Consumers are at greater risk following the changes to the consumer credit lender, writes Adam Leach for ICAEW Financial Services Faculty.
Should a bank or a credit provider seek to make their customers ‘worry less’? According to the co-founder and CEO of Klarna, Sebastian Siemiatkowski, the answer is not only that they should do so, but that it should be one of their operational imperatives and driving motives.
In his introductory note to the company’s most recent annual report, he argues that ‘making them worry less’ is on a par with enabling the customer to ‘save time’, ‘save money’, and to ‘ultimately improve their finances’.
It is a hard point to argue against, because in addition to serving as a custodian for their earnings and savings, and trying to minimise the disruptions and time they dedicate to managing their accounts, it would appear almost self-evident that a financial institution should ultimately also cause them to worry less.
However, as sensible as the proposition might at first appear, could an attempt to reduce worry, not in the end lead to increasing it? Could the development of a product that is specifically designed to defer concern, not actually end up exacerbating it?
In the same note to shareholders, Siemiatkowski suggested that Klarna’s credit offering, which enables people to delay or split large but also small purchases, was an answer to the ‘menace to society’ that traditional providers represent due to the fees they charge retailers and interest to borrower.
He then added that they were essentially an ‘inverted Robin Hood’, due to the fact that those with the most money benefit disproportionately more than those with the least from schemes such as interest free, loyalty points, and cash back.
In this realm, “the real heroes”, are the more than 400,000 retailers who have partnered with the company, who pick up the borrowers fees and pay it to the lenders instead.
“Retailers told us ‘no more’,” he explains, “with Klarna’s model their cost of payments goes directly to the pocket of consumer in the form of short-term-interest-free credit that further increases their spending power.”
However, while the rapid growth that has seen the Buy Now Pay Later (BNPL) payments sector grow to $160bn globally and £6.4bn in the UK at annual growth rates of 39% and up to 70% respectively that show no signs of slowing certainly prove the popularity of the concept. Might it be just a little too good to be true?
Commissioned to carry out a review into the UK unsecured credit market by the Financial Conduct Authority, its former chief executive Christopher Woolard CBE made it clear that this could create a conflict of interest.
“These subsidies help reduce the cost of credit but introduce conflicts of interest as lenders might not see the borrower as their end customer,” he said.
In other words, what Woolard was suggesting was that due to the fact that Klarna and other BNPLs earn their fees from the retailers who pay them a percentage of what the borrower buys, perhaps it is more a matter of Buy More Now Pay More Later?
Referencing the BNPL sectors “significant potential for consumer harm”, he spoke of an “urgent need to regulate all buy now pay later products”, which quickly prompted The Treasury to launch a consultation in the sector and the FCA to recently promise that the sector would indeed be regulated.
In response, Klarna recently announced that as of June, it will start to share its customers spending data with the Experian and TransUnion credit reference agencies with the information set to impact the credit scores of its customers by the end of 2023.
Klarna sought to put a positive spin on the decision by focusing on the fact that it will enable customers who pay in full and on time, to build a positive credit rating without taking out a high cost credit card.
“That will start to change on 1 June this year as the vast majority of the 16 million consumers who make Klarna BNPL payments in full and on time will be able to demonstrate their responsible use of credit to other lenders,” said Alex Marsh, the head of Klarna UK.
However, as much it might like to focus on those that it could affect positively, the move is also being seen as pre-emptive move to both get out ahead of its competitors and start to prepare for the sector becoming regulated.
“Klarna’s initiatives are aimed to try and prevent regulatory intervention and limit how radical this could be,” explains Francesco Burelli, a partner at Arkwright Consulting who specialises in payments and transaction banking, who spoke to ICAEW.
“[BNPL] is a form of credit that has so far been growing in a regulatory void and owes its success to a seamless user experience through which consumers are able to complete a purchase in a few clicks, but it has limited terms and conditions and information disclosure.”
In addition to pre-empting greater levels of regulation, the decision to share its customers spending data is also likely to be partly borne out of the wider economic environment that it is currently operating in and its customers are borrowing in.
Within this environment, the potential for unregulated lending products to add further debt onto customers already indebted is causing increasing concern.
