When Klarna launched its buy now, pay later (BNPL) service in the UK in 2016, point of sale interest-free credit looked like a sideshow. But with the payment method attracting growing interest from consumers and retailers, incumbent banks like NatWest are now entering the field.
It’s still early days for BNPL, which remains dwarfed by the credit card market. There are currently 35 million active credit cards in the UK, according to UK Finance, with £16.2bn spent in January 2022 alone. BNPL, on the other hand, was used at least once by around 15 million people, or around 28% of the adult population in October 2021, according to Equifax, with the average user repaying £125.32. That suggests overall BNPL lending is around one-tenth that on credit cards.
However, banks are keen to tap into the new market. NatWest looks set to be the first incumbent bank to enter the BNPL arena, launching a new product this summer. It promises to bring one of the main advantages of a credit card to BNPL: “consumer protection on all purchases”. BNPL will also be part of the NatWest mobile app, with the aim of offering an “effortless” customer experience.
The bank strikes back
NatWest hasn’t given details of what it might charge retailers. However, it’s possible that its size could help it undercut fintech BNPL providers. It may also have another advantage: incumbents know how to comply with regulation.
NatWest won’t be alone. Monzo was the first UK bank to enter BNPL with ‘Monzo Flex’ at the end of last year. This provides interest-free payments over three instalments, though it has an interest rate of 19% APR when the customer chooses six or 12 instalments. From a consumer point of view, this is similar to a credit card.
BNPL could eat into a much bigger, established business – so why are banks interested?
It comes down to consumer expectation, increasing choice, and why BNPL took off in the first place.
BNPL attracts consumers partly because it’s accessible to people who can’t get a credit card or don’t want a hard credit check. In the UK, it still comes under rules that allow informal credit agreements – for example, settling up with a newsagent at the end of the week – though that will shortly change. Mainly, however, it’s because it’s cheaper and less hassle.
It’s particularly important that BNPL costs less than a credit card or an overdraft, according to a survey by Bain. Some BNPL providers, like Klarna, charge no interest and no late repayment fees on smaller sums. Klarna has a regulated credit offer for larger amounts that does charge interest, but there is a fixed total cost and no revolving credit.
In contrast, the average cost of credit card borrowing was 18.28% in January 2022, while the effective interest rate on overdrafts was 20.83%, according to the Bank of England.
Klarna has described the credit card markets as “rigged” against both merchants and consumers and only working in favour of the banks that extract excessive fees. It’s not the only fintech that sees a business opportunity in the margins of incumbent players and in better customer service.
“Buy now, pay later can absolutely displace credit cards in the UK,” says Shachar Bialick, the founder and CEO of Curve, which aggregates multiple cards in one card and one app and also offers BNPL.
The BNPL benefit
BNPL offers a range of other advantages. Card providers like Visa, which have big economies of scale, charge retailers under 2% for the credit service. BNPL can demand more than twice as much.
On the surface, that seems potentially off-putting for retailers, who have long complained about excessive card charges. However, BNPL’s magic sauce is that it boosts sales when compared with other payment options. That matters in an online world where the competition is just a click away. Bain says that around 57% of merchants see an increase in ‘basket conversion’ and about 46% experienced an increase in order value.
BNPL also attracts a broader range of consumers, including the less well-off. All in all, retailers find that BNPL pays for itself even if it comes with a higher percentage fee than a card payment. The bottom line is that consumers flock to such solutions, meaning both retailers and banks will increasingly have to provide access.
“The fintech sector emerged out of demand for more diverse financial products that work for consumers as well as providers,” says Claudio Alvarez, partner at GP Bullhound, a technology advisory and investment firm. “Klarna and others have revolutionised the consumer lending space. It was only a matter of time before incumbents took notice and began adapting their product offering to keep in step with the new emerging fintechs.”
A radical change in retail finance
Though retailers are keen to offer BNPL, it’s not lucrative for the finance providers – at least not yet. Klarna, the largest BNPL player in the UK, had global revenues of around $1.6bn and net losses of around $758m in 2021 as it expanded. It now serves 45 countries. To compare, Visa’s net income in 2021 was $12.3bn.
But Klarna, like many tech companies, wants to reshape its whole market for the long-term, not make money now. It aims to be a major aggregator that only takes the slimmest of margins by eliminating what it sees as unnecessary financial taxes on the economy. If it succeeds, some banks will need new business models.
There are also regulatory issues to consider. UK regulators started taking a hard look at BNPL with the Woolard Review in February 2021. It concluded that “as a matter of urgency, the FCA [Financial Conduct Authority] should work with the Treasury to ensure the necessary amendments to legislation are made to bring BNPL products within the scope of regulation.” That is expected this year.
Incumbent payment firms, including banks, already comply with long lists of often onerous regulations on a global basis. This underpins their reach and scale. Some challenger banks, on the other hand, have struggled to keep up with the essentials of domestic market compliance, as the Prudential Regulation Authority recently noted.
Banks’ deep compliance skill could be a distinct advantage in regulated BNPL. No-one has suggested that firms like Klarna do not run their businesses well – and Klarna itself welcomes regulation.
However, while some fintech challengers are getting their knuckles rapped for poor back-end processes, incumbents are built to respond to regulation. With regulated BNPL, they now have a chance to step into a ready-made and growing market that suits their particular skills.