Lessons for card issuers from the point-of-sale credit craze

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When point-of-sale credit provider Klarna brought its solution from Sweden to the U.S. in 2015, it was a clear signal to traditional credit card issuers that they weren't fully meeting the needs of merchants and consumers.

Demand for buy now, pay later (BNPL) services in the U.S. is surging as cash-strapped consumers welcome the opportunity to get instant loans minus any official credit inquiry — with the option to repay with a low or no fee in small, quick installments.

As BNPL giant Affirm prepares for an IPO that could reach $10 billion, new data from Coresight Research suggests the average BNPL shopper uses more than one BNPL service, and users range from Gen Z to Baby Boomers.

Signals indicate at least some of this growth is coming at the expense of credit card issuers. Whether consumers are cautious about protecting their traditional credit scores, or they're embarking on a bigger shift away from cards, buyers continue to pay down balances on credit cards with charge-off rates at historically low levels, Fitch said last week.

What’s unclear is whether U.S. credit card issuers are taking the right lessons from the challenge BNPL lenders pose to their industry.

Friend or foe?

Capital One this month said it will ban BNPL payments on its credit cards, a move aimed to protect its potential losses from consumers whose finances are stretched.

But because most BNPL instant loans are tied to customers’ debit cards, Capital One’s decision isn’t likely to slow the growth of BNPL leaders like Affirm, Afterpay, Klarna, Uplift and a host of others.

“BNPL came along because nobody ever knows exactly what their terms are going to be with traditional credit cards, and for the most part all the BNPL [options] are very transparent in what you are going to owe and when — and for consumers operating in an increasingly e-commerce world with complicated finances, this is what they need,” said Kristian Thøgersen, North America president of ViaBill, a Denmark-based BNPL service that launched operations in the U.S. two years ago.

BNPL programs are also giving merchants much-needed flexibility in the offers available to consumers, Thøgersen said.

“Merchants using BNPL are very interested in future options as they get closer to directly financing purchases, and if you start to see credit card interchange being regulated, banks will have to seriously rethink their loyalty programs, which may change the equation for credit cards,” Thøgersen said.

The last time the U.S. had a Democratic president, merchants won debit card interchange relief from the Durbin Amendment of the Dodd-Frank Act. Retail research firm CMSPI recently said new data suggests a global interchange overhaul is in order.

The BNPL sphere so far is unregulated, but there are rumblings that BNPL programs — at least in Europe — are having a negative effect on consumer finances. The U.K.’s top watchdog group last week called for the government to “fully regulate” BNPL services.

Meanwhile, those services are rapidly evolving. PayPal is seeing strong growth from its simpler BNPL offers, and other providers’ instant-credit offers are moving to higher price-point purchases with some repayment terms stretching out for months.

Williams-Sonoma and its Pottery Barn and West Elm subsidiaries have added BNPL offers from Affirm — alongside its cobranded credit cards for each brand issued through Comenity — clearly hoping to capture shoppers at all ends of the income spectrum.

This isn't necessarily a new problem for card issuers. Last year at Arizent's Card Forum in New Orleans, Visa's chief economist, Wayne Best, said that fintechs held nearly 40% of unsecured installment debt in the U.S. — a sharp increase from the mere 1% fintechs held in 2010.

Beyond being a competitive threat, these lenders are also obfuscating borrowers' credit risk.

“When you as a consumer move a balance from credit cards … to unsecured installment credit, it doesn’t weigh as heavily on your credit score,” Best said in an interview at Card Forum. “Let’s say I was a near-prime customer prior; now, that has bounced me into a prime category.”

That difference is enough to create unseen risk for issuers, especially as borrowers encounter economic hardship.

Wayne Best, Visa's chief economist, speaks at Arizent's Card Forum in 2019.

Visa in July began piloting installment loan programs with U.S. lenders including Commerce Bank and bank processor TSYS, and Mastercard in September separately announced a partnership with TSYS to create BNPL offerings for credit card issuers.

Follow the money

In contrast to Capital One’s defensive move, other mainstream card issuers have reacted to the BNPL challenge by overlaying their own installment loans on top of existing credit relationships.

But this misses the point, according to Brian Riley, director of credit advisory at Mercator Advisory Group.

For example, American Express allows a customer to select a $150 purchase at Home Depot and schedule the transaction to be run as an installment loan, rather than part of the revolving process, he said.

“The idea is fine, but a little silly. All you had to do in the first place is to overpay the minimum due, but people like the feeling of knowing a transaction was paid for,” Riley said.

It’s still early to see where BNPL will fit in the market over the long term, but banks cannot ignore it, said Jason Pavona, FIS’ general manager for North American e-commerce.

“BNPL is really an explosive trend right now, but it’s not new — layaway plans have been around since the dawn of time. What FIwe’re seeing is some significant ways younger consumers handle their money, because millennials are not as wedded to credit card culture,” Pavona said.

FIS Worldpay is seeing similar trends in demand for BNPL across the U.K., Australia and Brazil, all pointing to the fact that consumers want more control over how they pay for individual purchases, and younger consumers are willing to try new approaches.

“Looking ahead, younger consumers like those in Generation Z are the first mobile-first generation, and here’s an unbanked group without credit that’s eager to make purchases. Smart merchants are looking at this and so should banks,” Pavona said.

Another expert predicts BNPL will ultimately evolve into a technology-driven approach to traditional credit, and BNPL providers also are expected to consolidate.

“I think BNPL or installments will gravitate to credit cards, which may have both a revolving and installment component,” said Ali Raza, senior vice president of FSS Technologies USA.

But it would be a mistake to assume this market is focused primarily on younger demographic groups, Visa's Best said at last year's Card Forum.

“Everyone thinks it’s only the millennials or the tech-savvy people. We went back and looked at who was making those movements and it was happening across all risk bands and all ages — including Boomers," Best said.

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