Amit Das is the CEO and Co-founder of Think360.ai, which has developed Algo 360, a flagship product that is revolutionizing digital lending using alternative data AI/ML. He has 17 years of experience in the field of management consulting and strategic analytics advisory. He is responsible for building and scaling Analytics/ Data Science teams’ multiple organizations including Pricewaterhouse Coopers LLP USA, Diamond Management; Technology Consultants, 3i Infotech, Inductis and Tata Consultancy Services. He has advised Fortune 500 clients, and been involved in many industry firsts – India’s first alternate credit score, risk based dynamic pricing secured lending, first checkout technology, fist global digital payment customer segmentation, first mobile banking initiatives, first comprehensive SKU forecasting in retail, first integrated network view in healthcare, and much more.
Buy now pay later (BNPL) is big, and here to stay. There are varieties of BNPL, good and bad stories about them, and importantly, there is a sense of excitement that BNPL will be able to break into segments that other forms of lending (digital or traditional) have not made significant inroads into. The BNPL segment witnessed massive volume growth led by the post-pandemic pent-up demand. According to a report by Redseer, the current Indian BNPL market size is about $3-3.5 billion and is estimated to reach $45-50 billion by 2026.
The native digital UX, ease of execution from mobile apps, pay-in-3, limited credit checks, have made it a highly preferred mode of digital transactions. BNPL also eliminates the limitations of a 2-factor authentication (such as OTPs) requirement on credit card transactions.
But, BNPL, like most such “easy credit” products, is a double-edged sword. While the BNPL players need to worry about risk, fraud, and the underlying economic model, the customers need to keep an eye out for debt traps and adverse impact on their credit scores.
Modern BNPL is expanding the Traditional Credit Cards’ Universe
The oldest form of BNPL we know of is the neighborhood store extending friendly credit to the nearby residents. The system was near flawless, but not scalable. Credit cards introduced the broader population to formal and regulated cashless/ pay-later transactions. Now, modern BNPL is taking the idea and design several steps ahead – through form, format, and financial engineering. Will that make a difference? We think so.
BNPL growth is outpacing credit cards.
India has ~69 million credit cards, and 937+ million debit cards (as of Dec 2022). There have been several cycles of aggressive growth in credit cards followed by poorer portfolio performance, portfolio takeovers, and a pull-back from credit card issuers. Just in 2022 – credit cards grew by 14% while debit cards grew bhe growth in credit cards issued by banks is 14% as against 5% in debit cards. While the alphas of credit card segment remain larger players like SBI, HDFC, ICICI, etc. banks such as SBM, RBL, Federal Bank, Au SFB, etc. have grown their credit card base by over 100% in the last 9-10 months, primarily on the back of fintech partnerships. BNPL activation is being driven through discounts and offers at partners – food/ dining, fashion, beauty, and personal care (BPC) contribute to 60%+ of BNPL transactions. Average credit limits offered are sub-20,000 (pre-paid wallet backed BNPL) vs sub-2,00,000 for bank backed credit card rails-based products. BNPL focus has primarily been on non-discretionary and impulse spending like online shopping for clothes, smart gadgets, ordering good, booking holidays, etc. But it’s a matter of time that other categories such as education, healthcare etc catch up and drive the size of the pie.
BNPL is not as tightly regulated, yet, whereas credit card is a well-regulated credit product that, can only be issued in partnership with Banks (with the exception of SBI Cards) . Historically, all institutions desirous of issuing credit cards, would find co-branding and co-development opportunities -such as Bajaj Finance-RBL, MTV-Citibank, BigBazaar – SBI, etc. In these products, the primary onus of compliance is on the card issuing bank, while the marketing and risk budgets might be shared through some well defined financial arrangements.
A need to be cautious – for both BNPL players as well as customers
BNPL players are looking at a lucrative and large market, the economics of which remain largely unproven, especially for fintechs. This is true not just for India, but globally, if one were to look at companies such as Affirm.
It is difficult to make money on a credit card product unless customers spend consistently, for larger sums, and are open to revolving. Given the cost structures of a credit cards (with CACs of Rs. 3000+), it is financially unviable to have very low spend/ limit/ utilization credit cards. Every discount offering marketing campaign puts a bigger dent on the profitability. It remains to be seen if BNPL portfolios can make significant returns on their own (without migrating customers to traditional lending or credit card products). Recently, Zestmoney report highlighted that a high share of their revenues are through subvention/ affiliate commissions rather than interest or fee earnings.
Expect regulation! Since the BNPL schemes (non-card, for instance) is currently not a tightly regulated financial product, micro-credit is available to a large population and thus, is witnessing a considerable surge in customers’ adoption. However, the regulator has already started putting pressure on fintechs, and all the BNPL players should expect tighter regulations around the product.
Do not end up as a feeder line to large credit cards players. In many cases, shortly after a customer starts actively on a BNPL product, and as long as they remain prudent and disciplined about repayments, we expect their credit scores to improve. At this point, larger players with better underwriting algorithms, deeper pockets, and deep experiences will swoop in and offer products at lower cost, higher limits. Fintech companies have the lion’s share in the BNPL lending space. According to McKinsey’s Lending Pools data, fintechs currently have the majority of BNPL’s market share, estimated at $8-10 billion of annual financing. They need to innovate continuously to keep the customers, and not just acquire them for the feeder line to banks.
Manage risk better. Traditional risk models do not work on BNPL products – shorter loan tenures, extremely dynamic credit limits, heavy marketing for driving spend activations, etc. make it a very different P&L. Also, the simpler UX attracts higher fraud and payment defaults.
Leverage alternate data. Traditional data sources and approaches fail to provide the right framework for BNPL products. Alternate data and AI led credit scoring (such as Algo360) is near real-time, rapidly evolving on streaming data, and accommodates short-term signals.
Design experiments. The product is in its infancy, and is evolving at a rapid pace. Hence, the culture of experimentation should be central to BNPL risk management.
Deploy ML at the core. Given the speed of diffusion of this product, its important the risk models have a carefully constructed core powered by Machine Learning/ Deep Learning algorithms.
The customers, on the other hand, need to stay wary of debt traps and the potential impact on credit score.
Avoid debt trap. Most customers may end availing too many different BNPL offerings in quick succession, driven by the lure of the marketing offers. This can also trigger impulsive spending and can lead them into a debt trap. As was noticed over the last couple of years, several digital lenders abused this “need” to drive expensive “ever-greening” where customers were taking loans to repay off existing debt, thereby increasing the overall debt outstanding and a mounting debt trap.
Monitor your credit score. Customers may also have an adverse impact on their credit score if they avail multiple credit products in quick succession, and fail to responsibly manage them. This will eventually also lead to a higher cost of credit for them in the medium to long term.
Endnote
What started the idea of eliminating friction from a credit card process (because of 2-factor authentication/ OTPs), is evolving into attractive propositions like EMI cards/ BNPL cards allowing businesses and consumers to stretch. BNPL is a great tool to increase financial access and inclusion and equality among various classes and help the economy grow by creating demand with microlending. These products are helping a lot of customers manage their cash flow situations, and can act as micro-boosters for spending in the economy. Also, most prominent lenders are deeply aware of the shocks from COVID-19 pandemic and the subsequent NPAs, making them more prudent. What would support this further, is a thoughtfully regulated framework that can cater to the large unbanked population in the country.