John Kavanagh of Australia's Banking Day argues it's time to regulate the buy now, pay later sector

John Kavanagh*

One conclusion that must be drawn from a reading of the financial reports released by buy now pay later companies over the past few weeks is that the sector needs to be regulated so that it is forced to provide adequate consumer safeguards.

In their haste to grab share in what they see as an important emerging consumer finance market, BNPL companies are consuming a lot of shareholder capital. That’s a matter for them and their shareholders.

They are also putting consumers at risk as they sign up as many customers as they can and, despite what they say, allow them to use a credit product irresponsibly.

That’s a matter for policy makers and regulators. That’s certainly the case with Sezzle, which made a provision of A$22.4 million for uncollectable accounts in the six months to June – equivalent to a little under half its income for the half-year and 22% of its receivables.

The metrics BNPL companies highlight are growth in underlying merchant sales, growth in active merchant numbers and growth in active customers numbers.

Sezzle reported underlying merchant sales of US$786.2 million during the June half – an increase of 156% over the previous corresponding period. Active merchant numbers rose 150% to 40,274 and active customer numbers rose 96% to 2.9 million.

Can these businesses double their numbers every year and keep control of their credit risk? The evidence suggests they can’t and regulators need to step in.

Openpay reported a spike in bad debt charges and arrears as it pursues an aggressive growth strategy in the United Kingdom and the United States, as well as locally. The receivables impairment expense grew 55% to $12.2 million in the year to June. Gross receivables were $63.2 million at June 30. Its arrears rate rose from 0.8% at 30 June 2020 to 2.8% at 30 June this year.

The company said the 55% increase in bad debt charges was a result of portfolio growth as well as “early stage” losses in the UK related to the company biggest retail merchant.

In addition, Openpay’s heavy cash outflow from operating activities prompted its auditor to say the company will need to secure additional funding in support of its business growth.

It appears that such losses are a cost of maintaining momentum in the highly competitive and fast growing BNPL market. However, elevated bad debt charges and arrears rates undercut the claims of BNPL companies that they are “changing the way people pay, for the better.”

Splitit’s original business model was to allow consumers to use an existing debit or credit card to pay for purchases on an instalment basis, free of fee or interest charges. This year it stopped funding debit card transactions as a way of managing risk that was getting out of control.

Afterpay earns one dollar in every 10 from late fees (9.6% of income in 2020/21). It made a provision for expected credit losses of $195 million, which is 12.5% of receivables at 30 June. The proportion of provisions to receivables is growing; in 2019/20 the provision for expected credit losses was $94.5 million – 11.6% of receivables at 30 June 2020.

Zip’s financial report tells much the same story. Customer numbers rose 247% to 7.3 million over the year to June and underlying transaction volume rose 178% to $5.7 billion.

Zip reported a provision for expected credit loss of 6% of gross receivables at 30 June, compared with a provision of 4.4% of gross receivables at 30 June 2020. Net bad debts rose from 2.3% of receivables to 3.5%.

Most standard lenders reported stable or declining arrears and bad debt expenses in the year to June, along with releases from their expected loss provisions, as government COVID stimulus measures allowed households to build savings and pay down debt.

It is a completely different story with BNPL providers. An absence of consumer credit regulation is a big part of the reason for the difference.

Another reason regulators should be overseeing the activities of these businesses is that some of them exhibit the characteristics of payday lenders.

BNPL minnow Payright earned a little over $4 million of its total of $11.5 million of fee income from customers, who pay establishment fees, repeat purchase fees, account keeping fees and payment processing fees.

It’s been some years since most consumers had to pay monthly fees on their transaction accounts but they pay them on some BNPL accounts. The sector needs to be more accountable.

(Note the New Zealand Government is to consult on potentially regulating the buy now, pay later sector).

* John Kavanagh is associate editor of Australia's Banking Day. This article was first published here and is used with permission.