UK banks are piling into buy now, pay later despite rising risks of default and increasing regulatory scrutiny, in a defensive effort to win back young users more comfortable with fintechs like Klarna than credit cards.
With nimbler rivals snapping up younger customers, NatWest, Virgin Money, HSBC and Monzo have all launched BNPL products — which allow users to put off or split payments for purchases — in the UK over the past year.
“It’s no surprise that banks want a piece of the buy now, pay later market,” said Amy Gavin, senior strategist at fintech consultancy 11:FS. “Providers that fail to offer it risk losing access to their customers, particularly millennials and Gen Z.”
Fintechs such as Sweden’s Klarna — formerly Europe’s most valuable private tech company before its valuation crashed during its latest funding round — have benefited greatly from the boom in online shopping and BNPL demand sparked by the pandemic.
Researchers at the universities of Chicago, Warwick and Nottingham estimated that the UK BNPL market grew to £5.7bn in 2021, more than double the figure calculated by the Financial Conduct Authority for 2020.
“Take up has been away ahead of what we were expecting,” said Monzo chief executive TS Anil of Flex, the service it launched in September, which he said was “the right long-term play” for the neobank.
Several bankers said that they did not expect their products to generate significant revenues in the short-term, but they would provide them to younger customers demanding the service.
One banker said they did not expect to make money on BNPL, but were concerned about the threat posed by the fintechs if they branched into offering other services.
Lenders have sought to position their products as responsible alternatives to incumbents, who are facing questions around the affordability of their loans.
Traditional BNPL transactions have mainly relied on soft credit checks, which attempt to gauge creditworthiness typically using data provided by consumers. These are not visible to other lenders and leave no permanent record, leading to concerns that users can take on debt from a number of companies. A growing number of providers have begun reporting their transactions to credit reference agencies.
By contrast, banks offering BNPL do a more complete search of a consumer’s financial record, which can discover cases of defaults or late payments. These harder credit checks are recorded on applicants’ credit history and can impact credit scores.
“We are concerned that users’ credit performance can suffer from the use of unregulated buy now, pay later,” said David Lindberg, chief executive of retail banking at NatWest. “As more of our younger customers use these services, we want to provide an alternative.”
NatWest’s BNPL option, which launched in June, is available to account holders over the age of 18 earning at least £10,000 a year, in line with the criteria for its basic credit cards.
In June, the government announced plans to strengthen rules on the sector, including requiring that firms checks that customer can afford to use their products. However, regulation is due by 2023 at the earliest.
UK banks could also benefit as incumbents face rising rates and a cost of living crisis which is squeezing borrowers and which has hit valuations — Klarna had its valuation slashed from $46bn to less than $7bn in July and US-based Affirm has suffered an 80 per cent drop in its share price since November.
Analysts also point to a number of advantages banks have over the incumbents.
“They have an existing customer base and large ‘cheap’ credit lines already in place,” said Rohit Mathur, a partner at venture capital firm Digital Horizon which invested in Klarna.
Gavin at 11: FS said that banks’ scale could allow them to charge retailers lower transaction fees, undercutting existing providers who already operate on razor-thin margins.
British equity research house Redburn estimated in 2021 that incumbents made on average 0.3 point gross profit before operating costs.
Banks will, however, also have to deal with late payments and defaults.
NatWest charges a £12 fee per month if payments arrive more than a day after they are due, while Monzo said it will attempt to take a smaller amount by moving to a longer-term instalment plan.
By contrast, Virgin said it would not be charging for late fees, an approach already taken by some buy now, pay later providers in the UK including Klarna.
But while many lenders are charging in, others are holding fire.
“It’s a risky time to start [a buy now, pay later product] in a down credit cycle. It is a product for people who tend to struggle with credit, after all,” said one bank executive. “Do we want to open ourselves up to the credit and reputation damage from that?”