Cost-of-living squeeze raises concerns about buying now and paying later

The rising cost of living is expected to lead to an increase in the number of consumers taking out credit from buy-now, pay-later (BNPL) providers such as Klarna, Openpay (AU:OPY)and Laybuy (AU:LBY), raising concerns about the still unregulated sector’s ability to navigate a tougher set of economic conditions.

BNPL started life as a challenger to traditional payment models and quickly became the golden ticket to e-commerce. Its most famous champion, Swedish unicorn Klarna, reportedly valued at $50bn (£38bn) or more, has become a standard payment option for online retailers. It allows buyers to delay payment for their purchases by 30 days or spread the cost over multiple installments. As Klarna does not charge interest or fees (other than late fees), this does not fall under UK credit laws and therefore no credit check is required to take out a loan.

Rather than relying on interest and late fees, BNPL makes money by charging retailers fees on customer transactions, often at rates up to three times what merchants pay service providers. traditional Visa and Mastercard cards, according to data from the Reserve Bank of Australia for 2019-2020. .

Already, the value of transactions processed by BNPL providers has more than tripled to £2.7bn in 2020 – and is expected to be much higher in 2021 – with 11% of all UK consumers saying they use the mode. payment since the start of the pandemic, according to a government consultation last year.

Economists have predicted that rising goods prices will cause the biggest drop in living standards since the 1950s over the next year, and Richard Lim, chief executive of consultancy Retail Economics, said Investor Chronicle that this will “inevitably” encourage more consumers to take out loans, buy now, pay later, and other forms of credit.

“We’re already starting to see people turning to credit to support their living expenses,” Lim said. Latest Bank of England figures show consumers took out an additional £1.9bn of credit in February, the highest level of borrowing in five years, but does not include lending BNPL.

The rising cost of living will hit less well-off households the hardest, as prices for non-discretionary items such as fuel and food are expected to rise the fastest, Lim said. As a result, the purchasing power of these households could drop by up to 19.5% and increase the number of people turning to the BNPL to cover essentials, which 8% of UK adults already do, according to a study. from Citizens’ Advice.

This is “not necessarily a healthy development” for the retail sector, said Jeff Tijssen, global head of fintech at Bain & Company. “What this does highlight is that consumers are not just using it as a convenient way to pay and spread the cost over payments for larger items, it has become a necessity for them to pay for basic goods and services.”

If more customers struggle to pay their debts, it will drive up default rates and leave BNPL players swallowing bigger credit losses.

According to data from the Center for Financial Capability published by the FinancialTimes.

Klarna reported an increase in customer defaults for 2021, from 0.56% of gross merchandise volumes (or overall sales for which its funding is used) in 2019 to 0.67% last year. Over the same period, the company’s net losses rose fivefold to 7.1 billion Swedish krona (£575m) last year, which chief executive Sebastian Siemiatkowski attributed to the company. expansion of the company into new markets.

So far, BNPL’s young talents have lived in rather favorable market conditions. Historically low interest rates drove flows into the consumer credit market, coupled with sky-high private equity valuations, created “very, very cheap” funding costs which then supported “margins extremely thin” of BNPL actors, according to Tijssen.

Rising interest rates have already resulted in a ‘bloodbath’ for BNPL players over the past year, with Australian fintech Openpay announcing plans to shut down in the UK amid pressures increasing competition in March. The big banks are also setting up in the sector, with Natwest (NWG) is looking to launch its own alternative BNPL this summer.

A golden ticket for e-commerce

The pressure on the BNPL model has implications for e-commerce. If interest rates continue to rise and market competition continues to increase, BNPL firms will likely have to increase the fees they charge retailers in order to stay afloat.

BNPL has established itself as a way for retailers to entice consumers to spend more on discretionary items. Adding a BNPL option is expected to increase retailer conversion rates by 20-30% and increase average basket size by 30-50%, according to RBC Capital Markets.

Nowhere has this been more evident than in clothing retail, where suppliers like Klarna, Clearpay, Laybuy and Openpay have partnered with almost every London-listed clothing company. Shoppers can try on clothes before the money leaves their account, which has helped speed the shift from physical to online sales. According to Accenture, 27% of all online fashion spend – £1 out of £4 – is now paid using BNPL.

This rush has been accompanied by a massive increase in online shopping. Online retailer only Asos (ASC) Klarna was first added to its payment options in 2017. Since then, its UK sales have soared 164% to £1.65bn in the year to the end of October 2021, with other BNPL enthusiasts Boohhh (BOO) and Joule (JOUL) also reporting notable increases in retail sales during this period.

Part of BNPL’s appeal is advertising. Klarna targeted young people in its campaigns, which tended to shed light on financial details, in favor of glossy photos featuring ambitious clothing brands. This has drawn criticism, as surveys show that many Klarna customers do not realize they are entering into a credit agreement.

The same criticism was directed at retailers who purchased BNPL. “I hate waiting for delivery, but you want new clothes? » tweeted JD Sports (JD) in December, promoting its free delivery offer to customers who chose to pay with Klarna at checkout, rather than using credit or debit cards.

“If you look at any of these players’ ads, they don’t even talk about the actual products they’re offering,” Tijssen said, adding that many of the bigger BNPL players “don’t necessarily see themselves as financial services companies”. , but rather as retail technology companies.

Regulators are forcing an existential overhaul. The Advertising Standards Agency has stepped up action in recent months, warning Laybuy in April. Meanwhile, the Treasury has also recommended that BNPL businesses be subject to regulation by the Financial Conduct Authority’s supervision, which could require the sector to carry out credit checks in line with traditional lending practices.

Currently, BNPL’s lack of credit checks makes it easy for financially precarious users to take out loans on loans, using different providers. According to the latest figures from Barclays Partner Finance, BNPL users owe providers an average of £293 and have often taken out multiple loans at the same time.

Adam Jackson, director of policy at fintech industry body Innovate Finance, said the regulations should be agreed and come into force no sooner than the next calendar year, but “ideally sooner”.

“The damage caused to consumers by BNPL is about the same as for any form of consumer credit. The lack of a ‘poverty premium’ and its interest-free nature has some advantages, but it also needs to be regulated to ensure the protections are consistent,” Jackson said.

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