BNPL: The Hottest Trend in Loans 🚀

BNPL (buy now, pay later) services have really come into its own since the pandemic. According to data from Accenture, buy-now-pay-later use is up 230% since 2020 with BNPL spending expected to reach nearly $1 trillion globally by 2026.

So what exactly is behind the BNPL craze, and what does it mean for players in the financial services industry?

What is BNPL and where did it come from? 💡

BNPL is a point-of-sale financing option that allows consumers to pay over time for purchases, usually without interest. Terms are variable and often depend on the amount of the purchase. For example, a €100 purchase might be financed over two months with payments every two weeks. A €1,000 purchase might be spread out over six to nine months, although some BNPL platforms have terms as long as two years for more significant balances.

The deferred payment model has probably been in use since shopping was invented, although modern BNPL is more closely related to catalog credit or the private-label department store cards that became hugely popular in the 80s and 90s.

When life went digital, so did POS lending—and modern BNPL was born. And the beauty of BNPL 2.0 is that it lets retailers outsource all the financial risk to the BNPL provider for a predefined fee.

Fintechs were the first to enter the space. Klarna launched in Europe around 2005 and entered the US market in 2015. Affirm, Afterpay, and Sezzle launched shortly after that. The uncertainty following the 2008 financial crisis laid the foundation for BNPL adoption among consumers across all income segments.

Since 2020, BNPL use is up over 230%. Consumers are eager for ways to hedge against uncertainty, spread out their payments, and hang onto funds as long as possible—without paying exorbitant interest and financing rates.

Why everyone wins with BNPL? 🙌

Consumers and retailers both benefit from modern BNPL. Today’s consumers are tech-savvy and digital-first; BNPL fits neatly into their lifestyles. And the cohorts with the most purchasing power and Millennials/Gen Z have a natural aversion to traditional financial institutions and credit models.

Having come of age during the financial crisis of 2008, they are naturally sensitive to debt (and the fees and costs that come with it). BNPL skirts these concerns and serves almost as a budgeting tool that helps them buy more—and more expensive—things. That it can be free to borrowers is icing on the cake. 

Shoppers use BNPL to extend their purchasing power and hedge against uncertainty. Even those with access to other types of credit choose BNPL to avoid paying interest. 

Retailers love BNPL because it boosts conversion rates by as much as 30% and ticket sizes by as much as 50%. And it expands access to the key up-and-coming demographics who are increasingly choosing BNPL as their payment of choice. According to Deloitte, nearly half of all Gen Z buyers use BNPL, and almost one-fourth consider it their primary method of payment.

Sure, the merchant transaction fees can be high (as much as 10% in some cases), but retailers more than make up for it with higher volumes and Average Order Value. Plus, the data they collect from BNPL provide powerful insight into who their customers are, the products they like to buy, and where they like to shop. 

It’s a common misconception that POS financing is for those with poor credit scores. As more premium merchants use BNPL, the credit mix has diversified. Today, consumers with credit scores of at least 700 are responsible for over 65% of the receivables originated by POS lenders. Even with the low-ticket pay-in-four model, consumers tend to have a thin credit file as opposed to a history of poor credit usage. 

It all points to an exciting new opportunity for banks and fintechs to provide the type of financing solutions today’s customers are looking for. McKinsey projects that POS financing will account for 15% of unsecured lending balances in 2023, up from just 7% in 2019. And in the US, some 60% of all consumers say they expect to use BNPL over the next six to 12 months.

The potential risk of regulation 🔍

Given the activity, growth, and demand in the BNPL industry, it’s no wonder it’s attracted the attention of regulators. In the UK, regulatory oversight will fall under the Financial Conduct Authority (FCA), and draft legislation is expected by the end of this year. Lenders will likely be expected to seek FCA approval and provide affordability checks as well as notices about terms and conditions. Access to a Financial Ombudsman Service to settle disputes is also expected to be part of the law. 

