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BNPL Ethics: White Hat or Black?

Buy Now Pay Later (BNPL) is arguably the hottest fintech and financial services trend. This post examines the ethics of the BNPL model and assesses the ethics of this form of credit.

First: A BNPL Primer

BNPL started as a payment method for online retailers but is quickly expanding in on-premise retail. Pioneered by pureplay BNPL startups, the credit method gives consumers the option to make purchases in a series of payments over a short period rather than all up front. They are very different from credit cards in that the customer pays no interest so long as they make on-time payments. The BNPL payment option charges a percentage fee to the merchant at the time of purchase. Customers can access BNPL through direct integrations with some retailers or an app. Historically, these services have been most popular in markets where credit cards aren’t given out “like water,” as they often seem to be in the US - markets like Australia and the UK.

Each BNPL Player has its own fees and terms. While some BNPLs offer long-term interest-bearing loans for larger purchases, the BNPL product “action” is in short-term loans over 6-12 weeks. One of the most common BNPL lender payment timelines is four equal installments over six weeks: one due at purchase, one in two weeks, and one in six weeks. These loans generally start at around USD $200-$300 and tap out at $1,500.

To determine credit worthiness, most BNPL services do not perform a “hard” credit check with a credit bureau, meaning a comprehensive and recorded review of your credit report. Hard checks differ from soft checks in that hard checks are noted on your credit report. Hard checks indicate the user has actively sought additional credit, like applying for a traditional credit card. Authorizing lots of hard checks lowers your credit score because they suggest you may grow your debt significantly. Soft checks are not reported -- they are like those conducted before you are "pre-approved" for a credit card.

This can be a credit-getting advantage for people who have little credit history, have had credit issues in the past, or who are concerned that a hard check may harm their credit score. Some do perform soft credit checks, which do not affect your credit. And some do not check credit at all but limit initial purchase sizes to lessen the risk exposure until the customer demonstrates creditworthiness.

BNPL services charge merchant fees a percentage on a sale - their foundational revenue source. That fee typically ranges from 2-8%. Fees below 3% are pretty uncommon, which means that the costs are higher than for credit cards, which average 2.9%.

Some BNPLs charge a transaction fee, like $1, at the point of each payment. Others charge late fees when people don’t pay on time. These fees tend to run a few dollars to a percentage of the total purchase price. When customers are late, they lose access to credit through the BNPL provider until they are again current. The record of on-time and late payments impacts the amounts the customer can borrow in the future.

BNPL Penetration and Popularity

Motley Fool’s research group says that about 57% of Americans reported using a BNPL service in March 2021. Their data also show that the popularity strongly skewed to younger demos:

eMarketer reports different penetration figures but the same overall pattern:

Cornerstone Advisors projects that BNPL will be a $100B category in the US in 2021, up from just $34B in 2020.

BNPL Demographics

Here the research data varies pretty widely. According to Payments Journal, usage skews toward younger consumers with middle incomes and those without sufficient credit. From the article:

  • Typical consumer profile for BNPL short-term loans: 18-24 and tech savvy.

  • Typical BNPL consumers will also have an annual income of around $75-149K and will be equally distributed nationally.

  • Buy Now Pay Later loans are procured online and in-person an equal amount. A BNPL loan is likely to be a last-minute decision at checkout.

By contrast, a Morning Consult study showed, across BNPL companies, a strong skew toward lower-income and non-white households (especially African American households), a pattern more similar to payday loans.

The study also reported that BNPL households have greater income volatility. But BNPL households were far less likely than credit card-only families to report being behind on debt. BNPL-only households were also more likely to report key long-term financial goals and progress toward realizing those goals. Many believe that the BNPL arrangement reaches into a sector underserved by financial institutions.

Why Consumers Like BNPL

BNPL makes it possible for people with limited income or savings to make purchases when they need to. Further, many people appear to think of them as something other than loans because there are no direct interest charges. That perception is particularly relevant to younger demos that, as a group, are more skeptical and wary of credit card charges than previous generations.

By offering a structured way to make purchases and payments, BNPLs appeal to customers who want access to goods now but believe they are making more prudent financial decisions because of the no-interest, short-term nature of the agreements.

