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Some players in the BNPL market are forced to shut operations or merge with banks, owing to stiff competition from large established banks and low profit margins in their initial phase of business
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In the past few years, the Buy Now Pay Later (“BNPL”) short-term financing solution has gained much prominence worldwide. Unlike credit cards, BNPL offers seamless credit to consumers, and repayment through simple, interest-free installments without any additional cost. According to the Worldpay Global Payment Report 2021, BNPL accounted for 2% of all global e-commerce transactions and is expected to double to 4% by 2024.
European countries have been the leaders in adopting this new financing solution, with Sweden (23%), Germany (19%), and Norway (15%) having the highest market share. India is also rapidly catching up to more mature markets with domestic e-commerce transactions via BNPL at 3% in 2020. In fact, in the last few years, the Indian BNPL market experienced a boom due to high adoption in the millennial and GenZ population. RazorPay, an Indian fintech platform, has reported over 600% surge in their BNPL offerings.
BNPL provides consumers with several benefits, including consumption smoothing, budgeting support, and a fast, convenient, and seamless credit-option as an alternative to traditional credit during check-out. Merchants are attracted to the value proposition of enhanced sales, increased conversion, and improved cash flow. However, while BNPL solutions offer significant benefits to stakeholders, it also hosts certain challenges.
One of the biggest challenges for BNPL players is regulation. Currently, BNPL is at a nascent stage compared to other payments methods globally. Unlike credit cards, there is no independent regulation, meaning that there are no standards for disclosures on fees, amounts owed, credit reporting, and payments. This has given rise to concerns over customer protection and ethical business practices. Hence, regulators around the world are deliberating and examining the potential of this new credit solution, amid apprehensions over excessive and unregulated lending, and no credit reporting.
Last year, the RBI clarified its stance on BNPL, recommending it to be categorized under Balance Sheet Lending (“BSL”), which should be allowed only to banks and non-banking financial companies (NBFCs) and classifying it as a credit product. While some FinTech companies offer BNPL as a credit option, to ensure proper credit reporting, some of them provide BNPL as a payment option/product for enhanced customer engagement and seamless user experience. Although, they position it as a potential replacement for credit cards, but not a “credit product,” it allows them to not report transactions to credit bureaus, under the rationale that it does not fall under the definition of “credit.” Many FinTechs are thus taking the exposure on their balance sheet and treating them as deferred payments. According to these companies, since no interest is being charged to the consumer, they are not required to book the loan on a NBFC or report it to a credit bureau. Hence, no regulations are applicable to them.
This practice creates a gap when evaluating a customer for other loans, thereby resulting in asymmetric information, sometimes causing the customer to be over-leveraged, by other potential lenders. Consequently, this results in customers taking more loans and falling into a debt trap. From a BNPL providers’ point of view, it is important since a FinTech company might offer credit to someone who has a bad credit record. Moreover, when the customer stops paying, the RBI’s code of conduct for collections needs to be followed. However, companies not treating it as a credit product may not follow the code of conduct, leading to some customers facing harassment from the companies—all due to the lack of monitoring. Therefore, the RBI highlights the need for a regulatory purview on BNPL companies. It recommends eliminating the regulatory arbitrage that BNPL businesses enjoy, by not sharing the information about transactions, customer payment behavior, and credit profile with the credit bureau.
The regulations, if it comes into effect, will increase the operational cost of BNPL service providers. The companies will have to do a full-fledged KYC process as well as credit bureau reporting. They are also required to set up a Self-Regulatory Organization (“SRO”) as a nodal agency to verify transactions and repayment. These changes are expected to bring transparency and accountability to businesses, as well as customer-oriented guidelines for better interaction and exchange between the lender and borrower. The recommendations reflect a cautious approach to approving the current system of self-regulation, particularly considering the rapid growth of the BNPL industry.
Globally, several countries are also taking significant steps to bring about radical changes in the BNPL market, including a fair regulatory framework. In February 2021, the UK Financial Conduct Authority (“FCA”) justified the urgency to bring regulations, laying down the procedure of engagement between consumers and BNPL providers. Companies will have to seek FCA authorization to extend their services. In the US, regulators have taken steps to regulate the BNPL market. The Consumer Financial Protection Bureau (“CFPB”) notified several BNPL businesses in the US to submit information about their organization on three parameters—accumulating debt, regulatory arbitrage, and data harvesting—to evaluate all risks and benefits of services offered by them. In 2020, Sweden amended its Payment Services Act under which merchants are required to offer a list of payment options and methods to customers during online payments. The rationale is to avoid customers prioritizing installment-based payment options that may put customers into debt.
These developments will pave the way for organized legal frameworks that are expected to make the BNPL industry function more efficiently, with less risk and more accountability to both agencies and customers. As the awareness about BNPL increases, more innovations are expected to disrupt the space with a wide customer base to cater to. Few other challenges faced by the BNPL service providers include:
High Default Rate: Without any KYC and credit checks, that sometimes raises the risk of non-payment of credit by consumers, excessive and unregulated lending often results in extending credit to the over-leveraged consumer, who have no intentions of repayment. In India, as per media reports, precise BNPL industry default rates are not available in the public domain. However, the estimated rate of default hovers around 15–20%. Australian Securities & Investments Commission (“ASIC”), states that 21% of customers missed out on at least one payment to BNPL providers.
Competition from Incumbent Banks: Some players in the BNPL market are forced to shut operations or merge with banks, owing to stiff competition from large established banks and low profit margins in their initial phase of business.
The author is AVP, Benori Knowledge
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