Bank for International Settlements fires BNPL warning shot across the bow of those tasked with maintaining financial stability

The Bank for International Settlements (BIS), the central banks' bank, is warning that buy now, pay later (BNPL) payment schemes warrant monitoring from a financial stability perspective, given both their high growth rates and high loan delinquency rates.

In a special feature, Buy now, pay later: a cross-country analysis, BIS says the typical profile of a BNPL user appears high-risk.

"The majority of BNPL app users across countries are under the age of 35. Younger and tech-savvy individuals, including 'Millennials' and 'Generation Z,' often do not possess credit cards and are generally less financially literate than older generations. Consistent with this, a survey of US BNPL services reveals that they are more often used by individuals with low income levels and less educational attainment," BIS says.

It notes that while the highest BNPL use rates are in Australia and Sweden, New Zealand's among a group of countries with significant BNPL uptake, alongside China, Finland, Germany, the Netherlands, Norway, Singapore, the United Kingdom and the United States. (See image at the foot of this article).

"While consumers enjoy the advantage of immediate purchases with deferred payments at no added cost, merchants expand sales and their customer base. However, despite earning revenue from merchant fees, BNPL platforms face profitability challenges due to high fixed costs, increasing funding expenses and elevated delinquency rates," BIS says.

"The rapid ascent of BNPL could be of concern to public authorities for two reasons: consumer protection issues and the accumulation of credit risk. It is thus important to establish whether BNPL schemes take advantage of financially constrained individuals through misleading promotions and inadequate information. In turn, since BNPL platforms suffer from high delinquency rates, a sustained growth of these platforms would warrant monitoring of their direct and indirect links with the rest of the financial system."

In NZ the Reserve Bank is tasked with maintaining financial stability.

Regulation in the pipeline

In November 2022 NZ's then-Commerce and Consumer Affairs Minister David Clark announced the BNPL sector would be brought in line with purveyors of other forms of consumer debt, with BNPL transactions to be treated as consumer credit contracts under the Credit Contracts and Consumer Finance Act (CCCFA). In August this year Clark's successor Duncan Webb announced BNPL loans would, however, be exempt from affordability and suitability assessments. Instead BNPL lenders would have to complete comprehensive credit reporting when customers sign up or increase their credit limit.

The Credit Contracts and Consumer Finance (Buy Now, Pay Later) Amendment Regulations are scheduled tp come into force on September 2 next year. Whether the new coalition government makes any changes to incoming BNPL oversight remains to be seen.

How it works

A BNPL transaction typically involves three agents; a merchant, a customer, and a BNPL platform. BNPL payment schemes allow consumers to divide their spending into interest-free instalments, with the cost of the platform-based BNPL service primarily falling on merchants. That means consumers can manage their expenses while incurring only small or no fees. However, there are penalty fees for late payments. And imprudent spending or a poor understanding of BNPL terms can lead to over indebtedness, BIS notes.

"Merchants pay high fees to transfer credit risk to the platforms and broaden the customer base. BNPL schemes are accessible even to consumers without a credit history or stable income and do not typically affect their credit scores. Relying primarily on fee revenues, platforms have faced profitability challenges due to high operating costs and rising credit losses," says BIS.

With high operating costs for marketing, administrative and technology expenses among others, major BNPL platforms such as Affirm, Afterpay and Klarna, haven't broken even since 2018, BIS notes.

When consumers decide on a purchase and select the BNPL option at the checkout, the BNPL platform approves a credit line. Upon approval, the platform pays the merchant the full amount of the goods purchased and takes on the customer’s credit risk. Customers pay the first instalment
upfront to the platform, while the residual amount is typically due in instalments.

"Merchants benefit from offering BNPL payment options in several ways. First, credit and fraud risks are transferred from the merchant to the platform. Second, offering BNPL options allows merchants to reach customers who lack immediate financial means. In some cases, merchants also benefit from non-payment services such as marketing and the data analytics provided by BNPL platforms. This results in a higher share of website visitors who finalise a purchase and an increase in both the number and value of sales," says BIS.

"At the same time, merchants incur high costs when offering a BNPL option...These variable costs are consistently - and several percentage points - higher for BNPL than for online banking credit or credit cards. In addition to these costs, merchants using BNPL also incur a fixed membership fee to join the platform’s network and may also pay a fixed fee per transaction. Despite these costs, as of August 2023, a significant proportion of merchants in many jurisdictions offer BNPL payment options on their websites."

BIS cites research showing e-commerce merchants offering BNPL as a payment option benefit from expanding sales, with some customers buying things they might otherwise not buy, and others spending more than they had initially planned.

*Also see our Of Interest podcast: Grant Halverson on the rise and fall of the buy now pay later sector and what the future may hold for it.