In 2021, Buy Now Pay Later (BNPL) has picked up steam all around the world. Dubai based BNPL platform Tabby raised $50m in its series B financing, Indonesian BNPL giant Kredivo is going public in a $2.5B Spac merger, Apple is launching a BNPL program with Affirm, and Square recently announced its largest ever acquisition- a $29B price tag for Afterpay. All of these activities happened within a span of one week, indicating the potential growth for this new payment method and the fierce competition waiting ahead.

What's BNPL?

With BNPL, shoppers have the option to apply for Point of Sales (POS) financing at check out, allowing them to split the total payment into multiple periods (interest free) instead of paying everything up front. Depending on the service provider, consumers can pay back the loan on a monthly, semi-monthly, or weekly basis.

How is this different than traditional POS financing methods?

On the surface, this payment method doesn't sound like a new innovation as installment lending and layaway have existed for almost a century. Unlike the traditional POS financing methods, BNPL allows buyers to have full ownership of the purchased item and pay 0% interest rate. Additionally, the model focuses more on facilitating sales rather than "a customer's ability to repay their loan"1 which is what the traditional credit model focuses on.

What's the BNPL demographic and selling point to merchants?

With fixed payments, zero interest if paid on time, and no hidden fees, BNPL is an appealing payments option for the younger population who often have limited credit scores for traditional lending option. ASIC estimates that 60% of BNPL users are between the ages of 18- 34 and 40% make less than $40k.2

From the merchants' perspective, BNPL lifts conversion and sales by 20% while also increasing average order value by 60%.3 BNPL is a new approach that enables both sides of the transaction to win which enables BPNL providers to charge a higher fee, ranging from 3-6% (compared to 2.5% for a credit card transaction).

Given its popularity, a lot of players such as issuers, card networks, and fintechs have tried to grab a portion of this pie. As the market becomes more crowded, each player is focusing on choosing the right business model to offer their services.

Why should banks care?

Incumbents are known for their risk averse mentality and often approach a new trend with a watch and see attitude. Despite its fast growth, BNPL still only represents a fraction of the overall payments market. This fact doesn't necessarily mean incumbents should overlook BNPL; in fact, they should keep a close eye on its development as this trend could potentially eat into the bank's core business.

The biggest examples are Affirm's debit card along with Apple Pay's BNPL launch. Earlier this year, Affirm unveiled its BNPL debit card that has a pay later option but functions like any other debit card. This move poses a risk to issuers because the offering will eat into incumbent's card business as Affirm grows its user base. Additionally, as Karen from PYMNTS noted, Apple Pay threatens issuers more than fintech players since issuers would have to "pay a fee to Apple to erode their revolving business and disintermediate their relationship with the customer."4

What can banks do?

There are multiple business models banks can choose to get involved with the BNPL space.  Each option presents a different mix of costs, potential upside, time to market, business disruption, and customer segmentation. Understanding the fundamentals behind each model and assessing the banks' own business objectives/drivers will facilitate the decision making process.

 Figure1: Factors assessment for different BNPL model

1. Rent out their balance sheet to BNPL firms: Cross River Bank is currently riding the BNPL trend with this model by providing Affirm with funding capacity. The model is safe as BNPL companies often purchase those loans after origination, but it also caps the potential gains banks can earn as the fee is often a small percentage of the total origination.
2. Integrate installments into credit cards: Due to market pressure, banks are already offering installment options for their clients. In 2019, both Citi and J.P. Morgan launched new products that let customers pay off purchases through fixed payments (Citi Flex Pay & My Chase Plan). However, those fixed payments would still include interest rate, going against BNPL biggest selling point. A few weeks ago, Scotiabank introduced a different variation to the BNPL model by enabling its customers to pay off credit debt in fixed installment payments. Moving forward, other financial institutions might allow BNPL purchases by using their customers' credit card balance. All of these BNPL variations could be a way for banks to get involved but this method wouldn't be effective in targeting the main demographic for BNPL users who, in the Ascent survey, indicated that they want to avoid paying credit card interest (37%) and don't want to use credit card (20%).5
3. Acquire a BNPL company: Given the capital that has been injected into this segment over the past year, BNPL firms are being assigned at a hefty valuation. Affirm's approximate ARR is $1M, representing a revenue multiple of 30x while Afterpay's revenue multiple is 60x. These BNPL companies are being valued at a sizable multiple (note that the industry average for a SaaS company is around 16x and a bank is around 5x- BNPL companies share similarities to a lending business).6 It's understandable considering that these fintechs are growing at a pace of 100% YoY and have a risk model that is "built on more than a billion data points".7 The question remains on whether this growth is sustainable given the increase in competition and regulatory scrutiny.
4. Partner to build BNPL solution: Banks are known for their monolithic and antiquated technology stack that prevent them from providing the next gen customer experience and scaling rapidly to adapt to customers' demand. Thus, partnering with a fintech infrastructure solution solves this problem as it allows fintech to find gaps in banks where they can support and accelerate the speed to market. One of the first firms to take this approach was Barclays, who decided to partner with Amount to bring a BNPL solution to the market later this year. However, many banks are hesitant to adopt this model as it could cannibalize its existing credit card business.

How can banks mobilize?

To enter the market and compete with fintechs, banks should leverage their balance sheet and tap into existing customer networks. Incumbents have an advantage over fintechs with their large existing consumer and merchant base. For reference, back in 2006, ChasePaymentech's customer base included more than 600k merchants. This number is significantly bigger compared to that of fintechs – Afterpay with 55k merchants, Affirm with 6k merchants, and Klarna with 250k merchants.8  Having an existing customer base will allow incumbents to cross sell their product and achieve economy of scales faster. Additionally, with their sizable balance sheets, banks can invest in their own BNPL product through a low cost insured deposit. This is a significant benefit comparing to fintechs who have to pay a higher fee for funding and are reliant on originating bank partners.

Mckinsey predicted that in 18-24 months, laggards either will be unable to compete or will need to pay a heavy premium to enter the market.9 First mover advantage is the theme for BNPL as firms are rushing to attract merchants to their platform; therefore, the question is not whether banks should pursue a BNPL option, but rather which one? There is no one size fits all model as each bank has different goals and constraints. Starting the conversation and discussing multiple factors such as cost, potential upside, time to market, business disruption, and customer demographic is the first step for banks to embark on this journey.

Sources:

1. Buy Now, Pay Later: A Modern Take on Retail Financing | PaymentsJournal
2. Buy now pay later infographic (asic.gov.au)
3. The Benefits of Adding a Buy Now, Pay Later Option to Your E-commerce Store - Mutesix
4. Apple Pay Later's Target: Startups Or Issuers? | PYMNTS.com
5. Study: Buy Now, Pay Later Services Growing Quickly Among U.S. Consumers | The Ascent (fool.com)
6. Revenue Multiples by Sector (nyu.edu)
7. Affirm's 10Q
8. From Afterpay, Affirm and Klarna's website
9. US lending at point of sale: The next frontier of growth | McKinsey & Company