Why ‘Buy Now, Pay Later’ Plans Are Threatening Banks And Credit Cards

CNBC

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Video Summary

Buy now, pay later (BNPL) services are experiencing rapid growth, offering consumers an alternative to traditional credit cards by splitting purchases into interest-free installments. This trend is particularly appealing to younger demographics and those who prefer to avoid credit cards due to past debt issues, with 20% of US households falling into this category. Retailers are embracing BNPL to boost sales, as it encourages larger purchases and makes items appear more affordable upfront.

Traditional lenders, like banks and credit card companies, are wary of BNPL's impact. BNPL loans often don't appear on credit reports, creating a "black hole" in consumer credit profiles, which makes it difficult for lenders to assess risk accurately. This can lead to more conservative lending practices and stricter credit criteria from these institutions.

The integration of BNPL into credit scoring models is evolving, with companies like FICO introducing new scoring systems. However, questions remain about data sharing from BNPL providers. The financial landscape is shifting, with traditional institutions launching their own BNPL options to remain competitive and offer consumers a wider range of payment choices.

Short Highlights

Buy now, pay later (BNPL) services are rapidly growing, offering consumers an alternative to credit cards with interest-free installments.
BNPL appeals to younger consumers and those who have had negative experiences with credit cards.
Retailers are adopting BNPL to increase sales by making purchases seem more affordable and encouraging larger cart sizes.
Traditional financial institutions are concerned about BNPL because these loans often don't report to credit bureaus, creating a gap in understanding consumer debt.
The credit scoring system is adapting to BNPL, with new models being developed, but data sharing from BNPL providers remains a challenge.

Key Details

The Ubiquitous Rise of Buy Now, Pay Later [00:00]

Consumer use of buy now, pay later (BNPL) services is continuously increasing, becoming widespread in online shopping and in-store purchases.
BNPL plans alter consumer spending habits by allowing purchases to be divided into short-term, typically interest-free installments, serving as an alternative to credit cards.
Credit itself is not new, but credit cards have struggled to adapt to consumer needs, leading to widespread adoption of alternatives.
BNPL was created for individuals who either preferred not to use credit cards or had limited credit available.
There is a significant opportunity to disrupt the credit card industry in the US.
One of the largest BNPL players saw its stock increase by 15% during its public trading debut.
Beyond challenging credit cards, banks and financial institutions have other reasons to be cautious of BNPL users.
In 2024, an estimated 86.5 million Americans used BNPL loans, projected to rise to 91.5 million in 2025.
BNPL currently represents a large unknown in credit profiles and the understanding of consumer credit quality.
New product introductions often face skepticism and uncertainty, with existing players aiming to protect their products.

The thing that we're seeing in the industry right now is widespread adoption of alternatives to credit cards.

The Mechanics and Growth of BNPL [01:49]

BNPL typically involves paying a portion of the price upfront, followed by three bi-weekly installments for the remainder.
These are essentially short-term financing tools at the point of sale, with prominent BNPL providers displayed at checkout.
The number of BNPL loans originated in the US by the top five lenders grew from 16.8 million in 2019 to 180 million in 2021, a 970% increase.
Nearly half of Americans have used a BNPL service, with 11% having used one at least six times.
BNPL loans are appealing due to their accessibility, affordability, and convenience.
Approval rates for BNPL are around 80%, which is notably higher than many traditional credit products.
Approval is instant, making the process quick and frictionless.
BNPL is especially popular with younger consumers, with half of those under 40 having used an installment plan.
Younger consumers, particularly when shopping online, are seeking alternative payment methods.
There's a segment of consumers, termed "self-aware avoiders," who have tried credit cards, experienced debt, and now prefer BNPL for its fixed installments, 0% interest, and clear budgeting.
This group constitutes 20% of American households.

Approval rate is around 80% typically for consumers who requesting these at point of checkout. That's a notably higher approval rate than many traditional credit products.

