In the winning essay of the 18-19 age group in our Young Financial Journalist competition, Linus Barnett looks at the pros and cons of Buy Now, Pay Later (BNPL) schemes.
Covid-19 and BNPL schemes
No set of circumstances could better have accelerated the widespread adoption of BNPL schemes than those of the Covid-19 pandemic. Non-essential shoppers were all but forced to stay in their homes during lockdowns.
The ensuing inability to purchase in-store, combined with the intense monotony posed by quarantines, caused a huge uptake in e-commerce activity. In fact, internet commerce’s share of global trade increased from 14% to 17% between 2019 and 2020.
As e-commerce surged, so too did the need for consumer financing. Many lost their jobs during the pandemic, some 800,000 in the UK in 2020, whilst others were paid only 80% of their wages whilst furloughed.
These factors led to a widespread loss in income, so shoppers turned to finance options that could blunt the force of all-in-one payments for their goods. BNPL services offered these finance options, and as a result enjoyed a huge surge in popularity.
BNPL products and users
Klarna, a BNPL industry leader, saw their monthly usership in the UK rise from 140,000 to 460,000 between 2019 and 2020. By March 2021, it was estimated that 37% of UK residents had used BNPL as a payment method at least once – 81% of these users said they’re likely to use it again.
The rapid uptake in BNPL products in such a short period of time has left the UK government to play catchup. Despite widespread criticism, most BNPL services still benefit from an exemption from credit regulation by the Financial Conduct Authority (FCA), as the loans are time-limited and commonly interest-free.
An absence of regulation for fintech firms offering BNPL has allowed for them to achieve significant successes in augmenting their user-bases. But it has also allowed for them to be lacklustre in how they inform their customers.
A recent study by Barclays found that two in five BNPL users didn’t fully understand how the products worked, suggesting clear information asymmetry in the market for the payment services.
The study also found that 36% of BNPL users did not fully understand the consequences of missing repayments – highlighting the risk that users may indebt themselves to a greater degree than they can manage without realising.
A lack of understanding when making financial decisions has the potential to be significantly damaging to consumers – 57% of customers regret using BNPL products due to their cost, according to a study by YouGov.
This finding, like those provided by Barclays, points clearly to the risk of over indebtedness that these services expose shoppers to when perfect information is not provided up front. More than one in three say they are using BNPL to spend more than they can afford.
This number could be far higher in reality, as some consumers are likely to be misinformed as to how much they’re payments stand to be in the future – thanks to hidden interest payments or late fees that BNPL services go little way to illuminating during the sign-up process.
What are the risks involved with BNPL?
Scarcity of clear information may not be the only reason that consumers seem to struggle with managing their BNPL loans. Due to the absence of regulation in the industry, customer screening is largely carried out on a provider-by-provider basis.
Clearpay and AfterPay, for example, carry out no credit check at all when considering their customers, and the sign-up process takes but a few clicks for both services. Convenient as it may be for customers in the short-term, this feature of many BNPL providers may actually have a negative effect on their welfare over time.
Pervasive access to these quick loans has the potential to instil in borrowers a false sense of security – that they aren’t in fact indebted and they need not worry about payments creeping up on them in the future.
These (very real) future payments, if missed, can have consequences unanticipated by consumers making use of BNPL products – consequences independent of late fees or interest payments.
In February, Equifax and Experian joined TransUnion in including BNPL loans in their customer credit files. This inclusion by the UK’s main three credit reference agencies means that the risks involved with defaulting on BNPL payments has increased significantly.
Not only may consumers be subject to high interest rates and added fees, but they may also now find their credit scores are affected negatively.
In summary, Buy Now Pay Later schemes, despite their utility to many, can pose great risks to consumers. A lack of point-of-sale information, combined with less than scrupulous screening processes, means that often it is the least financially literate in society that are left with the most financial products to juggle at a time.
The UK’s BNPL debt bubble was calculated to have surpassed £4bn in October of last year. This will have increased since Christmas. One can only hope that the service is brought within the FCA’s regulatory powers soon.
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