Taking Measured Steps Towards BNPL Success

Since lending is their primary business, why would any traditional bank be resistant to adding a popular credit-based fintech offering to their portfolio of products? Buy Now Pay Later, or BNPL, is the latest payment trend to catch the eye of the world, but still seems to be beyond the vision of many banks. As its name suggests, BNPL allows customers to make purchases on credit, and pay the amount back over time. A key difference between BNPL and credit cards is that BNPL providers charge their users low or no interest.

An interest-free line of credit sounds like a great option for consumers, and it is! It’s also why the BNPL market is growing at such a rapid pace. In fact, in 2020, reports pegged the value of the BNPL market at just over $90 billion and projected its potential growth to almost $4 trillion between 2021 and 2030.

The COVID-19 pandemic did play a catalytic role in the growing popularity of BNPL. Social distancing, lockdowns, the fear of income loss, a hoarding mentality, the urge to conserve cash, and the need to transact while staying at home, pushed thousands of people to make online, contactless payments when possible and to avoid paying immediately if given the option. For several people facing unfortunate financial situations, BNPL was the answer to buying essential items online, especially if they did not own a credit card.

The big question remains

Is it a good idea for banks to go beyond their traditional format of lending and embrace this new-age method of offering credit? We must remember that banks earn revenue from the interest they charge on loans they provide. So, will offering interest-free credit with a late payment fee, make good business sense?

Two sides to an ongoing debate

Frankly, the jury is still out on this. Some experts believe that BNPL is just a hyped up fintech fad that will soon die out. They propose that banks will not be impacted by refusing to jump on the BNPL bandwagon.

Other payment experts like us (my colleagues and I), stand firmly on the other side of the fence with those who believe that BNPL could soon eat into the market share of traditional lending products such as credit cards. It’s very telling that over 60% of a survey’s respondents thought that BNPL could potentially replace their credit cards. Another study found that more than 50% of Australians are unhappy with the high interest rate of credit cards and more than half of BNPL users would like to replace their credit cards with BNPL solutions. Statistics also tell a positive story about the growing use of fintech solutions. In fact, reports have slated the global fintech market to grow to $310 billion by 2022.

Here’s what we believe

BNPL is an excellent revenue-earning opportunity for traditional banks, that will complement their credit card business, increase their customer satisfaction, and broaden their consumer base. There’s good earning potential as merchants are willing to pay a high commission for using a BNPL provider’s service. This is because adding an attractive payment option brings in more customers and leads to more purchases.

The top reason for a bank’s BNPL reluctance

Why are banks so reluctant to join the BNPL fintech revolution and enjoy a slice of the pie?

Defaulting customers is a key concern

Millennials, and members of Gen Z, are the most likely to use BNPL, as many of them lack the credit history and scores to qualify for a credit card. This makes them high risk credit customers for any bank.

There simply isn’t enough information about the BNPL default rate to make an informed decision. Fintechs that provide BNPL often claim that their default rate is at par or lower than the default rate for credit cards. For instance, an article highlighted that according to Afterpay’s financial results in 2021, less than 10% of its total income was from the payment of late fees – a figure that is apparently down, from 14% in 2020 and 19% in 2019. Additionally, Laybuy has said that its defaulting rate is falling year-on-year.

Some reports suggest that the BNPL default rate is increasing. Almost 40% of BNPL users who responded to a survey said they have missed at least one payment. And of those who missed a payment, over 70% saw a decrease in their credit score as a result.

Leveraging strengths to overcome challenges

Banks must capitalize on their existing advantages to deliver BNPL as a solution, starting small and using a safer, more calculated approach.

First, it should be noted that some banks are already dipping their toes into BNPL waters by acquiring fintechs and using their platforms to provide the option. Others have created credit card products that work very similarly to BNPL. Many acquirers are simply integrating with fintechs to route BNPL transactions from the merchants to the fintech platforms. Mastercard has even rolled out ‘Mastercard Instalments’ to offer BNPL services to consumers, merchants, and lenders, and Visa is developing a similar solution. But most banks are still holding back from launching a full-fledged BNPL product. We understand the reason for their reluctance to go all in at once.

