It should come as no surprise to anyone in finance when traditional lending corporations take issue with emerging competitors. However, the level of vitriolic commentary that often results from such criticism might be surprising.
In the debate between traditional lending and emergent “buy now, pay later” (or “BNPL”) providers, the back and forth brings up several pros and cons for both sectors that bear further discussion. These concerns beg the question: which lending source is best and why?
Barclays vs. Klarna
Earlier this week, tensions between the banking establishment and the increasingly popular BNPL sector bubbled to the fore. This came after a particularly thorough report published by Barclays and StepChange cast aspersions against the BNPL industry.
The report implied that nearly 900k British citizens might find themselves in financial straits due to selecting BNPL payment options. Citing the role of retailers in the BNPL landscape, the bank argued they fail to fully understand the “pitfalls of unregulated lending” for unsuspecting consumers.
This debate brings many industry tensions to the surface, particularly during a summer rife with lingering supply issues and skyrocketing global inflation. Are alternative lending sources like Klarna and Quadpay a better option during these uncertain times, or does Barclays have a point?
According to Forbes, BNPL options might seem like free financing, but they aren’t. There is the risk that consumers can use BNPL options to make non-essential purchases that get them into trouble later.
Although BNPL promotes the idea that consumers can have whatever products they want for small interest-free payments, this is still a loan. And, like any loan, BNPL arrangements may bear serious consequences for those unable to pay. Additionally, since there is a decided lack of regulation and limit-checking involved with BNPL, users frequently find themselves in uncomfortable financial situations.
Despite these legitimate concerns, Alex Marsh, the head of Klarna UK, issued a statement in response. “It is mind-boggling and frankly irresponsible in a cost of living crisis that Barclays should use StepChange to endorse their high-cost installment credit product, which charges 10.9% interest and to lobby against interest-free and manageable Buy Now Pay Later products,” he said.
Marsh added that Barclays’ conclusions are patronising to both consumers and retailers. It is “unsurprising that UK retailers, like their customers, are ditching the old banks,” he says.
Traditional Lending: Up Close
In our estimation, both sides make excellent points, although further research is certainly needed. Whether one is better than the other remains to be seen, as each holds its own share of benefits and potential pitfalls for the average consumer.
For instance, a traditional term loan is financing provided by a bank that ensures the loan is paid back incrementally over a fixed period. Standard bank loan terms are generally set between 1 and 25 years (depending upon the size of the loan, what is being purchased, etc.) and hinge upon monthly payments.
To be approved for such a loan, a customer must prove their loan viability. This is done through strict background and fiscal health checks to determine what they can afford before a loan is extended.
Such a stringent approval process protects the bank and its subsidiaries from bad loans issued to customers who cannot afford the services they are applying for. However, it can also be exclusionary, and perpetuate individual and broader social problems.
Relying heavily on credit bureau reporting to determine a customer’s worthiness bears two serious side effects. First, it creates large tracts of untapped revenue. Second, it can foster a general lack of consumer confidence and trust.
Regardless of these concerns, traditional lending is, for the moment, the preferred method. It often guarantees the customer meets or exceeds lending criteria.
What About BNPL Options?
BNPL and other alternative lending forms don’t rely upon credit reporting or financial health checks to determine a customer’s loan worthiness. BNPL servicers like Klarna set a low lending limit from the start, which a customer can increase as they make successful payments through the repayment process. Lending through Klarna, in particular, processes payments through valid checking accounts only. The company will divide the item’s cost, then divide those payments into a bi-weekly schedule that will be auto-debited from the customer’s account.
As of yet, BNPL options rarely factor outside retail and are therefore not subject to long-term lending terms like traditional bank loans. Most BNPL loans are per-item or checkout cart-based and generally operate within a predetermined amount.
This payment method is very popular with consumers who feel the post-pandemic inflation crunch. These buyers seek to make guilt-free purchases that can be broken into manageable, bi-weekly payments that deduct straight from their bank accounts. This ‘hassle-free’ approach to lending encourages consumers to spend money they might otherwise have saved. It has helped keep the wheels of commerce turning despite endemic supply and demand fluctuations.
That said, heedless of ardent defenders like Marsh, BNPL raises red flags for many agencies other than banks and financial institutions. Due to the rising backlog of debt that British citizens have incurred with BNPL payments, the UK government laid out long-awaited plans to enforce affordability checks and curb misleading advertisements.
Parliament intends to publish a consultation regarding draft legislation at the end of the year, which aims to propose secondary BNPL legislation by 2023, in a lead-up to an FCA ruling on the sector. The effect this ruling will have on lending remains to be seen.
The Bottom Line
Neither form of lending is inherently risky nor free of risk. In our estimation, both traditional credit lending and BNPL options can be significant assets for consumers looking for flexibility in finance. However, both can also be dangerous if they’re not managed responsibly.
It is certainly easy to empathize with consumers struggling to make ends meet in the post-pandemic ecosystem. Still, it is also important to remember that the overall health of the global economy depends heavily upon commerce. The backlash could incur further market stagnation or inflation if consumers aren’t spending for fear of losing basic amenities or hard-earned savings. Either way, consumers are the core concern as it is their revenue each lending agency relies upon to thrive.
Perhaps both methods are equally necessary? In that respect, what is lacking here is not greater oversight from banks and governmental bodies. Rather, what’s needed is dedicated consumer education and more responsible lending across the board.
If, for example, banks took a less-exclusionary approach to small-scale borrowing, they might collaborate with BNPL lenders to improve regulation in the alternative lending space. A collaborative approach to lending might be just the thing for the market and an untapped number of consumers.
