Is BNPL’s Profitability Problem an Opportunity for Banks?

Is BNPL’s Profitability Problem an Opportunity for Banks?

Is BNPL’s Profitability Problem an Opportunity for Banks? 

By: Tyler Brown

March 5, 2024

Buy now, pay later (BNPL) providers have bright prospects, as we wrote in our preview of 2024, as they continue to grow quickly and test new products that compete further with banks. But profitability is a sticking point. When interest rates were low, these companies were awash in venture capital and very unlikely to secure cheap long-term financing. Now, private capital is harder to come by (and some bigger ones like Affirm are no longer tied to it) while rates are higher. Altogether, this dynamic appears to be squeezing their margins, as they’ve become reliant on pricey debt to fund their loans. This could present an opportunity for banks to compete and win with such products.  

Affirm, which is public, shows how this debt can hurt. The rates it pays on loans are tied to an interest rate benchmark, which means that the company probably pays about 7% to banks and other lenders. Those interest payments together have reduced Affirm’s cash flow, forcing it to depend on convertible debt and cash it raised in its IPO. Cash flow challenges also raise the risk that the company will need to secure more financing.  

Banks, on the other hand, have built-in strengths in the BNPL space, should they choose to use them. First, deposits, while currently under pressure, are cheaper funding than debt, meaning that banks in general don’t face the same high financing costs as BNPL providers. They should also know how to manage credit risk and know enough about the risk profile of their retail customers to be able to extend credit profitably. 

Some banks have used their advantage to dabble in BNPL. At least several offer fixed-rate installment plans using consumers’ existing lines of credit. This approach is likely efficient to implement and makes it unlikely that bank BNPL offerings would compete head-to-head with credit cards. Others have created a BNPL product tied to a standalone payment method, like a card. Banks aren’t on their own to build these products, either — Visa and Mastercard offer application programming interfaces (APIs) to help. 

The “dabble” approach to BNPL, however, isn’t enough to compete effectively with BNPL providers in the long run, despite banks’ lower cost of funds and risk management advantage. That’s true for three reasons:

  1. BNPL providers have classically competed at the point of sale by being embedded in the checkout process. By issuing debit cards, they also now compete directly with cards issued by banks. 
  2. Digital wallets elbowing into BNPL create another competitor to banks at checkout and are particularly dangerous if there are multiple ways to pick a BNPL option — like if multiple BNPL choices are available in a wallet. 
  3. BNPL providers may eventually become cost-competitive with banks’ financing, perhaps by acquiring a bank license and offering deposit products. That’s not an outlandish possibility — Klarna acquired a European banking license in 2017 — though it would likely be harder to achieve in the US. 

“Dabbling” also doesn’t address a crucial point for banks to offer a competitive BNPL product: The customer experience. There’s friction in the experience of using BNPL when it’s a feature secondary to a credit card — much more friction than clicking to use a payment option embedded in checkout. 

Paze, a bank consortium’s digital wallet, could fix this friction by rolling up a BNPL option with a bank’s other payment products. But banks first need to offer BNPL as a standalone product that a customer can pick right away as a payment option, and a dedicated experience within digital banking to manage BNPL payments. 

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