Breakdown: Buy now, the Pay Later invoice is due

LONDON, October 14 (Reuters Breakingviews) – What do Goldman Sachs (GS.N), Square (SQ.N), PayPal (PYPL.O) and Amazon.com (AMZN.O) have in common? They all agree that the “buy now, pay later†loan is the next generation credit card. The short-term finance tool is disrupting the way consumers shop online, prompting established lenders to scramble to catch up with newbies in the industry. Meanwhile, regulators are worried about an explosion of unsustainable debt. Breakingviews explains how the invoice comes due.

HOW DOES THE LOAN WORK WITH PAY LATER?

As the name suggests, it allows consumers to order a product without handing over the money immediately. Unlike credit card purchases, buyers agree to repay in multiple weekly, bi-monthly, or monthly installments. In most cases, they pay no interest. Pioneers like Swedish Klarna and Australian Afterpay (APT.AX) are offering instant short-term loans for everything from Nike sneakers (NKE.N) to ASOS clothing (ASOS.L) to tickets. concert and grocery store. Customers then pay their bills through the suppliers’ smartphone apps.

This is appealing to buyers, especially when shopping online. It is also attractive to retailers keen to remove any barriers that discourage customers from clicking “Buy”. Merchants therefore give later payment providers a discount to improve their chances of a quick sale. The lender collects the full amount from the buyer in installments and pockets the difference in the form of a fee. On average, this represents 3% of the purchase price but can go up to 8%. Loan amounts vary: the average first customer using Klarna borrows around £ 100, but regular users have access to more credit. Affirm (AFRM.O) offers loans worth up to $ 17,500 in the United States.

Late payment providers typically fund loans with their own balance sheets, although Affirm has pooled installment loans used to purchase products, including $ 1,900 Peloton static bikes, and sold them to investors. Consumers who fail to complete their payments may face late fees and be barred from future purchases.

This model is attractive to lenders. To understand why, consider a deferred loan for a pair of shoes for $ 100, paid off in three monthly installments. The lender pays the retailer $ 97 up front and collects the full amount from the borrower. In other words, he pockets $ 3 on a loan with an average balance of $ 48.50 over its term. Repeat the trick four times a year, and the late-paying lender pocketed $ 12 on just $ 48.50 overall balance sheet exposure, a gross annual return of almost 25%. After deducting its own borrowing costs and credit card charges which should still represent a good return on capital for the lender, bad debt charges remain under control.

WHAT IS THE IMPORTANCE OF PAYING LATER LOANS?

A report from the Worldpay / FIS payment processor estimates that customers funded an estimated $ 96 billion of online purchases with installment loans last year. This could reach $ 300 billion worldwide by 2024, when it will account for 4.2% of global electronic payments. This is still a small proportion of global credit card payments, which the report says will reach $ 1.5 trillion in the same year. But it is clear that deferred loans are gaining market share.

Late payment loans are also emerging in physical commerce. Klarna, Affirm and Zilch, a UK-based supplier whose investors include Goldman Sachs, issue virtual cards that customers can use in stores. McKinsey estimates that up to 30% of deferred payment loans issued this year in the United States, Europe and Australasia will fund face-to-face transactions.

HOW WILL THE MAIN LENDERS RESPOND?

Credit card providers have struggled to catch up. American Express (AXP.N), Citi and Barclays (BARC.L) have installment plans in place for customers. Others won’t be far behind: Visa (VN) and Mastercard (MA.N) are building interfaces that allow credit card providers using their networks to develop payment offers later. Online payments pioneer PayPal, which launched its service last year, granted late payment loans on transactions worth more than $ 1.5 billion in the three months to June. Klarna processed $ 20 billion over the same period.

This attack suggests that there are few barriers to entry. However, payment groups also bought. Square in August paid $ 29 billion for Afterpay, giving the company run by Twitter founder (TWTR.N) Jack Dorsey access to the group’s 100,000 Australian merchants in more than 40 countries. Last month, PayPal bought out Japanese company Paidy for $ 2.7 billion, securing a foothold in a country where many citizens still use cash.

At the same time, large-scale distribution is joining forces with financial partners. Amazon said in August it would work with $ 40 billion Affirm to offer its customers late payment loans worth up to $ 17,500. Apple (AAPL.O) is exploring a service for iPhone users through a partnership with Goldman Sachs.

WHAT ARE REGULATORS DOING?

Any fast growing financial product gives rise to complaints and concerns. Late payment loans are no exception. Regulators have focused on what they see as inappropriate marketing of credit, especially to younger consumers, and whether buyers can afford the loans they take.

The main danger is that the debt to be paid later is hidden. Loans are generally not classified as conventional credit, so vendors do not need to report them to the credit bureaus who get a holistic picture of a consumer’s indebtedness. Sometimes lenders don’t even report late or missed payments.

This blind spot allows consumers to accumulate loans from multiple providers. A to study by Credit Karma found that one-third of late-paying U.S. borrowers were behind on one or more payments in August. In 2020, Klarna set aside 2.5 billion Swedish kronor ($ 275 million) to cover bad debts, on a portfolio of consumer loans worth 42 billion Swedish kroner.

Affordability checks are therefore urgent. The UK’s Financial Conduct Authority plans to introduce new rules next year. Reporting late payment loans to the credit bureaus is a first step. More drastic options would be to insist that all late payment providers obtain a banking license, or to require retailers to seek regulatory approval before offering the loans.

WHO WILL WIN?

Companies like Affirm, Afterpay and Klarna have the advantage of being pioneers. With the help of substantial marketing budgets, they have built brands recognized by young tech-savvy consumers. It’s hard to imagine conventional banks teaming up with artists like Snoop Dogg and Lady Gaga, like Klarna did. Users provide data that suppliers can pass on to retailers to drive future sales. Newcomers may also seek to increase their income by selling other financial products to their users.

They can also be too big to buy. Klarna, which has 90 million users and partnerships with 250,000 retailers, raised funds earlier this year at a valuation of $ 46 billion, making her more valuable than many European banks.

However, any sustained regulatory crackdown is likely to slow the growth of late-paying loans, while greater oversight will also increase compliance costs. This is important because the pioneers in the industry are not making any money right now.

Meanwhile, higher interest rates pose a particular threat to lenders who pay later. Because much of their income comes from retailers, they cannot easily pass rising borrowing costs on to consumers. Although they can start charging interest, it would lessen the simple appeal of the product.

The widespread rush to offer late payment loans suggests that the model is here to stay. It remains to be seen how profitable it will be. Right now, consumers are enjoying a bargain by buying things and paying for them in the future at no additional cost. But for late-paying lenders, like their customers, the bill will eventually fall due.

To follow @karenkkwok, @peter_tl on Twitter

NEWS CONTEXT

– Standard Chartered announced on October 13 that it will provide $ 500 million in funding to help Singapore-based fintech company Atom expand its buy now-pay later service in Southeast Asia.

– The London-listed bank said it has also acquired a strategic stake in Atom, the Singapore-based consumer unit of Advance Intelligence.

– Mastercard launched a service on September 28 that allows banks, lenders and fintech companies to offer buy-now and late-pay products.

– U.S. payments firm Square announced on August 1 that it would buy Australian lender Afterpay for $ 29 billion in shares.

Editing by Ed Cropley and Oliver Taslic