To minimize their risk and implement learnings along the way, banks should ease into offering BNPL, rather than plunging right in. This starts with an initial focus on customizing systems, applications, and processes, to manage the new offering. The existing strengths that banks can leverage are as follows:

Creating a more apt credit decisioning process:

• To lower the risk of defaulters, banks can piggyback on their current credit decisioning process to develop a comprehensive credit decisioning strategy specifically for BNPL

Tapping into their customer base:

• Providing a one-stop shop for all banking needs, is a sure way to improve customer satisfaction. Therefore, banks are always looking to cross-sell products to their existing customers, and they can do this by providing BNPL
• Being privy to the financial health, transaction history, and credit-related behavior of their existing customers can be very beneficial when initially selecting customers for BNPL. For instance, a customer that has paid back loan instalments on time, every time, is a good candidate for BNPL

Leveraging their existing merchant network:

• Banks can tie up with merchants in their network, who regularly record a high number of sales transactions. Those merchants can then offer the bank’s BNPL solution at checkout
• Merchants can share past transactional data about their customers with their banking partners. This is mutually beneficial. Banks can provide their BNPL solution to customers of the merchants who have a good history of spending. In turn, merchants reap the benefits of offering a more convenient method of credit payment, to attract more customers and higher spends
• Banks can cross-check their data with the data provided by merchants, to gain a more comprehensive understanding of customers that they have in common. Analyzing the combined data can give them more insights on customer spending patterns and preferences

Established technology, systems, infrastructure, and expertise:

• Banks are already in the business of lending, so they need minimal investment in technology and systems, when launching a new product. Customizing their existing systems and making minor configuration changes, should enable them to easily add and manage a BNPL product
• Banks can extend their expertise in reconciliation, settlement, dispute resolution, and collections, to BNPL

In-depth data analytics:

• Banks understand the value of the transactional data they collect. Therefore, they already analyze vast volumes of data to gain insights about their customers. They can use these established information management systems to study incoming data on the use of their BNPL product
• Data analytics can also be used to study trends and patterns, to customize their BNPL offering

Expertise in regulations and compliance:

• Currently, BNPL is largely unregulated in most countries. There is however a growing demand to bring it under the purview of the world’s regulatory agencies. When rules and standards are set in place, banks will be at an advantage as they have more experience than fintechs with regulation compliance

Effective loyalty programs:

• For years, traditional banks have successfully implemented value-added services and loyalty reward programs to attract and retain their customers. BNPL customers can similarly be retained and encouraged to spend more, through rewards

Ensuring sustainability:

• Fintechs may be able to sustain their BNPL offering because of the low-cost funds currently available in the market. This may change in the future. In fact, they may soon find it hard to offer the BNPL benefits of zero interest on instalments and low or capped late payment fees. Banks on the other hand will find it easier to manage the cost of funds in a higher interest rate economy

Appropriate communication processes and systems:

• Good and timely communication between BNPL providers and users is essential. Customers must understand exactly what they are signing up for. It is also important to communicate with the customers who are not approved for BNPL, so they do not feel alienated. Most banks already have set processes and systems in place to stay in touch with their customers. This can be leveraged for BNPL too
• Some studies have shown that another reason (other than lack of funds) that customers may default is because they lose track of their repayment schedule and forget to make a payment. This is an issue that can be addressed by using a robust alert and notification system, to remind customers when an instalment is due

Conclusion:

By implementing a targeted and calculated strategy, banks can introduce BNPL to their customers and merchants in a phased and low-risk manner. But that is only the beginning. To truly benefit from BNPL and enjoy a share of this fast-growing market, banks must periodically review and revise their overall risk strategy, based on incoming customer information. Over time, as they gather more data on the response to their limited BNPL offerings they could gain more insights on customer preferences and risk profiles, through analysis. They can then tweak or change their BNPL offerings to target new customer segments. BNPL customers can further be offered other bank products as they build a credit history by using BNPL. More merchants can be added to their network and offered other products like SME loans. The credit limit can be lowered for customers who habitually make late payments. And those with a history of defaulting on instalments, can be removed from the BNPL customer list.

Deepak Haria is a Senior Client Partner in the Synechron Payments business division. He has over 18 years of experience in the cards and payments domain, spanning application development, consulting, and delivery management. In his role, he assists customers with product feature assessments, product strategy, new product launches, innovative solutions, and the implementing of highly beneficial technology and business accelerators.

If you have any questions on payment-related technology services, you can email deepak.haria@synechron.com