|Nathan Woodley

What will a recession mean for Buy Now, Pay Later?

Inflation and interest rates are decreasing real wages

in short

The Bank of England raised interest rates by 50 basis points last Thursday, the biggest single increase in 25 years. Deputy Governor, Dave Ramsden, has this week suggested they may need to increase further.

 

This comes as part of the Bank’s commitment to reduce inflation from a historic high of 9.4% to 2%.

 

Interest rate hikes make borrowing more expensive as the cost of credit increases. Saving also becomes more lucrative as consumers theoretically earn more interest on the money they have in the bank (though lenders are yet to pass on this benefit to their customers).

 

The impact on the economy will be a reduction in demand and thus a fall in consumer spending. 

 

Increases in interest rates affects consumers and businesses in two major ways:

 

  • Consumers with variable interest mortgages and loans will see an increase in costs as their monthly repayments rise in line with the Bank of England’s base rate
  • For businesses, the cost of corporate borrowing becomes more expensive. This extra cost is either passed on to customers, or the business loses profit

 

The economy needs consumers to spend and businesses to invest in order for it to grow. A hike in interest rates slows down spending as consumers and businesses scale back their purchases and rethink their budgets. When spending stops, the economy starts to shrink. When the economy shrinks for two consecutive quarters, that’s a recession. And that, at the moment, looks to be the likeliest scenario for Britain.

 

The big question then becomes, how will this probable recession affect the Buy Now, Pay Later (BNPL) industry? Well, to put it simply…

 

A recession could be very bad news for BNPL

Recessions wreak havoc on an economy. 

 

Reduced output encourages cost-saving exercises for businesses, which often comes in the form of redundancies. A reduction in the number of jobs leads to increasing unemployment and disposable income, further reducing demand for goods and services.

 

You don’t need to be a financial expert to see how reduced demands for goods and services impacts the consumer retail sector and the businesses who operate in this space – and yes, that includes BNPL.

 

Interestingly, checkout finance has actually increased in demand since the cost of living crisis started earlier this year, around the time the War in Ukraine started. Whether this is part of the sector’s natural growth, or whether it has something to do with consumers starting to adjust their spending habits is hard to tell. However, one way or another, it is reasonable to assume this trend will continue as the UK enters a recession.

 

That’s not to say the checkout finance industry can look forward to a bumper year – quite the opposite. The macroeconomic environment is brewing up into a ‘perfect storm’, some analysts predict. 

 

Checkout finance providers sit atop a house of cards, propped up by their merchant clients, their clients’ suppliers, and their clients’ customers. If one of the cards falls, it could bring the whole tower down with it. In other words, while BNPL may remain in demand, the fundamentals underpinning the business model may still get caught up in this so-called perfect storm.

 

This is the worst-case scenario, and hardly a foregone conclusion. Plus, as we said, BNPL will indeed remain very popular. In fact, from what we’ve seen so far, there appears to be plenty to be optimistic about. So, let’s turn to the up-side…

 

Less consumer spending = more BNPL?

One would assume the uptake of BNPL would decline through a recession. 

 

Not only does consumer spending drop, credit becomes notoriously hard to come by too – lenders become more sceptical about whom they finance, while consumers grow wary of high interest rates. 

 

However, this might not be the case for checkout finance.

 

Data from the Divido platform suggests applications for retail finance have been relatively consistent for 2022 so far, despite the worsening economic environment. 

 

More interestingly, approval rates from our lenders have increased by 6% since the start of the year, while consumer activations have gone up 20%. No matter where we look, we see no loss of appetite.

 

We will caveat this by pointing out that we expect to see BNPL lenders tightening their eligibility requirements throughout the rest of this year, to ensure their risk is managed, and this could lead to a decline in acceptance rates. But still, the story so far has been a positive one.

 

Indeed, the gradual but consistent increase in rates of applications for checkout finance seems to suggest consumers are increasingly using retail finance as an interest-free alternative to other forms of credit. BNPL is moving from a convenient way to pay, to a legitimate cost-saving exercise.

 

The sceptic would suggest this is a red flag, a symptom of poor financial health, and a cause for concern. And that would be true if these purchases were for everyday essentials like food, fuel and energy, or if lenders were not operating in accordance with upcoming regulation

 

But this is not the case – at least, not with Divido. 

