The BNPL Model and Rising Default Levels in the Ecosystem

Millennials worldwide are gushing over Buy Now, Pay Later (BNPL), a new credit option making waves internationally. Thanks to consumerism and the possibility of purchasing a commodity in real time, without having to pay immediately, BNPL has become extremely popular among the tech-savvy smartphone generation.  

With BNPL, a customer can buy an item and pay for it at a later date or over a stipulated period. Unlike credit cards or bank loans, the customer need not pay any additional fees or interest on top of the selling price. As BNPL enables people to purchase luxurious commodities without KYC and stringent background checks, it is increasingly finding acceptance in developed and developing economies. 

Expanding Footprint of BNPL  

While the BNPL concept is certainly not a new idea, given that most people have running accounts with their neighborhood stores or regular suppliers such as milk vendors or vegetable vendors, the concept has now developed into a full-fledged financial vertical featuring several major players vying for customer attention. Akin to the grocery store, where one pays for a month’s purchases at the end of the month without any accumulated interest, the BNPL model allows users to acquire things without paying for them at the time of purchase. The model has rapidly turned institutional over the past decade, playing on people’s desire to own luxurious commodities. 

The explosion in e-commerce, especially during the pandemic, has fueled BNPL. As per a survey by Australian BNPL major Afterpay, the BNPL model increased new customer traction at a rate of 48–80% while reducing returns by 8–18%. The pandemic further boosted the segment amid high unemployment rates and low financial liquidity. A Business Insider report suggests that BNPL might end up raking up approximately $680 billion in global transaction volumes by 2025. 

Quick Adoption and Seamless Disbursals 

Given the massive demand for BNPL services, the sector is expanding aggressively and bringing in new players from across the world. Major BNPL companies are ensuring quick onboarding and seamless loan disbursals to stay ahead of the competition. The BNPL model encompasses the following three broad types of service providers: 

1. Direct providers, such as Affirm, Afterpay, and Klarna, that provide BNPL solutions at the point of purchase
    
2. Facilitators, such as Stripe and Mastercard, that enable merchant networks to provide direct BNPL services
    
3. Retroactive players, such as Amex and Chase, that offer financing options on all credit card purchases 

Customers have moved away from credit card models that require stringent KYC compliance because of the growing popularity of the BNPL model and the availability of seamless and quick financing options. An example of the BNPL segment’s tremendous potential is the fact that the quantum of transactions made via Afterpay doubled from $5.2 billion to $11.1 billion in 2020. 

Rising Default Rates 

The BNPL model has its pros and cons. Its quick onboarding, indicating lax KYC norms, and fast loan disbursals lead to multiple loan defaults. In addition, the sector’s debt performance is comparatively opaque, and BNPL debt is usually not visible on the credit scores of individuals. This leads to potential borrowers tapping multiple avenues for loans. Eventually, many of these loans end up as defaults when the customer does not pay back the amount at the specified time. Unaware of a borrower’s actual debt status, BNPL companies end up overestimating the potential customer’s capacity to repay the debt, resulting in a cycle of rising defaults across companies. While companies do not publicize default rates, the fact that regulators are now stepping in to oversee the sector indicates a worrying rise in default rates. 

Regulators Stepping In 

Government authorities across Australia, the UK, and India are stepping in to oversee the expanding sector and making concrete efforts to control BNPL defaults. While the Australian Securities and Investments Commission is monitoring the segment consistently and has raised concerns regarding the threat of rising debt levels in BNPL, the UK aims to bring in norms as stringent as those applicable to typical loans. The Reserve Bank of India has released a set of guidelines—aimed at safeguarding both parties—for digital lenders. In Australia, the segment does not fall under the purview of regulators, but the ballooning debt is prompting Australian authorities to take a hard look at the model and bring in laws to protect the economy from falling into a bubble that could burst at the slightest prick.

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