Is the Party Over?

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Tobias Baer shares an article on credit risk and the perils of the buy-now-pay-later trend.

A just-published TransUnion study shows that buy-now-pay-later (BNPL) takes the UK (just as other markets) by storm, with 35% of the population having used it in the past 12 months (driven in particular by Gen Z and Millennials with up to 60% usage). There are both obvious and not-so-obvious implications for traditional lenders.

BNPL promotes further fragmentation of consumer debt – and therefore will make it even harder for less disciplined consumers to keep a grip on their financial obligations. 50 years ago consumers could easily understand their financial capacity by checking the amount of cash in their wallet – that was all available to spend. The credit card has greatly increased both financial flexibility and the haze through which consumers see their financial capacity – but many cards give consumers at least some orientation by indicating the credit line and the available “open to buy” portion. By contracting loans one merchant transaction at a time, a consumer needs to be a real accounting wizard to know at every point of time how much money she owes or still can afford to spend.

For traditional lenders, this means that the large portion of borrowers with relatively low “conscientiousness” (i.e., limited financial planning and self-control) is becoming even riskier as the risk of excessive borrowing has become even greater. This is not only because BNPL fragments the financial affairs of consumers but also because BNPL is offered through retailers who want to use credit to maximize sales – in a sense, retailers suffer from insufficient conscientiousness themselves when they prioritize short-term sales maximization over long-term trouble for their customers (as customers going through personal bankruptcy barely make an attractive consumer). In addition, many retailers (rationally) subsidize borrowing cost by sacrificing a part of their margin, essentially to bear credit losses. As traditional lenders only can use interest and fees to cover their losses, they are at a structural disadvantage.

 

Key points include:

  • Consumer psychology
  • Limited financial planning and self-control
  • Credit bureau regulations

 

Read the full article, How will BNPL Affect Credit Risk?, on LinkedIn.