Consumer credit behavior also shows that BNPL gives people perceived “permission” to make more and larger purchases than they might have with a different payment method. This is particularly true in more impulse-oriented “want” instead of “need” categories. It reputedly makes people more likely to pull the trigger on things like the latest pricey “It” bag. BNPL services tend to be an easier borrow for people without credit history or past credit challenges.

Why Retailers Like BNPL

First, retailers are in the business of pleasing shoppers. Offering a popular method of payment makes a great deal of sense. Second, data show that offering BNPL increases commerce conversion rates and AOV. Further, these programs are highly popular among Millennials and Gen Z, many of whom are wary of credit cards and their interest. So more, larger sales to a new generation of shoppers. Not a challenging concept to like.

The Players

There are an estimated 100 BNPLs globally. Fintech Consultancy Fincog reported the following breakdown of service types:

The Ethical Questions

Like any form of credit, BNPL has its proponents and detractors. Let’s examine some of those questions now.

Are BNPLs a “good” or “bad” form of credit?

Pro-BNPL analysts say that making no-interest loans with transparent terms and short payback plans is an excellent service for people to get things they need but cannot afford at the moment. One area where BNPL excels is transparency. For most big players, fees are transparent, and payment terms are clear. These attributes are crucial to their appeal. Proponents often compare them to a layaway plan, a financial tool that has been used for decades.

BNPL may look like layaway – but there is a big difference. With layaway, the customer makes their timed payments BEFORE they take an item home. With BNPL, the customer receives the goods immediately. Layaway is not a loan, but BNPL is. Users may not perceive it as one, but it is a form of credit, and late payments can impact credit reports with at least some of the vendors.

Opponents suggest that BNPL encourages more and larger purchases by people who really cannot afford them. To return to the “It” bag example, detractors suggest that BNPL encourages large and unnecessary purchases that consumers would be better off avoiding. They also suggest that the marketing of these services focuses on creating the perception that BNPL is not a loan or a form of credit. Further, opponents sometimes draw a connection to the much-criticized but enormous check-cashing and payday loan industry.

BNPL is even less like a payday loan than layaway. Sure, it’s a short-term credit extension. But by their own admission on the industry association site, a typical payday loan provider charges about $15 per $100 borrowed in interest charges – for a two-week borrowing period. That’s 390% APR. Pay late, and the rate goes up higher, and there are often additional penalty fees. At best, the debt rolls to another 390% interest cycle. According to many sources, the average user gets 8-10 loans per year and often pays more for the interest than the principal amounts.

To be fair, the check-cashing industry counters that they offer an avenue to credit that traditional banks won’t touch. Which, in many cases, is true. Soft focus “we care” bank commercials to the contrary, banks don’t like lending to poor people very much. They have historically been less likely to put branches in poor neighborhoods. They (most of them) have fewer branches in communities that are majority people of color. While the Internet makes the availability of branches less of an issue, in theory, the reality remains that it is difficult for many people to get a loan, and certainly a loan at a reasonable rate of interest.

Further, payday loans are typically for essentials like rent, food, and daycare. Is that an indictment of society or payday loans? But however you feel about payday loans, it’s clear that they are nothing like BNPL. BNPL is a no-interest loan, though according to a Credit Karma survey conducted for Reuters, about 33% of users report paying late at least once, which often leads to penalties. Not an interest charge per se, but a cost of credit. But these charges only come when the person fails to live up to their payment agreement. And don’t run to 390%.

Do BNPLs overextend credit to people?

In the earliest days of BNPL, many alleged that these companies were too free with loans, allowing customers to go too deeply into debt. A sizable number of people end up paying service charges and sometimes see damage to their credit ratings, and possible default.

In many markets, BNPL is in a limited regulation space. It is often governed by exemptions initially developed for sellers of high-priced goods like furniture. There is a growing view that this may not be appropriate because this exemption was based on a different use case.