The FCA hasn’t been quiet, even while formal legislation is pending. In a November 2022 letter, the authority noted that they have already intervened with four BNPL providers to amend their contract terms and pay redress. They also issued a warning to firms offering BNPL that they must have an FCA-authorized firm approve their financial promotions or risk potential criminal penalties. They also offered guidance about the language used in advertising.

The EU will likely follow suit with tighter regulation, although specific legislation will be left to each member state, so expect discrepancies across the region as a whole. 

In the US, the Consumer Financial Protection Bureau (CFPB) announced plans to scrutinize BNPL. While specifics are thin, most proposed regulations, focus on transparency and data security.

Wherever the regulators land, official rules are expected by mid-2023. For BNPL providers, the potential is too great, so the focus will be on providing a fair and transparent process for consumers and staying on the right side of the regulators.

5 BNPL Models 📱

BNPL is not a one-size-fits-all offering. Different market segments have different needs and priorities, from both a merchant and a consumer point of view. Here are five of the most commonly used models:

1 - Integrated shopping apps

These are the giants in the BNPL space, typically using a pay-in-four model for small-ticket purchases of less than €250 (think Klarna and Afterpay). While the integrated app is a pure financing play for smaller entrants, the largest ones are using BNPL to transform the shopping experience end-to-end. 

These apps engage consumers at every stage of the journey, monetizing the engagement via affiliate marketing and cross-selling credit cards and other financial products. Some are building ‘super apps’ that combine shopping, payments, financing, and banking all in one platform.

This model is the fastest-growing BNPL model, with growth of 300%-400% since 2020. Mature users tend to make between 15 and 20 BNPL purchases a year on these apps, and log in up to 15 times a month to shop or browse.

Receivables turnover about eight times a year and generate a return on assets of 30% to 35%. Loss rates are comparable to traditional credit card products and hover at around 6%. 

The challenge for banks and traditional players attempting to compete in this space is to address the entire purchase journey to engage the customer. Shopping cart integration, an easy-to-use and engaging app, and robust self-service customer service are critical to success. 

Advanced technology, including underwriting and decisioning, consumer fraud models, and the ability to manage billing in real-time is essential. In fact, identifying intent to fraud at the time of application is often more important than ability to pay, given the short duration of the loan.

2 - Off-card financing

This type of solution is most often used for midsize tickets of €250 to €3,000 with average terms of less than one year. Unlike pay-in-four, where the cost is borne by the merchant, off-card financing carries an APR, often subsidized by the merchant, especially in low-margin verticals. 

These solutions are ideal for high-ticket, low-frequency purchases as a way to mitigate cart abandonment rates, which can run as high as 90% in some categories. They are also mostly digital solutions, although the rate of in-store use is on the rise. McKinsey projects that in-store originations will reach 25% or more this year. 

Users are far less engaged, making fewer than three purchases per year on average. This model faces stiff competition from credit card-linked installments offered at point of sale. Some players in this space are integrating across the entire journey, from pre-purchase to returns, in order to compete.

3 - Virtual rent-to-own

This model targets subprime consumers and carries a very high implied APR. Roughly 70% of users have a credit score below 600, and 90% are below 700. Unlike other BNPL models in which the merchant covers or subsidizes the financing costs, many merchants actually get rebates from the VRTO provider on originated volumes.

This model works most often with goods that could be repossessed—furniture, appliances, and the like. They tend to be integrated digitally as second or third-tier financing options. 

4 - Credit-card linked installments

This model is hugely popular across Asia and Latin America, but it hasn’t taken off in US markets yet. This is despite the best efforts of major players like American Express (Plan It) and Citi (Flex Pay). Post-purchase installments simply can’t compete with the low-to-zero APR offered by other BNPL point-of-sale options.

Card-linked installments at POS, however, do have potential to scale by engaging consumers in the pre-purchase journey and allowing them to select the items they want to convert to installments before the transaction is complete. They can also be used for merchant-subsidized offers through the existing offer portal provided by most card issuers.

Card-linked installments are likely to become table stakes for all issuers within the next few years. The key to differentiation in the space will be integration across the entire purchase journey, especially the pre-purchase experience.

