Understanding the Business Risks of Buy Now Pay Later

• Buy Now Pay Later is a relatively new form of FinTech tool. It is short-term financing that helps customers get over emergency financial requirements.
• But for businesses, it comes with its challenges. 
• We discuss some advantages it provides to customers, and also the risks to providers, along with mitigation

In contrast to credit card applications, buy now, pay later does not necessitate a credit check. Instead, these programs use algorithms to perform “soft” credit checks to determine a shopper’s eligibility.

According to Kaleido Intelligence BNPL Survey.

Its pay-over-time solution, ease of accessibility, and speedy onboarding process of customer-facing brands drive widespread adoption and rising average cart values.

For those with more stringent budgets, the option to spread out installment payments over time rather than incur a large upfront cost is appealing. Customers may find this convenient, but providers take on additional risks.

What is BNPL?

The term “buy now, pay later” (BNPL) refers to a financing option that lets consumers buy goods and services without immediately putting down the whole payment amount. It allows customers to finance purchases directly and repay them over time in fixed installments.

When a person needs more time to save money but doesn’t want to take advantage of a good deal, this financing option can be very beneficial.

Users guarantee to repay the money, just like when using a credit card. But unlike the credit card, it is easier to make payments. One of their biggest advantages is that these services usually come with no interest or late fees. The financing process is streamlined and made simpler by BNPL.

Furthermore, no credit check is necessary since BNPL withdrawals are made directly from the bank account. Depending on the provider, users can normally pay for their purchases in fixed installments over a predetermined length of time, which can be anywhere from three to twelve months.

Difference between BNPL and Credit Cards

Thanks to its clear advantages, BNPL is fast becoming a preferred form of payment for customers.

According to C+R Research Buy Now Pay Later statistics,

However, one of the biggest drawbacks is that not all merchants offer plans through BNPL services. On the other hand, Visa and MasterCard credit cards are accepted at virtually all establishments.

Additionally, BNPL cannot substitute for a credit card’s adaptability and ease of use in an emergency.

Despite these drawbacks, BNPL is seeing growth. Here are some reasons why BNPL is gaining an upper hand over credit cards:

Fees: There are no additional costs related to BNPL, such as joining, processing, or annual fees. On the other hand, credit cards come with additional costs such as joining, processing, and annual fees.

Procedure: In comparison to BNPL, the credit card application process is more complicated. People must provide their identity proof, financial records, and credit score to apply for a credit card. All that is required for BNPL is a Know Your Customer (KYC) procedure.

Interest rates: Compared to most credit cards, BNPL has a lower interest rate. With BNPL, customers can repay the full amount owed without incurring any penalties during an interest-free 10 to 30 days. Should they fail to complete the transaction, the penalty assessed will be determined by the amount of money used.

Credit limit: BNPL grants its customers credit limits with a certain amount limit in compliance with guidelines. There is no such cap when it comes to credit cards. The lender determines a customer’s credit limit after reviewing their credit history. This is an advantage for customers with sudden financial needs of the heavier kind.

Business Risk as a Buy Now Pay Later Provider

BNPL is impacting consumer lending and borrowing behavior today. However, though the BNPL concept may favor quick spending for the consumer, the providers have challenges they need to take care of.

Here are some stats from the 2023 Buy Now Pay Later survey by Money and Pensions service:

This indicates that consumers utilizing BNPL might be less inclined to accumulate a savings cushion. They are comfortable with this unlimited, zero-interest, any-time, any-amount availability of funds.

By offering a convenient and reasonably priced alternative to other forms of financing, BNPL loans can support consumers’ overall financial capabilities when used responsibly and transparently. BNPL lending does, however, come with risks for both banks and customers.

Banks are exposed to credit, compliance, operations, strategy, and reputation risks due to BNPL lending. Among the risks facing banks and customers are the following:

• It’s possible for borrowers to overextend themselves or to have unclear repayment obligations for BNPL loans.
• BNPL applicants may have little or no credit history, posing underwriting challenges to banks.
• Lack of standardized, unambiguous disclosure language may make it difficult to understand the true nature of the loan, injure consumers, or increase the chance of breaking laws against unfair, abusive, or deceptive acts and practices.
• For banks and BNPL borrowers, merchandise returns and merchant disputes can present challenges because they might not be settled in the short loan term.
• Relationships with third parties can make a bank more vulnerable to risks related to operations and compliance because the bank might need to have direct control over the work that the third party does.
• Due to BNPL lending’s highly automated processes, prompt credit decisions, and heavy reliance on outside parties, there is a higher risk of fraud and other operational issues.
• Structures with BNPLs may have a higher risk of first-payment default due to borrower error or fraud. Since loan payments are made using a debit or credit card, going over the limit may result in additional costs for the borrower, including late fees, overdraft fees, and non-sufficient funds fees.
• Given the limited amount of BNPL activity that credit reporting agencies can obtain, lenders might need to know about an applicant’s borrowing activities on BNPL platforms.

How BNPL Can Providers Reduce Fraud ?

The primary factor contributing to the BNPL model’s success is its ability to provide customers with immediate access to credit. The point-of-sale loan in place is crucial to this payment strategy.

BNPL providers must utilize new technology to assess fraud more precisely in a manner that does not disrupt the customer experience to maintain the checkout process’s speed and security.

Businesses are increasingly turning to artificial intelligence (AI), machine learning (ML), and device fingerprinting to do that by discreetly screening potential clients in real time.

• The Capability of Machine Learning

Compared to employing fraud rules alone, BNPL providers can more accurately fraud detection with the high-performance analytical power of machine learning.

Machine learning (ML) can establish links between recent transactions and past fraud cases as they occur to detect and stop fraud proactively.

BNPL providers can analyze transactions much faster and more effectively with ML technology. It can identify patterns that older systems would have missed and relieve internal fraud teams of some of the burden of reviewing transactions.

The advantage of machine learning is its ability to continuously retrain models, enabling them to keep up with evolving fraud threats. Adding fraud cases and manual reviews can improve the model’s recommendation accuracy.

• Credit risk modeling

It helps BNPL (Buy Now Pay Later) providers protect themselves from customers who may default on their payments.

Given the regulatory emphasis on consumer financial security, effectively onboarding the appropriate customers is critical for mitigating risk.

• Device monitoring and authentication

Device fingerprinting is another technology that can greatly improve fraud screening for BNPL providers.

The ability of BNPL providers to gather and evaluate distinct identity data from each device can significantly improve their power to prevent fraud.

BNPL providers can identify fraudsters before they purchase by analyzing customer behavior and device data. ML tools can help them in device fingerprinting through a multi-layered approach. This process is automated to avoid inconvenience to authentic customers and proceeds directly to checkout.

Machine learning and device fingerprinting are the most effective techniques to examine device location, operating system, timestamp, and other data. It helps to spot minute alterations in user behavior that point to fraud risk.

BNPL providers can identify suspicious behavior before the fraudster proceeds to the payment stage. This is possible using tools to monitor password resets, IP address changes, and new device logins for accounts.

Key takeaways: 

Businesses can increase their Average Order Value (AOV) and improve the customer experience by providing more payment options through BNPL.

However, there could be risks like high merchant fees and customers’ chance to switch to BNPL exclusively. These need to be carefully thought through.

Brands need to stay updated about regulatory and compliance changes in this area. This will help them stay abreast of concerns like consumer debt spirals and the possibility of new rules about these debts and BNPL.

Businesses should keep a close eye on these constant BNPL developments to maximize the benefits of BNPL and address potential issues that may impact their financial performance.

Also Read: Buy Now, Pay Later (BNPL): Comprehensive Guide for 2024