Buy now pay later (BNPL) penetration has grown swiftly in the past few years as it offers great convenience and flexibility to consumers at a very low/zero cost. However, the sector has been struggling recently; defaults are rising to unsustainable levels and higher interest rates have increased borrowing costs. At the same time, Apple’s entry into the sector is an example of intensifying competition.
Since aggressive BNPL growth is putting both consumers and companies at risk, regulators in different markets are increasingly hatching plans to regulate the sector. These regulations aim to increase transparency, protect consumers and improve risk management. This might dampen near-term volume growth but should increase the long-term sustainability of the ecosystem. We think companies backed by strong financial institutions (such as banks) and those operating at a large scale are better placed to weather the coming storm.
BNPL is highly risky, and Australian BNPL woes confirm this
BNPL can trigger aggressive purchasing behaviour, even more so than credit cards, which is why merchants are often willing to subsidise the costs of this financial product. But recent experience shows that consumers may end up overburdening themselves. For BNPL providers, aggressive volume growth comes at the risk of a significant surge in non-performing loans, threatening the sustainability of the business. Macroeconomic challenges are further enhancing the risk profile of the product; consumers’ discretionary purchasing power is declining due to high inflation, and providers’ funding costs are increasing as interest rates rise.
The recent experiences of Australian BNPL companies confirm the difficult situation BNPL finds itself in; credit risk costs for BNPL operators have grown to 15% of receivables and 40% of revenues, while the share prices of the stocks have declined c80% this year.
Several countries plan to regulate the BNPL ecosystem
We highlighted in our note earlier this year that the BNPL sector is highly prone to attracting regulation, as greater adoption levels increase systemic risk. Recently, regulators in some leading BNPL markets have shown intentions to bring the sector under their ambit. These steps would target better transparency regarding the costs and risks of the product, improved consumer protection and enhanced risk management frameworks. Some recent examples of BNPL regulatory actions include:
India: The Reserve Bank of India, in a notification issued earlier this month, limited the lending activities of non-bank prepaid payment institutions (PPIs). There is not much clarity on the central bank’s directives, but news reports suggest BNPL products, particularly those offered by non-bank institutions such as Paytm and Slice, are likely to be impacted by these new regulations.
The United Kingdom. The UK government, earlier this month, announced its intention to introduce regulations for the BNPL sector to promote fairness and transparency, and offer more customer protection and awareness around the full implication of BNPL products. These regulations are expected to come into force in 2024. Key elements include:
BNPL companies need to be approved by the UK’s Financial Conduct Authority (FCA).
Firms will be required to perform regular affordability checks to ensure that the loans they are offering are affordable for the customers who receive them.
Advertisements for BNPL should be fair, clear and not misleading.
Providing more options to borrowers who feel like they’ve been abused, with the Financial Ombudsman Service (FOS) directly accepting BNPL complaints from consumers.
Australia. The financial services minister has indicated that the recently elected government plans to bring BNPL operators under credit laws. There is a Code of Practice currently in place which outlines best practices for Australian BNPL companies, but the new government intends to legislate to fill any gaps.
Regulations may bring near-term stress but are helpful for long-term sustainability
Additional regulation is likely to negatively impact the growth of the sector and may also increase the cost of doing business. However, in the long term, we think it will benefit the sector to be moderately regulated. To date, BNPL operators have tended to prioritise volume growth over risk management, as seen in the case of listed Australian firms, which could put both customers and companies at risk. That said, the regulators also need to balance the growth and risk management needs of the industry to avoid overregulating and removing what many consumers find to be an extremely attractive service.
Overall, we think BNPL operators backed by strong financial institutions (like banks) and those operating at large scale can better weather the coming regulatory storm. They could find their competitive position strengthened relative to other operators, which in turn could encourage greater M&A activity in the sector.