THE ECONOMIST: Buy now, pay later swipes away stigma as shopping millennials & gen Z normalise booming BNPL

Burritos ordered online, concert tickets and Botox injections. These are not just must-haves for some consumers — they can now all be bought using buy-now, pay-later financing.

Such purchases are often the subject of derision. Paying for lunch in instalments is, to some, consumerism at its most ludicrous. Others see something darker: lending that skirts the edge of mainstream finance, preying on precarious borrowers.

Neither mockery nor anxiety have dented the industry’s growth, however. Worldpay, a payments firm, suggests that BNPL accounted for $US342b ($598b) in spending around the world last year, up from just over $2b a decade earlier. Older financial firms, such as JPMorgan Chase and PayPal, have entered the market, just as BNPL companies are taking on tasks that were previously left to banks. The opportunity for BNPL in business-to-business loans — a fragmented, old-school market — may be even larger than that for consumers. And a new market is emerging for portfolios of BNPL debt, which are securitised and bought up, often by asset managers.

The idea of a loan at the point of sale is an old one. In 1856 Isaac Singer and Edward Clark, an entrepreneurial duo, began selling sewing machines in instalments, with great success. The modern industry operates in a similar manner. When a customer buys a product for $100, they can pay in stages. The BNPL lender — perhaps Klarna, a Swedish company, or Affirm, a large American provider — pays the merchant upfront, in exchange for a cut of, say, $3.

This works for retailers, since it boosts sales. Customers with access to loans spend at least 20 per cent more relative to those without access, even as the sticker price stays the same. The customer pays back the sum over time, often six weeks, in four instalments and with zero interest.

Despite the industry’s recent success, there is reason to think it is still in the foothills. Fewer than 2 per cent of Bank of America customers born before 1965 have an outstanding BNPL payment, compared with 10 per cent of the bank’s millennial and generation Z clients. As younger cohorts come to account for more consumer spending, the market should grow. In countries where BNPL has been around longer, it contributes to more sales: over one in five of those made online in Sweden, against less than one in sixteen in America. Local and regional firms are popping up to offer the service: Addi in Colombia, Atome in Singapore, Tamara in Saudi Arabia.

As the industry grows, the borders between BNPL and mainstream finance are blurring. Klarna, an early mover, has been a bank in Europe since 2017. Sebastian Siemiatkowski, the company’s co-founder and boss, says he wants it to become a digital financial assistant enabled by artificial intelligence. Affirm launched a debit card two years ago, and has seen uptake soar of late: the firm now reports almost 2m cardholders.

Customers can use the cards in shops, either to pay in full or in instalments, bringing a financing method synonymous with e-commerce into the real world. In the past two years, both the BNPL giants have been integrated into Apple’s and Google’s digital wallets.

Established financial firms are moving in the opposite direction. PayPal began offering BNPL services in 2020, capitalising on its strong relationships with merchants. Last year the payments giant processed $33b in BNPL spending — an amount it says is growing at about 20 per cent a year. Several banks now allow customers to split larger payments into smaller chunks after purchases. And Klarna’s recent deals with payments firms such as Adyen, JPMorgan Payments and Stripe mean that its services are now provided to millions of merchants.

Several fast-growing startups hope to disrupt trade credit, a vast market in which suppliers lend money to firms that buy their products. American companies alone report about $4.9 trillion in trade payables, money owed to other firms for supplies purchased on credit. The market is about four times the size of the $1.2t in balances on American credit cards.

It is also antiquated and ripe for innovation. Suppliers doing the lending are forced to manually assess whether each of their clients are creditworthy, with little information to go on, and chase buyers for payments.

Matthias Knecht, co-founder of Billie, a firm specialising in business-to-business BNPL loans, suggests that such lending is roughly fifteen years behind the consumer market. Richard Thornton, co-founder of Hokodo, another startup, believes that the potential impact on business spending is greater than with consumers owing to the limited alternatives available to young firms. He says that when small companies gain access to BNPL lending, baskets grow by around 40 per cent on average.

For BNPL providers, expanding their lending operations as fast as possible means keeping a light balance-sheet. The idea of burrito-securitised bonds may be the subject of mockery, but the relatively opaque market for BNPL portfolios is booming.

Asset managers and private investment firms that are snapping up the debt believe they have found an appetising asset class in which underlying assets mature quickly. In October, Elliott Advisors, a British affiliate of a mammoth hedge fund, purchased Klarna’s $39b British loan portfolio. In 2023 KKR, a private-markets giant, agreed to buy as much as $44b in BNPL debt from PayPal. Affirm has issued around $12b in asset-backed securities. One BNPL insider calls the market “a feeding frenzy”, where there is not enough debt to satisfy demand.

Some difficult questions linger over the industry, which has ballooned over the past decade — a period without a prolonged downturn. Chief among them is whether it is facilitating risky borrowing by consumers living beyond their means.

Customers undoubtedly have lower incomes than those using credit cards. And there have been worrying snippets of news. Klarna’s consumer-credit losses rose by 17 per cent year-on-year in the first quarter of this year. Research by the U Federal Reserve suggests that the proportion of BNPL users who have made a late payment has climbed from 15 per cent in 2021 to 24 per cent in 2024.

All the same, default rates remain markedly lower than other forms of consumer credit. The Consumer Financial Protection Bureau (CFPB), a regulator, notes that default rates for BNPL loans were about 2 per cent between 2019 and 2022, compared with 10 per cent for credit-card debt held by similar borrowers. Although Klarna’s credit losses have grown in the past year, so have its balances. The company’s overall default rate is lower than the industry norm.

Could a growing pile of distressed consumer debt be hidden from view, beyond the sight of banks and policymakers? Some lenders worry about loan-stacking (borrowing from multiple sources at once). Such doubling up can cause a downwards spiral, with consumers taking on more and more loans in order to pay off earlier ones. Yet other research by the CFPB offers reassurance. It finds that measures of financial distress — such as revolving debt on credit cards or extra charges on credit-card loans — do not rise after BNPL use. Nor are BNPL users more likely to borrow from other sources in the eighteen months after agreeing to pay for something in instalments.

In June, FICO, America’s main provider of consumer-credit scores, announced it would begin providing scores based on borrowers’ BNPL histories. Julie May, an executive at FICO, notes a surprising finding from its year-long study with data from Affirm: for the most frequent borrowers, credit scores were improved or unchanged when BNPL loans are included. Research in Scandinavia finds similarly positive results.

Christine Laudenbach of Goethe University Frankfurt and co-authors recently looked at one million loan applications to an unnamed Nordic bank that makes use of BNPL data. Clients with a history of BNPL use, as well as a strong repayment history, were able to borrow at an average interest rate of 1.4 percentage points below the level suggested by their credit ratings.

The final verdict on BNPL will come only in a severe downturn. But although its users are young, and many are new to borrowing, there are reasons for optimism. As the new form of finance becomes increasingly mainstream, it looks safer and more useful than its critics argue. Buy that burrito, and don’t let anyone judge you.