Kristy Dorsey: Buy now, pain later as BNPL industry gets set for its first economic downturn

But the economic malaise of 2022 has taken the sector down several notches with investors concerned about the impact of a looming recession and higher interest rates on the BNPL business model. Klarna – the world’s biggest provider by both the number of consumers and the number of retailers using its service – was forced to cut about 10 per cent of its workforce in May in a bid to rein in costs. The privately-owned Swedish firm then suffered an 85% plunge in its valuation in July following tepid interest in its latest funding round.

Klarna is not the only one suffering, with the market capitalisation of quoted rivals such as Affirm Holdings of the US and Australia’s Zip Co tumbling by comparable amounts this year. And yet the same economic circumstances that have brought the BNPL business model under scrutiny are also expected to continue feeding demand for interest-free credit among consumers.

A study released yesterday by Juniper Research predicted that the number of BNPL users will surpass 900 million globally by 2027, up from 360 million in 2022. The company says this substantial growth of 157% will be driven by the economic downturn as people search for ways to cope with the massive squeeze on disposable incomes.

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That trend is already in evidence. According to broker Credit Karma, UK consumers had by the middle of June spent more than £5.6bn via delayed payment services so far this year, an average of £396 per person. Last year it took until October to spend the same amount.

At the same time the number of missed payments has quadrupled, with 41% skipping at least one instalment, up from 11% last year. Credit Karma further noted that BNPL has been a “lifeline” for 58% of service users trying to navigate the rising cost of living.

The BNPL concept was born in Australia in 2014 by the founders of what would become Afterpay, now owned by US tech billionaire Jack Dorsey’s digital payments company Block. The financial model took root in the US in 2018 and exploded in popularity amid the pandemic, and followed a similar trajectory here after the UK launch of Klarna in 2014.

Known generically as pay-in-four, such products have not to date been subject to much of the regulatory oversight normally applicable to organisations that extend credit. Touted variously as “budgeting tools” or “shopping services”, they have proven particularly popular among younger consumers and those with poor credit history.

This has drawn fire about “reckless lending” from debt charity Stepchange and others who are calling for more affordability checks to ensure users don’t fall into unmanageable arrears. Citizens Advice says half of BNPL customers in the UK between the ages of 18 and 34 have had to borrow money to make repayments, including the use of overdrafts, borrowing from friends and family, traditional loans and payday loans. The most popular option among customers of all ages (26%) was credit cards.

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The irony is that the BNPL brigade has fashioned itself the consumer’s saviour from credit card issuers who earn the vast majority of their revenues from fees and interest charged to users who don’t pay off balances in full and on time.

By contrast, fees paid by merchants – up to 6% for BNPL transactions, versus typically 2% for credit cards – are the biggest source of revenue for most delayed payment providers. Yet while BNPL firms slam the evils of credit cards they also accept them as a way for users to pay on their platforms.

Meanwhile, losses among BNPL providers have grown. In the first three months of 2022, Block’s more than quadrupled on the same period a year earlier to $91m, driven primarily by delinquency on Afterpay loans.

In that same quarter Klarna’s credit losses rose by 51% to $115m. At Affirm, charge-offs – loans that have been handed over to a debt collector and recorded as a loss – jumped by 362% to $67.2m.

Born recently in an environment of exceptionally low interest rates, BNPL has yet to be tested in a meaningful economic downturn. As interest rates go up, BNPL companies will have to pay more to raise the money they extend out to consumers, putting pressure on their profit margins.

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Competition in the sector is also heating up, with major players such as Virgin Money, NatWest and Apple having all recently announced plans to offer customers split payments on their purchases. This and the prospect of greater regulatory scrutiny has led analysts to predict a forthcoming wave of consolidation across the sector.

The UK has been a frontrunner in the race to regulate BNPL, though the leadership turmoil triggered by the resignation of Prime Minister Boris Johnson could delay its plans.

As things stand, the Government expects to propose draft legislation by the end of this year, followed by a second consultation period in mid-2023 before then laying secondary legislation before parliament. In reality, then, it will likely be 2024 at the earliest before financial regulators get the go-ahead, by which time the economic landscape will have altered drastically.

Consumers may as predicted turn increasingly to BNPL, but whether they can make good on those repayments is a different question. This will contribute to driving out the weaker players, leaving behind a far less revolutionary industry than that currently lauded by the sector’s maverick advocates.