 

What this data therefore suggests is that consumers are turning to retail finance to support their necessary ‘big’ purchases – the kind of things they’d have to buy whether or not they were undergoing an economic squeeze. Things like school uniforms for the start of term, or a boiler upgrade ahead of this winter’s energy crisis.

 

This is a trend that we expect will continue into a recession.

 

Of course, there are other providers who offer retail finance on low-ticket items. Reports elsewhere also suggest demand for BNPL services is rising across the board, which is worrisome when you consider the types of products one can purchase on credit (socks, food and fuel for example).

 

A surge in demand for BNPL for consumers on low incomes could indeed be a sign of trouble to come during a recession. That’s why we urge you to follow a Duty of Care, especially at a time like this, in order to protect consumers.

 

Increased defaults and delinquencies 

As the squeeze grows tighter, users of Buy Now, Pay Later may face a choice between paying for their bills and groceries, or paying back loans they took out several months ago. 

 

Few could be blamed for choosing the former – particularly if they have undergone a financially debilitating event in the interim, such as a job loss. 

 

Indeed, these difficult situations may already be happening. Afterpay, one of the most well known BNPL brands, has already reported higher rates of late payments this year as a result of the worsening economic situation. And they are not alone. One in three BNPL users are struggling to meet repayments.

 

Defaults and delinquencies are a concern to zero-interest, zero-fee BNPL providers, whose business models depend on prompt repayments. A surge in defaults could suffocate these businesses, who have few options available when it comes to collecting lost revenue, besides bringing in expensive debt collection agencies.

 

Consumers may also be in line for financial penalties if they miss payments. What was initially an affordable purchase could quickly become an insurmountable debt, especially if these penalty fares build up. Consumers could also find their credit scores damaged, limiting their finance options in other areas of life. 

 

BNPL providers will also want to avoid any fallout potential damage to their reputations. Parallels are already being drawn between the BNPL and payday loan sectors, which gained a reputation for piling exorbitant fees on top of consumers. This link is misinformed and misguided, but pervasive nonetheless: lenders will want to avoid having to chase down debts, lest they draw any more unfavourable comparisons.

 

In summary, a recession will test the risk management, patience and integrity of any BNPL provider whose business model relies on low-ticket purchases by low-income consumers. Neither the media nor public will be kind to those who do not behave responsibly.

 

Buy the dip: Mergers and acquisitions

Klarna, once the most valuable privately held company in Europe, boasted a $45.6 billion valuation in 2021. By July of 2022, this figure was reduced to $6.5 billion in a $760.7 million funding round – an 85% reduction in value. Other well known BNPL brands are experiencing similar turmoil.

 

With the cost of doing business rising along with interest rates, the profitability of the sector has come into question. Critics suggest sky-high stock prices were helped along by pandemic-induced demand and a period of low interest rates, both of which are now over. Providers now have to pay considerably more to bridge the gap between paying merchants and getting paid by consumers.

 

Elsewhere, new competition seems to enter the market each week, most notably from banks and other large organisations.

 

Diversification is likely to become a popular practice for BNPL businesses during the recession. The question will be whether this will be enough to restore the astronomical losses many providers have experienced in recent months.

 

Low valuations are, however, an opportunity for mergers and acquisitions. Further or sustained reductions in stock prices may result in market consolidation as investors take advantage of low-cost companies. 

 

Mergers could also eliminate competition, or help to diversify existing business models. According to a report by GlobalData, mergers and acquisitions are likely to increase as a result of these market slumps.

 

That said, Australian BNPL providers Zip and Sezzle recently terminated a merger, citing current macroeconomic and market conditions. A new focus on profitability means the two firms will remain independent for the time being.

 

The bottom line

It’s yet to be seen how the market will shape up in order to tackle the recession, but one thing’s for sure: a big shake-up is coming. 

 

Consumers are starting to reign in spending on non-essential purchases in response to inflationary pressures. This trend will continue and is likely to increase as we enter a recession. Providers will be tested by the ‘perfect storm’ of macroeconomic pressures, perhaps leading to a wave of acquisitions.

 

But, at a time when 62% of checkout finance users think BNPL could replace their credit card, 0% finance may be exactly the sort of thing consumers need during an economic squeeze. There’s a reason why new players are still entering the market, week after week – the business model is clearly in high demand.

Divido is the platform partner enabling lenders and merchants to launch their own-brand checkout finance, fast. Consumer journeys are seamless, and can be optimised to convert more customers at every point of sale, online and in-store.

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