BNPL and the credit card players operate are very different segments. .
Kotowski, for example, points out that three-quarters of bank credit card customers have FICO scores over 680 and higher financial standing, while BNPL targets customers with lower scores and possibly lower income.
Therefore, banks cater to audiences who do not need to pay multiple installments for low-value commodities – the basic proposition behind BNPL.
With increasing competition in the space, it is possible that lending standards will drop. The lowering of lending standards is further compounded by the fact that high quality borrowers typically borrow from banks.
E-commerce companies, Paytm, LazyPay, MobiKwik and several others have entered the space, seeking to generate income from sourcing and collecting loans for NBFC partners.
So far, no regulations have been put in place to standardize operations or regulate players. Although BNPL’s share is currently low, the number of platforms offering these services is increasing.
Whether these companies really have a better understanding of the unsecured retail credit market can only be determined after the loan portfolio has been seasoned over time.