Buy now, pay later must be regulated – now

Klarna, the world’s largest buy-now pay laterer operator, looks like another tumultuous success story for enterprising Sweden. First, Ikea turned the furnishings upside down. Then Spotify revolutionized music.

Now the fintech, co-founded by CEO Sebastian Siemiatkowski, is once again campaigning for Nordic iconoclasm. Klarna, bolstered by a group of other BNPL operators around the world, has modernized payments for the millennial generation, challenging a cozy credit card market long dominated by Visa, Mastercard and the banks that issue their cards.

The Swedish group, together with other BNPL operators, gives its customers a few months of interest-free credit for large and small purchases. It now announces that 147 million people worldwide use its services through 400,000 trading partners.

BNPL has thrived during the economic boom of recent years and received an extra boost during Covid-19 as people redirected spending to retail and shopped more online. It’s painless to shop for endless amounts of clothes, gadgets, and other consumer goods. What’s not to like?

Well, quite a lot. Skeptics have long pointed to a business model that can be both cynical and fragile. And today, along with its competitors, Klarna may face a variety of stresses.

According to an analysis by UK equity research firm Redburn last year, the average BNPL transaction relies on a 4 percent gross margin, funded by a commission charged to the retailer. But profitability, even in good times, has been very poor or non-existent.

Of that typical 4 percent, Redburn estimates that 2 percentage points are gobbled up in fees to other companies in the payment chain; 0.5 percentage points is the average financing cost; 1.5 points remain for credit losses and net profit. In BNPL’s short lifespan up to last year, Redburn estimated loan losses averaged 1.2 points, leaving room for gross profit (before operating expenses) of 0.3 points. Slim but worth it if the volumes are big enough.

Take a look at Klarna’s latest results and the shortcomings of this model are obvious, even for a high-volume gamer. In the first-quarter results, loan losses represented 1.9 percent of customer loans (up from 1.8 percent a year earlier), eating up a third of the quarter’s revenue and leaving Klarna at a net loss of 2.6 billion).

No wonder the company decided last month to lay off 10 percent of its 7,000 employees. And this is before the economic pressures from the global downturn really kick in.

Every element of the BNPL business model is subject to stress. Revenue is likely to falter as consumers rein in spending. Klarna’s customer loans of SKr 62 billion were up 38 per cent in the year to the end of March but were little changed from December, reflecting the worsening times. The sales pressure on BNPL operators is likely to be all the greater as users tend to prefer lower-income individuals.

At the same time, default rates are likely to worsen. A big part of BNPL’s appeal is that it offers loans that don’t require you to jump through hoops. The standard two or three month payment deferral agreements usually include ‘soft’ credit checks, if any, rather than full checks, which will be flagged up on your official credit report (although this changes in the UK).

Another pressure point is the financing costs. Klarna itself has a banking license and funds most loans from deposits. But no one will escape the pressure on margins from rate hikes.

This is all bad news for BNPL operators and their investors. But the effects can also be systemic. Although most estimates suggest that BNPL accounts for only a few percentage points of total consumer credit, the profile of borrowers can amplify the volatility of BNPL usage, disproportionately impact consumer spending and increase economic damage if it shrinks.

Customers tend to use multiple vendors and make dozens or even hundreds of purchases that overlap. Not only does this mean that individuals’ finances can spiral out of control; it also makes it difficult to capture the macro effect.

Because the sector is unregulated, no one knows exactly how big it is. Estimates of the size of the UK market vary widely, from less than £6 billion to as much as $20 billion.

If there’s a message for policymakers, it’s this: Klarna doesn’t make comfy sofas and warming meatballs like your favorite Swedish crate retailer. BNPL operators are moneylenders, pure and simple. It’s time to properly regulate this industry before it blows up on us all.

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