We are witnessing a surge in buy now, pay later deals around the world.
While BNPL can be a useful alternative to other more costly credit sources, there is justified concern about consumers becoming over-indebted. These concerns are adding to voices calling for steps toward tighter market regulations.
What is prompting this interest in BNPL and what are the hidden risks to consumers?
How does it work? The concept is simple. The buy now, pay later provider operates the payment system for an online merchant. When it is time to pay, they run a proprietary algorithm using a wide range of data about the customer and the goods in the basket. If the algorithm approves, they then offer the customer no-interest, installment-based short-term credit, such as paying nothing now and the balance in 30 days.
That raises the question of who is paying. The answer is: Merchants. BNPL firms were founded to address one of the biggest problems with online commerce: Customers who go through the complete process but then do not hit the final “buy” button. BNPL providers reduce “basket abandonment” through the provision of interest-free, instant credit. In return, the merchant pays a fee, a few percentage points higher than conventional payment processing options. This creates an important dynamic. While credit card companies can make money out of those who struggle to keep up with payments (as long as the borrowers do not outright default), the BNPL providers have different incentives. As they do not charge interest, they need to get their cash back quickly to fund the next purchase transaction. It makes little sense for them to fund the purchases of those who go absent after happily taking delivery of the goods.
BNPL’s focus on fashion and beauty suggests that they are focusing more on impulse purchases that threaten to push consumers into financial overcommitment.
Mohamed Ramady
The interest in BNPL has evolved with consumers’ shopping preferences. Before the emergence of online shopping, there were shopping catalogs, published and distributed by retailers who offered everything. Shoppers could browse through the pages and order, by mail, the items they wanted. Payments could be made via bank transfer or checks, and in most cases, paying in installments (usually with some interest or added fee) was also an option.
As e-commerce began to take hold, these catalogs were eventually replaced by websites. However, technology was the key in helping BNPL take off. Growth in e-commerce is closely aligned with innovation in financial technology, particularly in digital payments.
Some 10 new BNPL startups have emerged over the past year across the Middle East and North Africa. It is a segment of fintech that has benefited from the pandemic, bolstered by the rise of e-commerce and the ongoing uncertainty over financial security among large swaths of the population. Investor enthusiasm is remarkable.
In the UAE, there are leaders in this sector. Tabby, the UAE and Saudi-based fintech provider, has announced that it has raised Series A financing of $23 million in debt and equity led by Arbor Ventures and Mubadala Capital.
Is there a viable future for BNPL? As the only part of the value chain that customers can control, they want to receive and touch the product before they pay for it. BNPL allows them to do this. They receive the product and pay for it in small amounts as opposed to a big financial commitment in one online transaction.
With BNPL, customers can receive their order first and when it is received and are satisfied, that is when they pay.
What is the impact on consumers of BNPL? What causes some concern is the psychology of the buy now, pay later checkout. A credit card requires a formal application. Getting BNPL credit happens in a single click at the checkout when the consumer is focused on acquiring something they want, not on making a measured assessment of their finances.
Unlike credit card providers, BNPL providers do not exchange information about bad payers or share data with credit agencies, although this may change. This means that a consumer could potentially run up credit with multiple providers on top of other debts. That is not the only looming problem. New providers could create lookalike services with a more exploitative business model. For instance, current providers monetize the valuable data they collect across merchants by sending consumers targeted offers. They could also be more ingenious in finding ways to extract value from late payers, such as by referring them (for commission) to other services, such as debt consolidators.
There is some evidence of young people racking up large debts with BNPL offers, and so-called social influencers promoting this service to naive followers.
BNPL’s focus on fashion and beauty suggests that they are focusing more on impulse purchases that threaten to push consumers into financial overcommitment, while presenting itself as a consumer-friendly cash flow management tool rather than an interest-free loan.
There are currently no regulations in the Middle East specific to BNPL, but in October 2020, Tabby and Saudi-based Tamara became the first BNPL startups to operate in the Saudi Central Bank’s regulatory sandbox.
Is this regulatory oversight enough? The sector is still too small in the region to attract the focus of regulators or even banks for that matter. The market is big in the region, but it is not big enough for six, seven or 10 players, and in the coming months we will start to see some of the players who have been late to the market fizzle out.
• Dr. Mohamed Ramady is a former senior banker and Professor of Finance and Economics, King Fahd University of Petroleum and Minerals, Dhahran.