Speaking to ICAEW, Ruxandra Ioanitescu, payments expert at PA Consulting, stressed that while the decision to share spending data might deter those who are facing financial difficulties, it will be critical that this potential impact is communicated extensively.
“BNPL firms need to ensure they provide the right level of consumer support with clear communications so customers understand what the consequences of their borrowing could be,” says Ioanitescu.
“This of course could be exacerbated by the cost-of-living crisis as more people may turn to various forms of lending and could potentially engage in more irresponsible financial behaviours.”
She added that for both Klarna and the BNPL sector as a whole, it will be vital thorough vulnerability and affordability checks are carried out in order to protect against those already in financial stress do not end up in an “even worse situation”.
By carrying out such checks in order to better ascertain the suitability of its products for customers, Klarna should be able to reduce the risks and the rate of delays to or non-payments. However, part of this problem that it and the wider sector will face is the fact that the sector is still relatively new so hasn’t been tested in times of economic stress.
“BNPL credit models have never been tested in a downturn,” says David Ritter, financial services strategist at digital consultancy, CI&T, who spoke to ICAEW. “That didn’t happen in the pandemic due to the extraordinary government stimulus measures. It may happen in this cycle but at least unemployment has returned to historically low levels so that is a positive factor.”
Amid this air of economic uncertainty, and with regulations likely to clamp down on the riskier parts of the provision of BNPL and in particular on its promotion, where Sweden has previously made it law that no forms of credit can be promoted above full payment, there may be a shift in focus for the sector.
One way in which this might emerge, is for the likes of Klarna to shift away from lower cost and fashion driven purchases, towards more substantial purchases, which would also help to overcome the additional costs of regulation.
“These plans are more appropriate for larger purchases anyway,” says Ritter. “People should not be spreading out payments on smaller purchases. It’s a recipe for higher credit losses.”
In his introductory note to the company’s most recent annual report, he argues that ‘making them worry less’ is on a par with enabling the customer to ‘save time’, ‘save money’, and to ‘ultimately improve their finances’.
It is a hard point to argue against, because in addition to serving as a custodian for their earnings and savings, and trying to minimise the disruptions and time they dedicate to managing their accounts, it would appear almost self-evident that a financial institution should ultimately also cause them to worry less.
However, as sensible as the proposition might at first appear, could an attempt to reduce worry, not in the end lead to increasing it? Could the development of a product that is specifically designed to defer concern, not actually end up exacerbating it?
In the same note to shareholders, Siemiatkowski suggested that Klarna’s credit offering, which enables people to delay or split large but also small purchases, was an answer to the ‘menace to society’ that traditional providers represent due to the fees they charge retailers and interest to borrower.
He then added that they were essentially an ‘inverted Robin Hood’, due to the fact that those with the most money benefit disproportionately more than those with the least from schemes such as interest free, loyalty points, and cash back.
Heroes, villains and conflicts of interest
Perhaps unsurprisingly, he concluded that the counterbalance to this wrong, is the innovation that Klarna itself has pioneered and the likes of Zip, Zilch, Clearpay and Openpay have latched onto, in removing the costs of credit to their customers.In this realm, “the real heroes”, are the more than 400,000 retailers who have partnered with the company, who pick up the borrowers fees and pay it to the lenders instead.
“Retailers told us ‘no more’,” he explains, “with Klarna’s model their cost of payments goes directly to the pocket of consumer in the form of short-term-interest-free credit that further increases their spending power.”
However, while the rapid growth that has seen the Buy Now Pay Later (BNPL) payments sector grow to $160bn globally and £6.4bn in the UK at annual growth rates of 39% and up to 70% respectively that show no signs of slowing certainly prove the popularity of the concept. Might it be just a little too good to be true?
Commissioned to carry out a review into the UK unsecured credit market by the Financial Conduct Authority, its former chief executive Christopher Woolard CBE made it clear that this could create a conflict of interest.
“These subsidies help reduce the cost of credit but introduce conflicts of interest as lenders might not see the borrower as their end customer,” he said.
In other words, what Woolard was suggesting was that due to the fact that Klarna and other BNPLs earn their fees from the retailers who pay them a percentage of what the borrower buys, perhaps it is more a matter of Buy More Now Pay More Later?
