With the buy-now-pay-later market expected to grow almost 400% by 2025, incumbent lenders that still rely on traditional credit cards and cumbersome financing methods are set to lose out to the likes of Klarna. Banks may have even more cause for concern as these new players could capitalize on their well-recognized brands to move into other financial services.
The concept of 0% finance has been around for decades — typically a paper-heavy and lengthy process when buying a kitchen or car — but it has "really caught fire" with the entrance of buy-now-pay-later companies in the last three years, said Simon Taylor, co-founder of financial technology consultancy 11:FS, in an interview.
What companies such as Klarna, Afterpay Ltd. and Affirm Holdings Inc. have changed is the ease with which such financing can be obtained, he said, with online shoppers now getting a "slick and near-instant" option to pay for a product in 30 days or split their payment into installments when purchasing from certain merchants.
The buy-now-pay-later companies will typically charge the merchant a fee for the service, making the financing free for the consumer, while in return promising a 20% to 30% boost to the merchant's sales.
A coronavirus pandemic-driven boom in e-commerce has in particular benefited providers of this form of finance. In November, Sweden-headquartered Klarna announced it had reached 11 million customers in the U.S., a 106% increase year over year.
The growth is set to continue. In 2025, $731 billion will be spent globally using electronic point of sale finance, according to data from research company Kaleido Intelligence. This is driven by a significant boom in spending using buy-now-pay-later options over e-commerce channels, which is expected to grow to $352 billion, up from $89 billion in 2020.
That is a "warning sign" to incumbent financial institutions, whose alternatives are typically the credit card or unwieldy online financing offers, according to the research company.
"There's a danger of being locked out of pieces of the pie, so to speak," Steffen Sorrell, Kaleido Intelligence's chief of research, told S&P Global Market Intelligence.
While credit card use in markets such as Europe and North America is still prevalent, the rise of buy now, pay later is a sign that consumer behavior is beginning to shift, the company found.
11:FS has observed the same trend. "We've done consumer surveys, and especially younger consumers massively prefer buy now, pay later to credit cards," Taylor said. "Credit cards are seen as predatory, hard to control. Their business model is predicated on getting people into debt that they can't afford to buy their way out of."
Space for competition
Sorrell said there is "still plenty of space for competition in the market," both from card networks as well as banks, particularly in Europe, North America and Asia-Pacific.
Some banking players are already moving into this space. Lunar A/S, a Danish challenger bank, launched a pay-later solution on Dec. 11 that allows customers retroactively to split or postpone transactions via its banking app.
Lunar's solution is built for customers rather than merchants. Because the bank has a clear picture of customers' transaction history and behavior, the pay-later option can be used to finance their "entire financial life," rather than only online purchases with select merchants, said Ken Villum Klausen, founder and CEO of Lunar, in an interview.
Without merchant partnerships, Lunar instead charges the customer a small, up-front fee, helping them to avoid the "interest rate mayhem" that can often come with a credit card, Klausen said.
Larger financial players are entering the game, too. Last year Citigroup Inc. launched Citi Flex Pay, while JPMorgan Chase & Co. introduced My Chase Plan this year, both of which let customers pay off big purchases over time for a fee, although the solutions are still linked to banks' traditional credit cards.
Mastercard Inc. and Visa Inc. also announced this year they are working with payment companies to enable cardholders to split transactions into installments.
The incumbent edge: data
One concern about buy-now-pay-later companies is their lack of comprehensive credit checks and whether their risk levels are sustainable for the long term. In 2019, Klarna wrote off around 5% of its lending as losses, which is fairly high for the wider lending industry, according to Taylor.
In the first nine months of 2020, Klarna further recorded a 35% jump in credit losses compared with a year earlier.
Where banks may have an advantage is that they hold a "massive wealth of data" on customers with which they can assess risk more reliably, said Sorrell.
So far banks have not managed to use that data to offer the same rapid, on-the-spot credit decision that the buy-now-pay-later companies do, he said.
Even if incumbent banks did accomplish just that, they will still have to compete with other established players and newcomers. Tech giants such as PayPal Holdings Inc. and Amazon.com Inc., which already have buy-now-pay-later offerings, are in "a very strong position to develop the market further," said Sorrell.
He also expects that more neobanks will look at this space, while the likes of Klarna will grow in size, enabling them to improve their credit decision abilities.
Taylor is not convinced the buy-now-pay-later market is a space for traditional banks, because they have left it "far too late."
"There's a lesson there, which is that the products that banks have had and the way that they've been packaged for the last 200 years are probably not the ones for the next 50 years," Taylor said.
As long as incumbent lenders continue to offer the same financial products they always have — be it consumer loans, credit cards or overdrafts — they will face pressure from innovations that "fit the way we live," said Klausen of Lunar, which in one such example is looking to expand into leasing for bicycles and furniture.
The Klarnas of the world are well-positioned to expand into other financial services, said Taylor. Klarna already has a full banking license in Sweden and entered the German savings market this year after partnering with online deposit marketplace Raisin.