Another red flag emerged from the recession last week: fintech startup Klarna announced it would lay off 10% of its 7,000-employee workforce to cut costs. Founded in 2005, Klarna has grown into Europe’s most valuable private company, valued at $46.5 billion, with ambitious plans to break into the U.S. market with a much-anticipated IPO. Its core product is simple: give online shoppers the option to pay in instalments with zero interest.
The bet made by the company’s Swedish founders that consumers, especially younger ones, could be lured by the new, online-focused financial offerings, appears to be paying off. Buy now, pay later (BNPL) loans are now a $100 billion global market, of which Klarna is the largest single payer. The main source of a lender’s revenue is the retailer’s fee – usually about 4% of the sale price. For retailers, the incentive is an increase in sales— up to 30%according to an estimate in the United States.
Like the rest of the digital economy, the pandemic has transformed BNPL.Financial Conduct Authority’s Woolard Review finds BNPL market in the UK Quadrupling in 2020 to £2.7bn, accounting for about 1% of the entire credit market, with 5 million users. The growth dramatically bucked an industry-wide trend as households were suddenly confined to their homes and spending significantly less, starting to pay down debt and build up savings. The expanding BNPL borrower base is also young: in the UK, three-quarters of borrowers are under the age of 36, according to a Woolard report.
Klarna’s valuation soared. BNPL’s impressive growth points to the possibility of future expansion, fueled by the belief that the pandemic has permanently changed shopping habits. Big tech funds like SoftBank and Sequoia have poured into the industry in 2020 and 2021.
BNPL’s business model relies on chasing a penny from marginal borrowers — people who may not be brought into additional borrowing at all. According to Citizens Advice, a quarter of UK BNPL borrowers say they use it for other things they can’t afford, suggesting they don’t have access to other types of credit.The industry has small profit margins – perhaps only 0.3% profit In a typical transaction, it is comparable to that of other financial products. But as Redburn equity strategists say, the key difference between more traditional lenders and BNPL is that BNPL spends far less on risk assessments and customer credit checks. In regions with poorly regulated financial systems, BNPL relies on providing relatively small amounts of credit to lenders that might otherwise fail traditional lenders. In boom times, that didn’t seem to be a problem: The number of borrowers who couldn’t repay was relatively small.
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But the pressure will become more pronounced as broader economic conditions deteriorate. Citizens Advice reports that one in 10 people in the UK used BNPL to buy essentials in the six months to March 2022. Borrowing on credit cards and other consumer loans has risen sharply over the past three months, even as retail spending has fallen. Cash-strapped households facing higher prices for basic commodities such as fuel, energy and food are reportedly cutting back on non-essential spending. As inflation heads into a lockdown-free spring, this has had some unusual effects – UK Netflix subscriptions are down, overall retail sales are down, but restaurant and pub sales have risen slightly over the past three months. Crucially for Klarna and other BNPL suppliers, however, online sales continue to decline.
In principle, BNPL’s proposal to share the payments could provide some temporary relief to households squeezed by debt. cost of living crisis. But as long as inflation Still well above growth in household income – whether from wages and salaries, pensions or welfare payments – is not a sustainable solution. Back in November, a major bank reported to the Woolard Review that 10% of customers using BNPL exceeded their overdraft limit in the same month.More and more BNPL customers will be delinquent and defaulted – especially if they are wrongly sold loan products: 40% of BNPL customers reportedly have unknowingly borrowed.
At the same time, the suppliers themselves are already barely making ends meet, and their own borrowing costs will rise sharply as interest rates rise and commercial loans become more difficult to obtain. Credit costs for Klarna have increased significantly since the start of the year. Investors are increasingly wary of the industry. US-based BNPL company Affirm went public last year, but its value has fallen 60% since peaking in November. As of March, Klarna itself was still in a public offering, but the valuation is expected to be a third below its 2021 peak. Profits were hard to come by before consumer prices surged: Klarna had been profitable for several years in a row, but rapid cost growth, fueled by expansion, produced even bigger losses, doubling to 5.4 in 2021 billion pounds.
The BNPL market is unlikely to survive the cost of living crisis in its current form. But the industry’s woes are an ominous harbinger of an impending recession and tell us what it might look like: households squeezed to a breaking point by high prices and low incomes; many fintechs can’t afford to trade at higher rates and higher risk environment; and the possibility of a major consumer debt crisis by this fall. Debt relief and write-offs, especially in cases of misselling, should be a core part of the response.
[See also: What is inflation?]