Merchant Benefits and Lender Concerns [03:39]

Unlike credit card companies that earn revenue from interest, BNPL providers primarily charge fees to merchants.
Retailers increasingly embrace BNPL to boost sales.
Stores like BNPL because consumers tend to spend more, and purchases appear cheaper when only a quarter is paid upfront.
BNPL allows consumers to make purchases outside their typical budget or existing financial means by spreading out the financing.
The goal for retailers is to increase checkouts and the size of shopping carts.
Banks have both justifiable and less justifiable reasons for being wary of BNPL loans.
BNPL and other fintech companies compete with legacy businesses in lending and deposit services.
Every purchase financed through BNPL is a potential purchase that could have been financed by a credit card or checking account, reducing card transaction activity and utilization, which are major revenue drivers for banks.
Banks make significant revenue from credit cards, and a shift away from them is not favorable.
Approximately 80% of credit card profits come from interest charges, with the remaining 20% from late and other fees.
In 2022, credit card companies charged consumers a record $130 billion in interest and fees.
This interest revenue is lost to incumbent financial institutions when purchases are made via BNPL and go to a third party.
As consumers use credit cards less, their balances become less utilized, decreasing potential fee and interest revenue.
The US credit card market is rich with rewards for those with good credit, income, and credit limits, which is not the primary focus of BNPL.
BNPL is designed for individuals with mid-prime credit scores who may have less open credit.
The consumer credit industry is enormous, with over $1.2 trillion in revolving credit balances and over $5 trillion in consumer credit transactions in the US.
There is a clear understanding that changing this market will not happen overnight.
BNPL introduces competition, especially for small-dollar, short-term lending products that banks often don't offer.

Around 80% of credit card profits come from interest charges, while late and other fees make up most of the remaining 20%.

The Credit Reporting Gap and Consumer Risk [06:44]

BNPL loans represent a significant gap in understanding a consumer's financial life because the majority are not reported to credit bureaus.
Lenders have difficulty knowing how extended consumers are on their credit obligations without this data.
When assessing loan risk, banks need to know a borrower's existing debt. If BNPL debt isn't on credit reports, lenders may not have a complete picture.
This lack of information forces lenders to be more conservative, tightening approval criteria, reducing credit lines, and potentially increasing interest rates.
A 2023 Consumer Financial Protection Bureau report found BNPL users tend to have lower credit scores, higher credit card balances, and are more likely to be highly indebted than non-users.
BNPL users are often financially fragile, carry more debt, and may miss payments.
Taking out BNPL loans can indicate maxed-out credit cards or struggles to pay for items in full.
Industry-wide, BNPL borrowers are increasingly falling behind on payments, with 41% reporting late payments in the past year, up from 34% the previous year.
One major BNPL provider, which began sharing all consumer data with credit bureaus, uses machine learning models to achieve better credit outcomes and extend credit responsibly without late fees or revolving debt.
Some experts believe current credit scoring models are not well-suited for BNPL loans, potentially making it appear as if a consumer is maxing out their credit when responsibly using multiple BNPL loans.
BNPL, if not paid off, could hurt credit scores, and it's unclear if it can help credit.
Credit bureaus and scoring companies need to ensure BNPL doesn't harm credit.
Positive repayment information from BNPL users is considered crucial for future credit reporting systems.
Credit bureaus are struggling to incorporate BNPL data to accurately reflect consumer financial situations without unfairly punishing users or failing to reflect risk.

Even though their FICO scores may be lower, some experts say the current credit scoring models are not well designed for buy now pay later loans.

The Future of BNPL and Credit Integration [10:02]

FICO announced a new credit scoring model that will factor in BNPL loans, rolling out this fall.
Questions remain about whether existing BNPL companies will share the necessary customer data for these new models.
If BNPL data negatively impacts customers, companies might withdraw their data from these scores.
Several traditional banks have launched their own BNPL offerings to compete.
The question is whether these traditional institutions can replicate the experience consumers enjoy from BNPL innovators.
The future will likely see an opening up of payment options, allowing consumers to choose their preferred journey, whether it's BNPL, installment loans, or credit cards.
These different industries are starting to converge, offering various products for consumers to decide upon.
The vast amount of consumer credit consumption in the US presents an opportunity to offer better financial products.