Industry
- Banking
Banking on purpose-led ecosystems
Highlights
- As the buy now, pay later (BNPL) trend gains popularity, especially among the millennials, traditional financial services firms are faced with more opportunities than challenges.
- Although not a novel concept, BNPL is fueling innovation in the payments space, with industry players looking to create app-based marketplaces to bring merchants and consumers closer and facilitate the discovery of new products.
- The BNPL potential will be best tapped into when it is offered as part of a large financial or an ecommerce ecosystem, which makes it a perfect candidate for the embedded finance model.
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The buzz around BNPL
Buy now, pay later (BNPL) has emerged as a popular mode for financing purchases in recent years.
It is especially popular among millennials who are a tad more open to trying out new products and services compared with other customer segments. This trend gained traction during the COVID-19 crisis when a large portion of consumer spending moved online. New entrants have tweaked traditional pay-later and point-of-sale (PoS) options to offer differentiated lending products and capture market share from incumbent financial institutions.
By venturing into the BNPL space, banks can create two-sided marketplaces where they not only facilitate transactions but also provide a marketplace for the discovery of new products. This will allow them access to granular customer data that can be used for product design, credit assessment, personalization and customer engagement, and so on. We explore how banks should approach this space and make the most of it.
Picking up steam in the consumer lending space
During the COVID-19 crisis, buy-now-pay-later (BNPL) emerged as a hot segment within consumer lending.
It facilitated payments for all types of online purchases, in turn helping merchants increase sales, and captured a large share of wallet. BNPL has become a preferred method of finance for millennials, gaining significant traction over the last couple of years. This can be attributed to millennials’ willingness to explore new products across categories driven by social media and influencer marketing coupled with their distrust of legacy financial institutions. Consequently, even nascent BNPL firms have built a huge base of active users, thus setting off a flywheel effect, to scale rapidly.
Having experienced the after-effects of the 2008 financial crisis, millennials are reluctant to embrace a debt-friendly lifestyle. Moreover, BNPL is more transparent, making it an attractive option for millennials who are generally wary of the hidden fee implications associated with credit cards which can result in a debt trap. The far-reaching adverse impact of the 2008 crisis has also bred a degree of scepticism toward large financial institutions, as this cohort has experienced the tough processes of default, collections, and bankruptcy in their formative years.
In addition, many millennials struggle to access credit due to thin credit files or not-so-stellar credit histories. The emergence of BNPL firms—which is beneficial for unbanked and under-banked segments—must be viewed in this context. Even customers with excellent credit scores and access to high value and premium credit cards are choosing to use BNPL given its advantages of financial prudence and other value-added services. BNPL firms are attractively positioned to capitalize on this opportunity for growth and profitability.
For years, banks ignored BNPL, thinking of it as yet another variation of instalment-based payments, a segment they are already present in through credit cards. In its simplest form, BNPL is not a new proposition, and usually involves offering customers the facility to break the payments for goods and services into multiple instalments. However, new BNPL players introduced a major innovation—a two-sided marketplace to enable merchants and customers to discover each other. While customers get more options to pay for their purchases, merchants are able to offer easy payment options even for small ticket items and gradually move customers toward higher-value purchases by tapping into up-sell opportunities.
A typical BNPL journey (see Figure 1) starts with customers using the BNPL app to search for products, fill shopping carts, and then check out. As a result, their journeys cover the end-to-end lifecycle. This increases the engagement manifold as customers log in to their apps many more times to search for new products, deals, and so on.
In addition, BNPL is also a key component of embedded finance, where banking products and services are integrated into end-user journeys. For instance, car manufacturers may offer BNPL facilities to buy a car enabling a seamless customer experience. Similarly, a home improvement contractor can link a quotation for a piece of work to a BNPL offer to allow payments in instalments or a home improvement marketplace may enable customers to find reputed contractors and pay for their services through BNPL.
