Buy now, pay later must be regulated — now

Klarna, the world’s biggest operator to buy now, pay later, looks like another runaway success story for entrepreneurial Sweden. First, Ikea has turned furniture upside down. Then Spotify revolutionized music.

Today, the fintech co-founded by CEO Sebastian Siemiatkowski is once again championing Nordic iconoclasm. Klarna, bolstered by a handful of other BNPL operators around the world, has modernized payments for millennials, challenging a comfortable credit card market long dominated by Visa, Mastercard and the banks that issue their cards.

The Swedish group, together with other BNPL operators, grants its customers a few months of interest-free credit on small and large purchases. It now claims that 147 million people use its services worldwide, via 400,000 business partners.

BNPL has thrived during economic boom times in recent years and received an added boost during Covid-19 as people diverted spending to retail and shopped more online. It’s easy to buy endless clothes, gadgets and other consumer goods. What’s not to like?

Well, a lot. Skeptics have long pointed to a business model that can be both cynical and fragile. And today, Klarna, along with its peers, may face a myriad of pressures.

According to an analysis carried out last year by Redburn, the British equity research firm, BNPL’s average transaction is based on a gross margin of 4% financed by a commission charged to the retailer. But profitability, even in good times, has been ultra-thin or non-existent.

Of that typical 4%, Redburn estimates that 2 percentage points are eaten up by fees charged to other companies in the payment chain; 0.5 percentage point corresponds to the average financing cost; leaving 1.5 points for credit losses and net profit. In BNPL’s short life to last year, Redburn estimated credit losses at 1.2 points on average, leaving room for gross profit of 0.3 points (before operating costs). Thin, but useful if the volumes are large enough.

Take a look at Klarna’s latest results, however, and this model’s flaws, even for a high-volume gamer, are obvious. In its first-quarter results, credit losses were equivalent to 1.9% of customer loans (down from 1.8% a year earlier), gobbling up a third of quarterly revenue and pushing Klarna to a net loss of 2. SKr 6 billion ($265 million). ).

No wonder the company decided last month that it should Fire 10% of its 7,000 employees. And that before any economic pressure from the global slowdown really kicks in.

Each element of BNPL’s business model is subject to constraints. Revenues are expected to weaken as consumers reduce spending. Klarna’s 62 billion Swedish krona customer loans were up 38% in the year to the end of March, but remained virtually unchanged from December, reflecting tougher times. The pressure on BNPL operators’ revenues is likely to be all the greater as users turn to low-income individuals.

At the same time, default rates are likely to worsen. A big part of BNPL’s appeal is that it offers credit that you don’t have to jump through any hoops for. Standard two or three month deferred payment agreements will generally involve ‘soft’ credit checks, where applicable, rather than full checks which will be reported on your official credit file (although this is changing in the UK).

Funding costs are another pressure point. Klarna itself has a banking license and funds most loans from deposits. But no one will escape the compression of margins due to the rise in rates.

This is bad news for BNPL operators and their investors. But the impact can also be systemic. Although most estimates estimate that BNPL represents only a few percentage points of overall consumer credit, the profile of borrowers can amplify the volatility of BNPL use, reducing consumer spending disproportionately and amplifying the economic blow if it contracts.

Customers tend to use multiple vendors and rack up dozens or even hundreds of overlapping purchases. This not only means that individuals’ finances can spiral out of control; it is also difficult to grasp the macro effect.

Because the industry is unregulated, no one knows for sure how big it is. Estimates of the size of the UK market vary wildly, from less than £6 billion to £16 billion.

If there’s a message for policymakers, it’s this: Klarna doesn’t make comfy sofas and hot meatballs like your favorite Swedish retailer. BNPL operators are pure and simple money lenders. It is time to properly regulate this industry before it explodes in our face.

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