How Buy Now Pay Later (BNPL) is Driving Unsecured Lending

Paying for goods on the installment plan is hardly a new payment scheme, but it has resurfaced in response to increased consumer interest. “Buy now, pay later” gives consumers greater control over how much they spend and where they spend it. It also gives them more freedom to purchase the things they want, even without enough cash on their account.

In the United States, point-of-sale (POS) financing services have grown significantly, especially because of COVID-19 restrictions. Usage among the younger population has greatly influenced the growth of BNPL, while banking digitalization has spurred adoption among merchants.

At this time, fintech market players are taking the lead when it comes to BNPL, and so far, only a handful of banks have responded quickly enough to compete. To avoid major losses in the future, banks need to understand the current landscape for POS financing and choose a model that works best for their new-to-credit customers.

New Business Opportunities with POS Lending

Traditional banks and financial institutions need to see the growth of POS financing models as a signal to rethink the lending landscape and their role in it. With fintech rerouting most of the value in POS financing from banks—estimated to be between $8–10 billion so far, it's obvious that it's a highly profitable market.

Another important factor is that most users engaged in online banking are young, tech-savvy millennials and Gen Z’s. If banks want to see their long-term goals achieved and get the attention of these younger users, they need to shift their focus to bringing these changes into the system

• Integration across the purchase journey
• Rethinking risk models
• Different approaches to credit

Integration across the purchase journey

While fintech is busy creating a complete customer purchase journey, banks are falling behind. Integration can contribute to scale and engage the younger generations to give banks increased visibility. Using rewards and subsidizing credit reward costs will bring more value to clients and ultimately increase their loyalty.

Rethinking risk models

Consumer expectations are getting higher every day, especially with merchant subsidies. It’s time for banks to rethink and update their risk models to address those expectations. One possible solution could be merchant partnerships, as merchants play a key role as intermediaries in this model.

Different approaches to credit

The difference between traditional credit products, installment-based credit cards, and debit cards with new features is growing blurry. Banks that start offering credit products in the format their customers want will gain valuable advantages and benefit from doing so.

Everyone, whether it’s neobanks, card issuers, lenders, or merchant acquirers, is competing for market share. By offering BNPL options, they can see how users interact with their platforms and find the right business model to stay afloat in a dynamic market.

It’s clear that Buy Now, Pay Later is growing fast. Indeed, the results of McKinsey’s 2021 Digital Payments Survey suggest that the use of BNPL may actually be growing faster than its penetration.

Distinct Buy Now, Pay Later Models

As not every POS system works the same, outlining the systems used across various financial markets demonstrates how much the service has evolved over a short period of time. At the same time, banks can get a deeper understanding of what they are competing with and ways that they might outperform it.

1. Financing Midsize Purchases with Off-Card Solutions
Solutions like Uplift and Affirm, which allow repaying in monthly installments, are ideal for small and medium purchases. On average, ticket size is somewhere between $250 and $2,500 and the time it takes to pay out the loan is around 8-9 months. Products purchased this way are typically household appliances, electronics, home fitness equipment, and furniture.

Most of these transactions are done digitally and their growth is fueled by increased adoption among users with higher credit scores. However, consumers are not very likely to use this financing strategy more than a few times a year

2. Post-Purchase Card Installments
This financing solution is popular in Asia and Latin America, although adoption rates are still fairly low in the US. Since the post-purchase repayment strategy has a higher APR than other POS purchase solutions, it's less popular. However, a big benefit post-purchase brings is the option for merchants to use it with special offers. Card-linked installments are currently available thanks to services like Splitit or network solutions like Visa Installments.

3. Shopping Apps Integration
The aspiration most big shopping apps have is to become “super apps.” Major market players like PayPal’s “Pay In 4” offer services that follow customers throughout the entire purchase journey. Moreover, they are steadily building scale. Unless banks find a way to increase their engagement, they might not be competitive at the same level and could expect to see losses in the near future.

Pay in 4 focuses on smaller purchases that are usually under $250, with installments that users can pay off in six weeks. Services like Afterpay have seen tremendous growth fueled by the pandemic lockdown. With more merchants integrating these products in their checkout offers, the increase of over 300% in 2020 could prove even higher in 2021. McKinsey estimates that Pay in 4 could generate between $4 and $6 billion in revenues by 2023.

Big market players are recognizing this integration trend. To ensure their market positions, many have decided to integrate Etsy.com with Klarna and Houzz.com with Afterpay.

Why Consumers Use BNPL
Convenience. BNPL loans require a deposit payment or an “installment,” such as 25% of the purchase amount. The remaining amount is then paid off in installments over a few weeks or months.

Zero or low-interest rate. BNPL loans don’t include any additional interest or banking fees, but they can come with a fixed repayment schedule.

Soft Credit Check. To prevent fraudulent behavior, a soft credit check is conducted to confirm the buyer’s identity. There will be no credit check or underwriting in the process.

Easy Approval Process. One of most popular features of BNPL is the quick, easy approval process. Not only does it not affect credit ratings, but it’s not relevant to other creditors.

How Banks Can Take Advantage of POS Financing

Banks interested in getting involved with POS financing solutions can choose among various financing models. Each presents a unique opportunity as it requires banks to understand the cost, time to market, and customer segmentation.

Rent their balance to a BNPL company

One of the examples of collaboration between banks and BNPL companies is the model that Cross River Bank and Affirm chose. Cross River is providing Affirm with banking services so they can approve microfinancing solutions.

Integrate installments into credit cards

As the BNPL market continues to grow, some banks have decided to incorporate installments into existing credit cards. JP Morgan developed Citi Flex Pay & Chase Pan to let their customers repay purchases in installments. The strategy of adding new features to existing products or developing new financing products is one good way to address client needs, especially since most of them started using alternative financing options to avoid paying exorbitant credit card interest.

Take over a BNPL company
The market value of some of the biggest BNPL players is estimated to be billions of dollars. AfterPay and Klarna have grown so much that even well-known market players like Mastercard, Apple Pay, and Goldman Sachs have decided to offer new ways to use Installments. However, as a standalone model, BNPL does not appear to be viable.

Develop Your Own BNPL Solution
Some banks and financial institutions are willing to cater to their clients’ needs and offer POS financing solutions developed in-house. If they want to compete with fintech, their advantage could be a partnership that will allow them to build a unique product equipped with the tailor-made features their clients need.

Final Word
Traditional lenders, brick and mortar banks, and neobanks are all focused on finding their place in the POS financing market. Fierce competition will require them to use their assets to fuel the right business models and go into the market with competitive products.

What we can be certain of is the underlying need that drives customers and how POS financing addresses it. The digitalization of large banking systems prevents some of commercial banks from putting together clear strategies for entering this market. But with the market scale constantly expanding, POS financing is here to stay.