Figure 1: An end-to-end BNPL journey
Riding the BNPL wave
For long-term viability and profitability, BNPL should be offered as part of a larger financial or ecommerce ecosystem as opposed to a standalone offering.
This might increase the pressure on standalone BNPL firms to expand into other areas and attempt to launch a super-app. This also translates into a big opportunity for incumbent banks seeking to expand their service offerings in the consumer lending segment and expand customer base.
Many incumbent banks have been offering zero-interest loans for quite some time. However, before the widespread adoption of smartphones, these were primarily offline offerings where staff were stationed at large retailers. The process was quick but not entirely digital as customers had to submit physical forms and documents for verification and the post-approval journey involved setting up automated debit mandates in the customers’ bank accounts.
Making the most of the BNPL opportunity will require banks to invest significantly in technology capabilities as well as marketing initiatives. Some leading banks have rolled out dedicated pay-later offerings under a separate brand and are implementing exclusive marketing strategies to promote them.
There exist several options for banks to foray into the BNPL space:
Funding BNPL players: Provide a warehouse line of credit, which the BNPL player can draw upon to fund their loans.
Co-lending partnerships: Partner with BNPL firms to finance a fixed percentage of the transaction value, with the remainder being retained by the BNPL firm to ensure risk-sharing.
Presence at PoS terminals: Leverage the retail ecosystem to enable BNPL offers through PoS terminals empowering customers to convert credit card transactions into BNPL.
Online payment partnerships: Collaborate with ecommerce platforms to offer BNPL services as a separate payment option ranging from instalment plans to customized financing options.
BNPL acquisitions: Acquire existing BNPL credit portfolios as well as technology capabilities, given the possibility of an industry consolidation over the medium term due to increased competition and the large number of players.
What next
BNPL is not just a new twist to merchant payments, it is truly a paradigm shift.
Before embarking on a full-fledged BNPL implementation, banks must evaluate a couple of key aspects at the strategy definition stage.
Monetization avenues
BNPL lends itself to multiple ways of generating revenue and incumbent banks must evaluate all the available business models before jumping into the BNPL fray. The single largest source of revenues is merchant fees charged on each transaction ranging from 4% to 12%. Like BNPL firms, banks too can package BNPL loans into bonds or securitize and sell them.
Usually, BNPL loans are offered free of interest, which often spurs customers to increase their order sizes, thus leading to higher revenue generation for merchants. The interest foregone on a 0% loan is compensated through merchant fees. However, for low ticket items and low margin purchases, banks can offer loans on an annual interest rate, part of which can be borne by the merchant.
Another monetization avenue involves introducing a subscription service through which merchants can access granular customer data, which can be used to tailor products, offers, and assortments for specific customer segments. This option is especially appropriate for banks that choose to position their BNPL offerings as part of a larger ecommerce ecosystem, rather than a standalone lending service. BNPL data spanning purchase data as well as pre-purchase behavior, starting from the time the customer starts researching a product to shortlisting prospective brands, selecting from among various variants, and finalizing the purchase can form the foundation for personalized upsell and cross-sell in the future.
Risk management
The key emerging risk for BNPL is regulatory. Currently, the sector is lightly regulated and many BNPL firms do not even report loan delinquencies to credit bureaus. Consequently, significant consumer credit exposure stays below the radar of regulators and financial institutions. This can result in customers getting overextended due to irresponsible borrowing. There is also a chorus of complaints from traditional banks that BNPL firms are operating in a regulatory grey zone, where they are not permitted to operate. We expect regulatory action in the near future, which could include stipulating capital requirements for large BNPLs, mandating reporting of loans and defaults to credit bureaus, prohibiting risky practices, and reducing the regulatory ambiguity that has so far given BNPL firms a free rein.
BNPL has emerged as a disruptive force in the payments and consumer finance industry. To retain customer base and a competitive edge, banks must quickly foray into this segment. Accomplishing this, however, may require them to partner with a service provider with the necessary contextual knowledge and technology expertise after a comprehensive market analysis.
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