How Buy Now, Pay Later Plans Threaten Banks and Credit Card Profitability, and Impact Consumer Credit Scores

CNBC

Introduction [0:00]

• Buy Now, Pay Later (BNPL) plans are increasingly popular among consumers, offering an alternative to traditional credit cards.
  • These plans allow purchases to be split into short-term, typically interest-free installments.
  • Many consumers and segments are adopting BNPL, which is becoming ubiquitous in online and in-store shopping.
  • Michael Linford, COO of Affirm, notes that credit cards have struggled to adapt to modern consumer needs, leading to widespread adoption of alternatives.

    

• BNPL was created for individuals who either prefer not to use credit cards or have limited credit availability.
  • Sebastian Siemiatkowski, Co-Founder and CEO of Klarna, sees a huge opportunity to disrupt the U.S. credit card industry.

    

    • Klarna's stock jumped 15% during its public trading debut, indicating market confidence.

      

• Traditional banks and financial institutions are cautious, viewing BNPL as a direct threat to their credit card business and raising concerns about tracking borrowers' credit histories.
  • The number of U.S. BNPL users is estimated at 86.5 million in 2024, projected to grow to 91.5 million in 2025.

    

  • Kevin King, VP of Credit Risk and Marketing Strategy at LexisNexis Risk Solutions, describes BNPL as a "giant black hole" in understanding consumer credit quality.

    

  • Penny Lee, President and CEO of the Financial Technology Association, acknowledges the skepticism and uncertainty that comes with new products, especially as existing players seek to protect their offerings.

    

Rise of ‘buy now, pay later’ [1:47]

• BNPL typically operates on a "pay-in-four" model.
  • Consumers pay a quarter of the price upfront, followed by three bi-weekly installments for the remaining amount.

    

    

  • These are short-term, point-of-sale financing tools offered by providers like Klarna, Afterpay, Affirm, and PayPal.

    

• The growth of BNPL loans has been exponential.
  • Loans originated by the top five U.S. lenders surged from $16.8 million in 2019 to $180 million in 2021, a 970% increase.
  • A LendingTree survey revealed that nearly half of Americans have used a BNPL service at least once, with 11% using it six or more times.

    

• Appeal to consumers:
  • Accessibility: High approval rate (around 79% in 2022) at checkout, significantly higher than many traditional credit products.

    

  • Convenience: Instant approval and a frictionless process.
  • Affordability: Often interest-free, with clear, fixed installment plans.

    

    

• Popularity among younger consumers and "self-aware avoiders".
  • 50% of U.S. consumers under 40 have used an installment plan.

    

  • Younger consumers are seeking flexible and controllable financing alternatives to credit cards.

    

  • Sebastian Siemiatkowski identifies "self-aware avoiders" as a significant demographic (20% of U.S. households) who have good incomes but avoid credit cards due to past debt experiences, preferring fixed installments and 0% interest.
• Revenue model for BNPL providers.
  • Unlike credit card companies that rely on interest, BNPL providers primarily earn revenue from fees charged to merchants.
  • Retailers embrace BNPL to boost sales, as it makes prices appear cheaper and enables consumers to make purchases that might not fit their immediate budget.
  • Kevin King notes that BNPL increases checkout conversion and the average shopping cart size.

Credit card profitability [4:19]

• Banks are wary of BNPL due to direct competition.
  • Wells Fargo CEO Charles Scharf acknowledges BNPL as competition in lending.

    

  • Every BNPL-financed purchase represents a lost opportunity for credit card or checking account financing.

    

  • This reduces card transaction activity and utilization, impacting major revenue drivers for banks.
• Credit card profitability relies heavily on interest payments.
  • Approximately 80% of credit card profits come from interest charges.

    

  • Late fees and other fees account for most of the remaining 20%.
  • In 2022, credit card users paid a record $130 billion in interest and fees.

    

  • Sean Gelles, Senior Director of Payments Intelligence at J.D. Power, explains that interest revenue shifts from incumbent financial institutions to third-party BNPL providers when consumers choose BNPL.

