How banks can find a winning position in the buy-now-pay-later market

As BNPL gains popularity with consumers and merchants, banks will need to carefully consider their position in this growing market.

In brief

• First burgeoning in Australia and New Zealand, BNPL is now quickly gaining scale globally.
  
• The rapid growth of BNPL has caught the attention of regulators who are focused on ensuring ethical lending and mitigating risk of defaults.
• Banks need to consider how, or if, they will participate in this increasingly tight market, leveraging existing strengths if they are to succeed.

The combined forces of digitization, a pandemic-accelerated shift to online shopping and the rise of young, engaged consumers mean that buy-now-pay-later (BNPL) is now the fastest-growing online payment method in many economies. Customers like the ability to purchase immediately and defer payment over several installments, with no fees or interest when paid on time. And, merchants are attracted to BNPL as an effective tool to reduce cart abandonment and increase sales. Some expect BNPL to increase revenue by as much as 20%, offsetting the generally higher transaction fees (around 4% to 7% per transaction) charged by providers.

BNPL first gained scale in Australia and New Zealand, quickly escalating in Europe which has seen the emergence of the main brand leaders. In the UK, the market grew to five million users in just over 12 months. And while the US was slower to embrace BNPL, growth here is now expected to match or surpass that of parts of Europe, with an anticipated compound annual growth rate (CAGR) of 20.7% from 2021 to 2028. FinTechs dominate BNPL, and typically follow one of three major existing business models, with consumer-centric application (app) models leading the market.

The rising popularity of BNPL also creates another risk for banks – losing access to millennial and Gen Z consumers attracted to this alternative form of financing. In its early days, BNPL’s typical customer was young, female, on a lower income and likely to make repeat, smaller purchases from fashion-focused ecommerce brands. While the core market remains below average income and trends younger, BNPL’s customer base is diversifying toward a broader group, including people with access to more traditional forms of credit (credit cards), who want to use BNPL as well.

Perhaps the most worrying trend for banks is that BNPL players are expanding into more traditional banking services. PayPal, which has lifted the upper purchase limits available via its Pay in 4 option, now allows customers to repay directly from their bank accounts, rather than credit cards. Others are moving into the B2B space. Australian FinTech, Spenda, positions itself as offering faster, more flexible “non-bank” lending that helps businesses grow.

Ensuring ethical lending and mitigating risk of defaults

The rapid growth of BNPL has caught the attention of regulators, who are considering various approaches designed to protect consumers.

The Australian Securities and Investment Commission looked at the market in depth, with Australia’s Treasury accepting an industry self-regulatory code for now. In the UK, the Woolard Review recommended regulation; legislation was passed in 2021 with HM Treasury currently consulting on orders to implement this.

Across Europe, other countries have legislated or are considering legislation about the prominence of credit on retail websites. In the US, in December, the Consumer Financial Protection Bureau launched an investigation into BNPL offerings, saying it was particularly concerned over the speed with which consumers can rack up debt via the plans, a lack of sufficient regulatory disclosures and the collection of customer data.

Many of regulators’ biggest issues with the BNPL model echo concerns of some within the industry around its long-term future. With an estimated 25% of some BNPL platforms’ revenue coming from missed payments, questions are being raised about the sustainability of the model. A lack of consumers’ credit transparency and affordability is also a concern due to the increased risk of defaults. The UK’s Woolard Review found that 10% of customers of one major bank who used BNPL for the first time were already in arrears.

Banks considering BNPL offerings will need to heed these concerns – and how regulators may mitigate them – if they are to build a model that is sustainable, compliant and balances the interests of the business and consumers.

Competing in a crowded market

As the growth of BNPL continues, banks will need to consider how, or if, they want to participate in this market. Those that decide against entering, or hesitate too long in doing so, may risk being shut out of an expanding value pool, and losing access to a generation of consumers with different credit needs. For those ready to contest the dominance of FinTechs in the market, considering how to leverage existing strengths may be the key to success:

• Partner to create differentiated products – Joining forces with BNPL players allows banks to make the most of their traditional strengths and capital while expanding into new, innovative credit options, including short-term microloans. For example, an Australian bank, has joined forces with a FinTech to give customers BNPL options using existing platforms. In the US, Barclays has partnered with Amount to offer merchants point of sale (POS) financing under the merchant’s own brand.
• Offer BNPL via credit cards at POS – In some Latin American countries including Brazil, Argentina and Chile, banks have long offered BNPL options via credit cards at POS, with customers choosing to spread payments over installments. While a more complex value chain in the US may make rolling out this payment method challenging, it does offer growth opportunities for banks, including into high-value segments, such as healthcare, professional services and home and auto maintenance.
• Buy or build their own platform – The Commonwealth Bank of Australia (CBA) is confronting the BNPL threat head on, with their own offering, StepPay, which has lower merchant fees. Other banks are following suit, seizing the opportunity to monetize merchant relationships and balance sheets while leveraging existing investments in infrastructure, including apps and payment terminals. A speedier go-to-market option is to buy an existing BNPL player. American bank, Truist Financial Corporation, has acquired Service Finance Company to accelerate its expansion into POS financing.
• Reduce merchant feeds – More BNPL competition and regulation is likely to drive down merchant fees. Banks may be more able to reduce these costs, calling upon their experience of operating in regulated markets and offering low-cost payment models.
• Innovate around card platform – Banks can enhance existing credit card options to offer some of the flexible types of financing that make BNPL attractive, such as bundling to manage multiple installments within existing accounts. Citibank has done this, launching Citi Flex Pay which allows credit card customers to purchase and settle on monthly fixed payments for a set duration.

The time to act is now

Banks have let FinTechs take the lead in the BNPL space – challenging their dominance will not be easy. But, with this new form of POS financing only growing in popularity with both customers and merchants, banks will need to consider their own position in this growing market, or risk losing further revenue and market share.