Urgent need for regulation
As a result of this conflict, and worrying findings quoted within the report that included that, 25% of users fell within the age bracket of 18-24, that 90% of transactions involved fashion and footwear; and that consumer research suggested that users had interpreted references such as ‘zero cost’ and ‘new ways to pay’ as more equivalent to a debit card than a credit product, Woolard made clear his concerns.Referencing the BNPL sectors “significant potential for consumer harm”, he spoke of an “urgent need to regulate all buy now pay later products”, which quickly prompted The Treasury to launch a consultation in the sector and the FCA to recently promise that the sector would indeed be regulated.
In response, Klarna recently announced that as of June, it will start to share its customers spending data with the Experian and TransUnion credit reference agencies with the information set to impact the credit scores of its customers by the end of 2023.
Klarna sought to put a positive spin on the decision by focusing on the fact that it will enable customers who pay in full and on time, to build a positive credit rating without taking out a high cost credit card.
“That will start to change on 1 June this year as the vast majority of the 16 million consumers who make Klarna BNPL payments in full and on time will be able to demonstrate their responsible use of credit to other lenders,” said Alex Marsh, the head of Klarna UK.
However, as much it might like to focus on those that it could affect positively, the move is also being seen as pre-emptive move to both get out ahead of its competitors and start to prepare for the sector becoming regulated.
“Klarna’s initiatives are aimed to try and prevent regulatory intervention and limit how radical this could be,” explains Francesco Burelli, a partner at Arkwright Consulting who specialises in payments and transaction banking, who spoke to ICAEW.
“[BNPL] is a form of credit that has so far been growing in a regulatory void and owes its success to a seamless user experience through which consumers are able to complete a purchase in a few clicks, but it has limited terms and conditions and information disclosure.”
In addition to pre-empting greater levels of regulation, the decision to share its customers spending data is also likely to be partly borne out of the wider economic environment that it is currently operating in and its customers are borrowing in.
Reigning in risky spending
In just the last few months, UK consumer spending on credit cards has hit an all time high with an estimated £1.5 billion spent in February alone, while total consumer credit reached a five-year high of £1.9 billion. This distressed environment has only been exacerbated by rocketing inflation that this week reached a 40-year peak of 9%, driven largely by fuel, energy and food costs.Within this environment, the potential for unregulated lending products to add further debt onto customers already indebted is causing increasing concern.
Speaking to ICAEW, Ruxandra Ioanitescu, payments expert at PA Consulting, stressed that while the decision to share spending data might deter those who are facing financial difficulties, it will be critical that this potential impact is communicated extensively.
“BNPL firms need to ensure they provide the right level of consumer support with clear communications so customers understand what the consequences of their borrowing could be,” says Ioanitescu.
“This of course could be exacerbated by the cost-of-living crisis as more people may turn to various forms of lending and could potentially engage in more irresponsible financial behaviours.”
She added that for both Klarna and the BNPL sector as a whole, it will be vital thorough vulnerability and affordability checks are carried out in order to protect against those already in financial stress do not end up in an “even worse situation”.
By carrying out such checks in order to better ascertain the suitability of its products for customers, Klarna should be able to reduce the risks and the rate of delays to or non-payments. However, part of this problem that it and the wider sector will face is the fact that the sector is still relatively new so hasn’t been tested in times of economic stress.
“BNPL credit models have never been tested in a downturn,” says David Ritter, financial services strategist at digital consultancy, CI&T, who spoke to ICAEW. “That didn’t happen in the pandemic due to the extraordinary government stimulus measures. It may happen in this cycle but at least unemployment has returned to historically low levels so that is a positive factor.”
Amid this air of economic uncertainty, and with regulations likely to clamp down on the riskier parts of the provision of BNPL and in particular on its promotion, where Sweden has previously made it law that no forms of credit can be promoted above full payment, there may be a shift in focus for the sector.
One way in which this might emerge, is for the likes of Klarna to shift away from lower cost and fashion driven purchases, towards more substantial purchases, which would also help to overcome the additional costs of regulation.
“These plans are more appropriate for larger purchases anyway,” says Ritter. “People should not be spreading out payments on smaller purchases. It’s a recipe for higher credit losses.”