    

  • Reduced credit card utilization directly lowers potential fee and interest revenue for banks.
• BNPL targets a different segment of the market.
  • Credit card markets in the U.S. are rich with rewards for consumers with good credit scores, high incomes, and large credit limits.
  • BNPL is designed for consumers who are "not quite in that level," such as those with mid-prime credit scores or limited open-to-buy on their existing credit cards.

    

  • Michael Linford emphasizes that the consumer credit industry in the U.S. is enormous, with over $1.2 trillion in revolving credit and $5 trillion in consumer credit transactions, presenting a vast market for Affirm to "chip away at."
  • Penny Lee highlights that BNPL introduces competition, providing credit access to many who cannot get it from banks for small, short-term loans.

    

Borrower’s credit history [6:42]

• BNPL loans create a "black hole" in credit profiles.
  • The majority of BNPL loans are not reported to credit bureaus, either the application or payment activity.
  • This makes it difficult for traditional lenders to accurately assess a consumer's overall debt obligations and credit risk.
• Impact on lending decisions.
  • Lauren Saunders, Associate Director at the National Consumer Law Center, states that banks need to know a borrower's total debt to assess risk.

    

  • Without BNPL data, banks lack a complete picture of a consumer's financial struggles or capacity for new loans.
  • This leads banks to be more conservative, tightening approval criteria, reducing credit lines, and potentially increasing interest rates.
• Profile of BNPL users.
  • A 2023 Consumer Financial Protection Bureau report found that BNPL users generally have lower credit scores, higher credit card balances, and are more likely to be highly indebted than non-users.

    

  • Lauren Saunders notes that BNPL users tend to be financially fragile and more likely to miss payments.
  • Using BNPL might indicate that a consumer is maxed out on credit cards or struggling to pay for purchases in full.

    

• Increasing late payments among BNPL borrowers.
  • 41% of BNPL borrowers reported paying a loan late in the past year, up from 34% the previous year.

    

• Affirm's approach to credit reporting.
  • Affirm was the first major BNPL provider to share all consumer data with credit bureaus.
  • They use machine learning models for better credit outcomes, aiming to extend credit responsibly without trapping consumers in revolving debt, even with lower FICO scores.
  • Michael Linford views positive repayment information as a crucial part of future credit reporting systems.
• Challenges with current credit scoring models.
  • Existing credit scoring models are not well-designed for BNPL loans.
  • Penny Lee explains that taking out multiple BNPL loans, even if paid on time, could appear as maxing out credit and negatively impact scores.
  • Current models are built around credit cards and longer-term loans, making it unclear if BNPL helps or hurts credit if not paid off.
  • There is ongoing work by credit bureaus and scoring companies to accurately incorporate BNPL data to avoid harming responsible consumers while reflecting risk.

What’s next? [9:37]

• Evolution in credit reporting and scoring.
  • Credit bureaus are actively working on how to incorporate BNPL data accurately into credit reports and scores.
  • The goal is to reflect whether individuals are struggling or not, avoid unfairly punishing those who use BNPL responsibly, and accurately assess risk.

    

• FICO's new credit scoring model.
  • FICO announced a new credit scoring model for Fall 202X that will factor in BNPL loans.

    

  • However, questions remain about whether existing BNPL companies will provide the necessary customer data if it proves detrimental to customer usage.
  • Kevin King suggests that if incorporating BNPL data into scores becomes a disincentive for customers, BNPL providers might withdraw their data.
• Traditional banks launching their own BNPL offerings.
  • Banks like Chase, Citi, and American Express have introduced their own BNPL services to compete.

    

  • Their aim is to consolidate customer activity within their own credit products.
  • The challenge for these banks is to replicate the flexible and seamless experience offered by BNPL innovators.
  • Penny Lee anticipates an "opening up of payments," allowing consumers to choose their preferred payment journey.
  • Michael Linford believes there's a significant opportunity to offer better, honest financial products in the vast U.S. consumer credit market, and this is "just getting started."