The UK and Australia are farther along on the road to potential additional regulation – these countries tend toward more and faster regulation than the US. The UK Treasury “consultation” on BNPL regulation, for example, notes that the exemption was intended for a different set of purchase circumstances:

  • The credit is typically used to finance higher value goods and services (such as big-ticket electronics, sports equipment, furniture and dental and medical procedures). It is also used to finance subscriptions such as gym and club memberships, or for season tickets

  • The lending tends to be carried on by third-party lenders who tend to be authorised by the FCA for other regulated activities, and the lending is often brokered on-premises rather than online

  • Third-party lenders tend to have bespoke, long-term business relationships with relatively few merchants

  • Credit is more commonly offered over a full year and 12 instalments, reflecting the higher value of the underlying goods or services that are typically paid for using these arrangements

  • Consumers typically do not have an ongoing relationship or an account with the lender, with each credit agreement being a discrete transaction where a consumer provides their personal details.

Many analysts predict that the space will be further regulated in the future. CNBC reports that in the UK:

Such firms will be required to conduct affordability checks before lending to customers, the government said, while people will also be allowed to escalate complaints to the U.K.’s financial ombudsman.

Do BNPLs Encourage “Excessive” Spending?

The evidence is clear that they encourage more spending. More and larger purchases. In the US, many believe that people overextend themselves too much. That’s reflected in high bankruptcy rates and the average revolving debt per household.

But singling out BNPLs here seems inappropriate because the charges are generally less onerous than other forms of credit. Credit cards charge interest beginning at the end of a cycle. BNPL does not if people pay on time, though some do charge convenience fees at payment times.

Every form of consumer debt is used – and sometimes abused – every day.

Do BNPLs prey on those least able to afford frivolous purchases? Or do they serve those least able to pay upfront for necessary purchases?

The same question asked two different ways. Yes, making it possible to buy more now does increase the debt load of users, including lower-income users. And it may – and does – encourage some people to buy expensive “It” bags or whatever. But it can also give people access to necessities (like, for example, a bed) without incurring credit card charges or other onerous interest rate debt vehicles.

It seems pretty clear that the answer to both questions above is yes. Customers do make more and larger purchases, and those purchases are often in what seem (to judgmental people such as the author) like discretionary categories. Since some BNPL providers try to make their service “feel” different from credit, they benefit from the deplorable level of financial education, especially for lower-income households.

Such services also benefit from the impulse for instant gratification, which is an important predictor of long-term financial challenge. BNPL – and all forms of credit – encourage some people to live beyond their means. But ultimately, BNPL is more transparent and lower cost than most forms of credit.

Are BNPLs Going to Start Increasing Fees and Penalties?

No one can predict the future. But VC and PE investors don’t get into this sector with the hope of modest profitability. The BNPLs are currently battling for market share – in customer base and retail footprint. All - or nearly all – lose money primarily because of this battle.

But as the number of these providers declines, it’s logical to expect that fees will increase. Making a few percent from the retailer, and then little or no fees from the customer is a far cry from credit card charges of 15.9% (current US average) and the tendency of many customers to pay minimum balances over years. Further, credit card late payments often result in significant late fees and increased interest charges.

Net, it’s hard to imagine a future in which fees don’t climb. But until then, BNPL seems a good value as credit goers. If fees do go up in the future, people will have to weigh costs and benefits as with everything else.

Are BNPLs “another way for the haves to take money from the have nots in society?”

When you read discussions about personal finance, many focus on the growing gap between rich and poor – the gap is very pronounced in the US, and growing. From Pew Research:

As a form of credit open to all, with a less formal or extensive credit-worthiness assurance process, and relatively little government regulation, BNPL may have both short-term and long-term impacts on the debt load of lower-income households. That said, the current fee structure and a high degree of transparency these companies offer seem less likely to cause problems for low-income families than many other forms of credit.

Where That Leaves Us

After examining all of the data above and more, there seems a great deal of evidence that BNPL is a more ethical personal finance sector than many other options, especially for people with little or bad credit history. Like any form of debt, some spend too much through BNPL. But on balance, the transparency and relatively modest consumer fees so far seem far better than most alternatives.

BNPL seems designed to appeal to customers with very different attitudes toward credit than previous generations. The digital values – clarity, transparency, universal access – are critical drivers of success. They also appeal to people who may not have access to credit without paying onerous interest rates.

As with most issues, the ethics of BNPL aren’t black and white. But on the continuum of options, especially for those with limited income, they seem white hat. Or at least very, very, very light grey.

On the Record

Be Informed on the Regular.

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