“Buy now, pay later” (BNPL) has exploded in the UK in recent years – one click, and the price of that new frock is divided into neat, affordable bundles. In a consumer culture in which speed and novelty are paramount, it is used by more than half of millennials to put off purchases until payday.
Companies such as Klarna, Clearpay, Laybuy and Openpay are thriving – Worldpay estimates that five per cent of online buyers break up their purchases in this way. Customers don’t pay any interest or charges, and retailers pay a small fee (comparable to the fees paid for processing card transactions) to the BNPL providers. In return, they get shoppers who are ready to spend without hesitation on what looks like a much smaller payment.
What BNPL companies actually do is extend miniature interest-free loans. Their margin comes from the difference between what they make from providing their services to retailers, and what they spend lending money to shoppers. The problem is that these companies rely on low interest rates. As central banks begin to raise rates, the BNPLs’ margins will narrow. Their scale and popularity is such that this could have knock-on effects for all of us.
Prices are on the rise: in the UK, inflation is forecast to reach 8 per cent by April, its highest level since the early Nineties. To combat that, the Bank of England has begun a rate-hike cycle, edging up interest rates every month. Faced with a supply crisis and rising energy costs, central banks all over the world are doing the same: increasing the cost of borrowing in order to dampen demand for goods and keep prices from rising still further.
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For companies like Klarna, which is based in Sweden but is one of the UK’s largest BNPLs, that’s potentially bad news. Klarna funds its loans in two ways: some comes from deposits across its banking arms, which operate in Sweden and Germany. The rest comes from its own borrowing: in the next two years, 3.1 billion krona (£244m) of bonds will mature, according to Bloomberg.
As rates start to rise, Klarna will be forced to pay its savers more for their deposits, and it will pay more for its borrowing. The problem is that its margins are already “razor thin”, says Jeff Tijssen, global head of fintech at the consultancy Bain & Co. Meanwhile, after several years of rapid expansion, Klarna made a loss of (coincidentally) 3.1 billion krona in the nine months to September. If rates rise, “what is likely to happen is that margins are contracting because of an increase in the fixed costs of running these businesses,” says Tijssen.
Klarna has already acknowledged the risk. In a prospectus for a 10bn krona bond in November, it said “the degree to which interest rates may vary… presents a significant risk to Klarna’s financial position”. It is not the only company that’s concerned: last week an American BNPL, Affirm, was even more explicit. In an investor call its chief financial officer, Michael Linford, warned that after 2023, every time borrowing rates rise more than one percentage point above expectations, one measure of its profit could fall 0.4 percentage points (on the same day its shares fell over 20 per cent after it accidentally posted its second quarter results on Twitter).
What are the BNPLs’ options? They could start charging their customers interest, although that’s unlikely, says Alice Tapper, the financial campaigner. “The reason that Klarna is able to exist is because of a loophole in the Consumer Credit Act, which says that if a product is no-interest and relatively short-term, it doesn’t need to be regulated,” she says.
Klarna does have a financing option that charges interest on larger transactions, she says, although it’s not likely to become the company’s core offering. There are other options: it could, for instance, charge merchants higher fees.
This is where it becomes everyone’s problem. There is already widespread evidence that the prevalence of BNPL is increasing costs for retailers: last May Klarna’s head of US, David Sykes, told Forbes that “we see retailers’ average order value increase between 20 per cent and 80 per cent” when Klarna is used. In other words, because they can afford it, people buy more.
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That’s good for retailers, because they make more – but the phenomenon has already increased prices, thanks to returns. “The merchant has to pay for posting, they have to pay to get it back. Very often, the products returned are not sellable anymore. They have to build in this huge cost,” says Ania Zalewska, a professor of finance at the University of Bath. Indeed, one KPMG report showed that returns are costing British retailers £7bn a year: many goods go to landfill because they can’t be sold on.
If interest rates increase, BNPLs will probably increase the amount they charge retailers – a cost that retailers will, naturally, spread across all their goods. So the more people who use Klarna, and the more they return, the higher prices will become for everyone.
This isn’t a problem that’s confined to fast fashion: BNPLs have already entered the grocery market. In the UK, Zilch.com advertises ways to pay for shopping at Asda and Morrisons on its website through its own service, although so far, no UK grocers offer a BNPL option. However, a survey by Pymnts.com has found 25 per cent of US grocers are planning to introduce BNPL in the next year. If more people choose to spread the cost of their weekly shop – and as inflation escalates, this could become more popular – then increases in BNPL fees could elevate the cost of food, whether you use BNPL or not.
What’s next for these companies? This week four BNPLs agreed to change terms and conditions that the Financial Conduct Authority said were “potentially unfair” – a small but significant step towards regulation. Meanwhile, Tijssen suggests the companies will begin to look at new ways to make money. Klarna, for instance, has already entered people’s wallets with a credit card that allows them to spread the cost of purchases. “When you speak to any… player, especially the more established ones, buy now, pay later was their entry into the market,” he says. “It was never the end game.”
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