What next for the UK’s beleaguered BNPL sector?

Providers of buy-now-pay-lat­er finance achieved block­buster val­u­a­tions on a wave of pan­dem­ic-fuelled hype last year, send­ing every­one from high-street banks to tech giants scram­bling to launch their own BNPL prod­ucts. But grow­ing reg­u­la­to­ry pres­sure and soar­ing infla­tion in the UK are start­ing to pose seri­ous prob­lems for the sec­tor. Could it be the ser­vice providers, rather than the users, who will ulti­mate­ly pay lat­er?

The surge in ecom­merce prompt­ed by 2020’s Covid lock­downs helped the BNPL mar­ket to gain seri­ous momen­tum. It dou­bled in val­ue to £5.7bn in 2020–21, accord­ing to esti­mates by the Finan­cial Con­duct Author­i­ty, as more and more entic­ing but­tons appeared on etail­ers’ check­out pages invit­ing cus­tomers to pay for their pur­chas­es by inter­est-free instal­ments. 

Stag­nat­ing wages and the return of high infla­tion have since caused a cost-of-liv­ing cri­sis that’s forced mil­lions of British con­sumers to tight­en their belts this year. In April, the Office for Nation­al Sta­tis­tics record­ed the first month­ly decline in retail sales for 15 months. 

“Peo­ple are spend­ing less on items such as cloth­ing, which has been a big dri­ver of BNPL prof­itabil­i­ty,” notes Bene­dict Guttman-Ken­ney, a PhD stu­dent at the Uni­ver­si­ty of Chica­go who has been study­ing the indus­try for his doc­tor­ate in eco­nom­ics.

As well as lim­it­ing the retail activ­i­ty that’s the lifeblood of the BNPL sec­tor, the cost-of-liv­ing cri­sis has caused con­cern that a wave of defaults is approach­ing as grow­ing num­bers of con­sumers find them­selves unable to make repay­ments. At the same time, ris­ing inter­est rates are push­ing up providers’ oper­at­ing costs, while the sec­tor attracts greater reg­u­la­to­ry atten­tion amid claims that it ensnares young peo­ple in debt.

Last June, Klar­na was val­ued at $46bn (£39bn), mak­ing it Europe’s most valu­able pri­vate fin­tech firm, but the Swedish com­pa­ny is now seek­ing new finance at less than half that val­u­a­tion, hav­ing recent­ly announced its inten­tion to lay off 10% of its work­force. Mean­while, the share price of rival Affirm tum­bled 80% this year. 

The cost-of-liv­ing cri­sis could boost demand for BNPL ser­vices, but uptake may be more focused on essen­tial, rather than dis­cre­tionary, spend­ing. Some providers have steered away from this cat­e­go­ry, but firms such as Zilch enable cus­tomers to spread pay­ments for gro­ceries and even ener­gy bills. Indeed, Zilch was recent­ly crit­i­cised for encour­ag­ing con­sumers to pay for basics such as super­mar­ket piz­za over sev­er­al weeks.

Retail­ers’ appetite for BNPL is based on the promise of bet­ter sales fig­ures. Providers argue that they help con­sumers man­age their spend­ing more effec­tive­ly and offer bet­ter terms than cred­it cards (sev­er­al of which have been charg­ing inter­est rates exceed­ing 20%). But crit­ics say that they can still trap cus­tomers in a debt spi­ral, and that BNPL’s sheer ease of use means that many peo­ple don’t even realise they’re becom­ing indebt­ed. 

“This trend gets wor­ry­ing when you see reports that increas­ing num­bers of cus­tomers are using BNPL to cov­er essen­tial pur­chas­es,” notes Han­nah Hilali, indus­try strate­gist at fin­tech con­sul­tan­cy 11:FS. 

A YouGov poll of BNPL cus­tomers for debt advice char­i­ty StepChange last Octo­ber found that 49% of respon­dents were strug­gling to keep up with house­hold bills and oth­er debt repay­ments. 

And research pub­lished by Cit­i­zens Advice this June found that more than 20% of recent BNPL cus­tomers had been oblig­ed to bor­row mon­ey to make their repay­ments. There are con­cerns that the sit­u­a­tion will wors­en in the com­ing months as the finan­cial pres­sure on con­sumers shows lit­tle sign of eas­ing. 

