BNPL Loans: Use the Strength of Financial Institutions to Capture the Market
From a lender's point of view, Buy Now Pay Later (BNPL) loans are a bit of a nuisance.
- Lending standards are lax, as evident in Australia, where delinquencies run 20%.
- Cost of acquisition is high: loans for $100 financing can cost as much as it does to book a $5,000 credit card when you consider the ability to pay, KYC, and necessary credit underwriting costs.
- With no regulatory requirements, consumers have little clarity regarding lending costs, as you find with the Schumer Box, named after Sen. Chuck.
- The BNPL lending model prescribes "payment in 4," meaning the debt will be billed four times over two months, forcing higher average payments.
However, consumers like BNPL, and for a variety of reasons. Easy lending reduces a turndown at the point of sale. The highly engineered process, delivered through APIs to the retailer's platform, makes it easy for consumers to initiate the loan before they have time to whip out their credit cards. And besides that, who likes dealing with bankers, anyway? (Full disclosure, I like bankers.)
Three top credit card issuers have their own version of the BNPL model: American Express Co. offers Plan It Pay It, Chase offers My Chase Plan, and Citi has Flex Pay.
The bankers miss that BNPL is more of a merchant play than a consumer play. With the seamless, slick integration by companies like Afterpay at retailers such as The Gap, the transaction is effortless.
When I tried Plan It Pay It, My Chase Plan, and Flex Pay, I saw just about the same offer by my credit card issuer. In my online account, I could select a transaction, then schedule it into an installment-like term. The silly thing is, I could have effectively had the same result if I just paid more than the minimum due.
Bank card issuers have an opportunity to disrupt the disrupters. Now that companies like Affirm are doing IPOs that might generate $10 billion, now is the right time to get serious. Banks can find the answer by looking at Affirm's S-1 filing with the Securities and Exchange Commission. You will discover Affirm's four top threats there:
- If we are unable to attract additional merchants and retain and grow our relationships with our existing merchant partners, our business, results of operations, financial condition, and future prospects would be materially and adversely affected.
- If we are unable to attract new consumers and retain and grow our relationships with our existing consumers, our business, results of operations, financial condition, and future prospects would be materially and adversely affected.
- If we fail to maintain a consistently high level of consumer satisfaction and trust in our brand, our business, results of operations, financial condition, and future prospects would be materially and adversely affected.
- A large percentage of our revenue is concentrated with a single merchant partner, and the loss of this merchant partner or any other significant merchant relationships would materially and adversely affect our business, results of operations, financial condition, and future prospects.
Let's break these four vulnerabilities down in the context of credit cards. First, every legitimate merchant on the planet can accept credit cards. In most cases, merchants use banks or bank processors to interact. The issue is more about merchant churn and how to avoid it than finding new merchants that do not accept credit cards and could.
Second, an integral part of the BNPL proposition is that it can address the portion of the population that does not have credit cards because financing dollars are low - many lenders offer credit for items as low as $50. With that low threshold, the lender does not need to consider the lifetime value of the relationship, but rather the single transaction event. As evidenced in Australia, where regulators identified 21% default rates, BNPL focuses on making a loan to close the transaction, rather than creating a consumer relationship which could fill a wide array of financial needs.
Credit cards are available to all, with consumer fairness protections and standards to ensure no discrimination. While the fintechs need to attract new customers, bank card issuers come in every size, ranging from small-town USA community banks to global giants like Chase and Citi.
Regarding the third point, attrition, credit card banks deal with this with every day. Something banks know well is that, if you can get the customer in with a credit card and grow the relationship by cross- and upselling car loans, student loans, mortgages, and deposits, there will be a long-lasting relationship.
The fourth vulnerability is close to the first issue because most banks have their merchant acquiring business-think Chase Paymentech. There are millions of merchants already established as credit card acceptors. Credit card issuers are already at the point of sale.
The Bank Solution: Invert the Game
- Fintechs are one-trick ponies when it comes to credit. They lack the capacity, girth, and vision to view the customer in its full lifecycle. With a bank, you can bring a customer in with a low credit card line, and as they mature, build up the line and fill their future household needs. Fintechs that have tried this strategy either could not handle the risk or could not handle the function.
- It takes about $250 to acquire a new credit card account before issuers add rewards. That is the marketing cost, not the simple on-boarding process. The credit card issuer model could easily offer free financing as an introductory offer, then throw in a pre-approved credit card once the loan books. I'd venture to say that if a bank card issuer did this at The Gap with a $70 pair of jeans, they could also offer the jeans for free, provided the customer opened a new card.
- Clarity and fairness are bank mantras. Thanks to regulators in most jurisdictions that operate as the CFPB does in the U.S., no one is going to get away with using four-point type to explain that deferred interest will be imposed if the account is late. Bankers can use their usual clarity standard to gain credibility.
Banks must do more than they do today to protect the retail market. They need more than just a fancy front end that allows the consumer to move a transaction. The effective issuer will work the installment lending process from the merchant side, then engineer a process that brings in inexpensive account acquisition, and finally expand the relationship as the customer matures.