5 - Vertical-focused large-ticket solutions

As the name suggests, this solution is aimed at tickets of €2,500 and up and targets specific categories such as healthcare or home improvement.

Providers in this space most often scale by partnering with original equipment manufacturers (OEM) for products such as HVAC, roofing, siding, solar, and even medical devices like clear aligners for home use. They are carving out market share from traditional lenders in home equity and personal loans.

The challenge for entrants in this space is determining which relationship to focus on (end-consumer vs OEM) and developing an effective go-to-market strategy to launch the solution. This is also an attractive space for banks to target high-credit customers and cross-sell other lending products. 

Building a BNPL offering with Skaleet 👨‍💻

A successful BNPL depends on meeting customers’ expectations and providing a seamless experience—and it starts with an agile credit engine and real-time decisioning. Here’s how to get started.

1 - Build your BNPL infrastructure

Next-generation modular technology makes it possible to bring new offerings to market in as little as three months. A modular approach allows you to choose best-in-breed partners for each architecture layer—front end, core banking, and downstream accounting and payments processing—for a custom framework that matches your business model. 

New credit solutions benefit from new sources of data, such as bank deposit and transaction data and CRM data for merchant offerings. Once you’ve chosen your data sources, develop a strategy for migrating and managing it and using it in your analytical models and decision engine.

2 - Develop a risk and compliance strategy

In the BNPL market, your risk framework can give your offering a competitive edge. Begin by deciding whether to measure risk at an individual or portfolio level and whether you’ll use progressive credit scoring based on ticket size. Then formulate policies about if and when you’ll hold debt on your balance sheet. 

Because BNPL skews slightly subprime for now—and has a slightly higher default rate than traditional credit products—you’ll need a collections strategy that aligns with your customer journey while still allowing for sensible financial management. 

Don’t forget to formalize a legal and compliance framework to manage your offering. With regulation on the horizon, transparency is essential.

3 - Create your core banking ecosystem

A successful BNPL solution starts with a cloud-native, API-core banking platform designed to handle the setup, credit decisioning, and management of POS loans. Core banking platforms leverage a microservices architecture that allows for personalized end-to-end workflows to manage every step of the credit journey, from data inputs to the accounting entries. 

Your banking ecosystem should be able to integrate best-in-class market solutions for KYC, banking data aggregation, document collection, and e-signature for a one-click experience at point-of-sale. It should also be able to collect and manage the internal and external data, both structured and unstructured, that are necessary to build new BNPL credit models. Finally, it should leverage the latest AI-enabled scoring solutions and credit analytics to manage risk. 

Skaleet’s core banking platform is ideal for BNPL solutions because it streamlines the credit journey, offering the immediate time-to-yes without sacrificing robust fraud suppression measures these solutions require.

4 - Bring your MVP to market

Once your minimum viable product is up and running, define your go-to-market approach. Your pricing strategy depends on the objective: retailers want higher conversions and AOV while banks need to wring value out of both product and merchant relationships. Decide how to bundle your product to create new revenue streams like affiliate marketing fees. 

Your go-to-market plan should account for customer acquisition and engagement strategies across all your audience segments. This is where all your premarket work defining your target audience, value prop, and incentives and benefits come into play.

Partner with Skaleet for BNPL 🤝

The BNPL market is ripe for new entrants to grab a piece of this fast-growing pie. Skaleet’s cloud-native platform helps you move quickly to create the credit solutions today’s consumers expect.

Skaleet’s core banking enables personalized BNPL workflows and streamlines the process of building a BNPL solution with rapid decisioning, lower risks, and an exceptional customer experience, regardless of the model chosen. The Skaleet platform is composable by design, integrating with best-in-class third-party APIs for a seamless customer journey and immediate time-to-yes. 

As 2023 comes into view, expect to see even more banks, fintechs, and retailers add BNPL to their payment mix as digital payments become a strategic asset for strengthening customer relationships. Investing in the technology to take advantage of this trend should be at the top of your strategic plan for 2023.