Why BNPLs fund the 'credit unworthy'
The credit scoring system was broken, BNPLs swept up the pieces and created an industry. Today's newsletter explores the 'credit unworthy' & fintech-run credit scoring systems
The Buy now pay later (BNPL) industry is on the rise and banks are worried. In a report released by Barclays, the British bank called for more regulation of BNPL products. Barclays said that the industry’s lack of oversight “can lead to irresponsible lending, with people taking out BNPL contracts when they have been rejected by the regulated alternatives.”
BNPLs aren’t banks – they’re fintech companies. They exist in the murky space between tech company and financial institution providing more wiggle room in determining who to lend to. They are the lenders for those banks consider to have low creditworthiness —the ‘credit unworthy’ is the term I’ve decided to use.
The metrics that banks use to determine loan-ability are outdated. Globally, a decreasing amount of people tick the right boxes necessary to acquire loans from traditional financial institutions. This is why users flock to BNPL products.
Buy now pay later platforms re-imagine credit. With troves of information that give them an intimate understanding of how, why, when, and where their users spend, BNPLs could open the door for more data-driven credit scoring models.
An ode to the ‘credit unworthy’ - freelancers, young people, and the Global South
Antiquated requirements for obtaining capital are a pain point for consumers.
The future is freelance, but many banks still require proof of steady work to get a loan.
I have a friend living in Italy. She’s in her mid-thirties and works as a freelancer under a long-term contract. She applied for a home loan at a bank, but they rejected her request. They claimed that she did not have a steady job, so she was not reliable to lend to.
Banks have not adjusted to the present and are struggling to orient themselves for the future.
What would happen if they started extending lines of credit for homes? My friend would no longer need a bank loan. This is entirely possible. Operators in the US are already offering long-term financing options for purchases up to $40,000.
The Buy now pay later industry is also expanding in countries throughout the Global South with scant consumer credit records and high requirements for bank loans.
I met someone who founded a BNPL company for electronics in Kenya. Interest charged on purchases may be exorbitant, but investors and users are flocking to his product. Kenya is on a digitization campaign right now and young people will need high-priced electronics to participate. BNPLs are set to become an attractive option for financing these purchases.
Safaricom’s MPESA also runs its own mobile money quick-loan distribution system in Kenya called M-shwari loans. Even though the loans come with a 7.5% ‘facilitation fee’, the product boasted 7.2 million individual customers 31 million customers in 2019.
BNPLs are more agile than banks
The consumer credit scoring system also struggles in the US, where a standardized model has been in place for more than three decades. In fact, 14.8% of the US population has no credit history or is “unscoreable”.
China’s government has been trying to expand its “social scoring system” for over a decade. But far more popular than the government-run credit score is a private in-app scoring system developed by a fintech company.
Here’s how they did it.
There’s a popular eCommerce platform in China called Taobao – it’s owned by the Alibaba group. Taobao became so popular that Alibaba developed an accompanying payment system called Alipay, in 2004.
Everyone was using Alipay because everyone was using Taobao, so the team spun Alipay off into a standalone mobile money app. Consumers started using this app for everything: paying bills, renting bikes, shopping online, sending and receiving money – you name it.
Through Alipay, Alibaba gathered all of this user data on consumer purchases and spending habits and assigned individual credit scores to users. They then took this data and began to distribute in-app credit scores to consumers. These credit scores are now used to issue loans, via Alipay, to individuals and small businesses.
I think that this could be the next direction for the broader BNPL industry.
There are hints of this if we look at specific BNPL companies, like Klarna, that are already trying to develop their own eCommerce solution. If they can get users to stay in-app for purchases, they’ll have better access to consumer data. Then they might be able to tell regulators, ‘look we don’t run hard credit checks but we do have a system that we use to determine who to loan to. Can we work together and share information?’
That’s what happened with Alipay. The company eventually started sharing in-app ratings with the government.
In-app credit scores are also a great move for fintech companies that have more reach than brick and mortar banks in some countries. They already know how people spend. why not develop credit rating systems with that information?
The problem is. The Alipay story is unique. They were able to develop an intimate, data driven, understanding of the way that their users bought and paid for things over a long period. They started from eCommerce, developed a mobile payments app, had a strong user base, then started distributing loans. All of this happened over a ten-year period. So, it takes time.
So what can we take home?
BNPLs have to be more careful with their userbase – 75% of BNPL users in the US are Millennials and GenZ customers. Many will go into debt. Many will not read the fine print. So, the onus is on BNPL platforms to ensure their users know what they are getting into.
If done well this could actually benefit BNPLs. One method could be to partner with financial literacy influencers on TikTok (yes this is a thing), and work with them to create content that explains what happens if you miss a payment, and how you can make sure that you don’t overspend.
They’d look more transparent, less predatory, and could also advertise their product.
I also think that BNPLs should let users know if they plan to use their data to generate credit scores before they employ any of the methods mentioned in this write up. Alipay didn’t and now they’re in trouble.
In any case. It’s time to re-consider traditional credit scoring models. A large subset of the global population cannot be scored with them, so maybe it’s time to look for something different.
Buy now pay later platforms are under scrutiny, but they won’t go away. It’s time to think about how they can be regulated without killing their unique selling point — ease of access.
This needs to happen quickly because we may be entering a recession. And, as Affirm CEO Max Levchin told Protocol last week:
“Buy now, pay later becomes more attractive in a slump.”
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