A surge in defaults would be painful for BNPL providers, giv­en that most of them don’t charge inter­est or late-pay­ment fees that they could use to off­set the dam­age. They make their mon­ey by charg­ing retail­ers a fee for each trans­ac­tion.

And then there is reg­u­la­to­ry uncer­tain­ty. West­min­ster is plan­ning to require lenders to per­form afford­abil­i­ty checks on BNPL appli­cants, but such leg­is­la­tion is unlike­ly to be enact­ed until next year. In the US, mean­while, the Con­sumer Finan­cial Pro­tec­tion Bureau has ordered, Affirm, After­pay, Klar­na, Pay­Pal and Zip to share infor­ma­tion about their com­mer­cial prac­tices.

“The longer this goes on, the more uncer­tain­ty there will be about what the rules are going to be and how they will affect busi­ness­es,” Guttman-Ken­ney says. 

Yet the gath­er­ing storm clouds haven’t dis­suad­ed new play­ers from enter­ing the mar­ket. Apple recent­ly became a notable chal­lenger in this sec­tor, along­side an increas­ing num­ber of retail banks. Bar­clays, Mon­zo, NatWest, Rev­o­lut and Vir­gin Mon­ey are among those offer­ing, or plan­ning to offer, new prod­ucts fea­tur­ing instal­ment repay­ments. How can these com­pa­nies avoid the worst effects of the loom­ing default cri­sis? 

“One approach could be to stop giv­ing cred­it to real­ly high-risk peo­ple, because they’re too risky to lend to in this envi­ron­ment,” Guttman-Ken­ney says. 

Klar­na, which decid­ed to strength­en its cred­it checks in the UK at the end of last year, intends to share infor­ma­tion with ref­er­ence agen­cies Exper­ian and Tran­sUnion.

Such moves won’t mit­i­gate the effects of infla­tion and recent increas­es in the Bank of England’s base rate on BNPL providers’ oper­at­ing costs, of course. 

“One option for them would be to pass their extra costs on by increas­ing the cut they take from retail­ers,” says Hilali. 

But, while BNPL providers have typ­i­cal­ly charged mer­chants between 3% and 6% com­mis­sion on each trans­ac­tion, Klarna’s CEO, Sebas­t­ian Siemi­atkows­ki, told Bloomberg in Jan­u­ary that inten­si­fy­ing com­pe­ti­tion in the sec­tor meant that retail­ers were no longer agree­ing to pay the top rate.  

Because most BNPL firms don’t charge cus­tomers inter­est, a fresh approach may be war­rant­ed, accord­ing to Hilali. 

“One of the wider trends we’re see­ing is that a lot of fin­tech com­pa­nies are alter­ing their busi­ness mod­els or explor­ing new ones to stay afloat,” she says. 

A study pub­lished last Octo­ber by equi­ty research house Red­burn indi­cat­ed that prof­it mar­gins in the BNPL sec­tor were wafer-thin or non-exis­tent even while the mar­ket was boom­ing. The researchers sug­gest­ed that providers would have to expand into all-pur­pose dig­i­tal wal­lets to ensure their sur­vival. 

Hilali notes that she has seen many play­ers, includ­ing Klar­na and After­pay “evolv­ing to focus on solv­ing adja­cent cus­tomer needs, such as build­ing shop­ping expe­ri­ences around their prod­ucts”. 

High­light­ing the impor­tance of Mastercard’s and Visa’s instal­ment prod­ucts in enabling firms to launch their own BNPL offer­ings, she adds: “I think we’re about to see a lot of com­pa­nies enter such part­ner­ships across the world.” 

Notwith­stand­ing the prospect of more strin­gent reg­u­la­tion, the BNPL rev­o­lu­tion could still be in its infan­cy, accord­ing to Guttman-Ken­ney. 

“I’m pret­ty con­fi­dent that it’s going to sur­vive this cri­sis,” he says. “The sec­tor has very attrac­tive eco­nom­ic and psy­cho­log­i­cal fac­tors – to both con­sumers and retail­ers.”