With rising interest rates, inflation, RBI’s lens, India’s BNPL players may face speed breakers ahead

“The provision of financial services through the digital channel, including lending via online platforms and mobile apps, have brought in issues relating to unfair practices, data privacy, documentation, transparency, conduct, breach of licensing conditions, etc,” the Governor said in a speech on June 17.

All of this coupled with the changing macro factors like rising interest rates, and dipping household spends led by inflation are set to slow down the pace of growth for these players, according to industry experts.

This is quite in contrast to how the industry had been growing over the past year – at a fast pace, with only self-regulation to separate the wheat from the chaff.

Last year, BNPL had become a buzzword, fast catching up amongst young spenders globally. Companies, even outside of pure play fintech, wanted a piece of the pie. Closer to home, food delivery players like Zomato want to have their own offering, while globally Apple jumped on the bandwagon recently.

BNPL is just the good old credit product with an option to repay in equated monthly installments (EMIs), tweaked increasingly to make it more attractive. According to a report by Razorpay, which saw total payment volumes of $60 billion last year, pay-later transaction volumes on its payment gateway grew by 637 percent in 2021, over 2020.

Cut to mid-2022, BNPL seems to have lost its sheen for a number of reasons. Customers who availed these products last year are waking up to the costs behind the scenes, and lack of full transparency while marketing these products is not going unnoticed by the RBI.

Ahead of the much-awaited norms, we take a look at the factors reshaping the Indian digital lending space and how companies are adjusting to new realities.

Global shift

The change in perception also comes from the massive fall in valuations of BNPL players globally. Swedish player Klarna raised $800 million at a valuation of just $6.7 billion, a steep fall from its valuation of $45.6 billion last year.

American pay later player Affirm’s stock is down close to 86 percent from its November 2021 peak. These falls can be ascribed to changing macro scenarios coupled with recession fears, according to reports.

Interestingly, these changes come at a time when the level of delinquencies is dipping for fintech non-banking financial companies (NBFCs). According to data in RBI’s Financial Stability Report (FSR), delay in loan repayments and defaults across fintech lenders has halved from its peak of 4.83 percent in September 2021 to 2.26 percent in March 2022.

What is important to note is that BNPL, which essentially is a loan disguised as ‘affordable’ and ‘convenient’ payment options, is made up of different business models based on the mode of lending, tenure, interest rates and accruing revenues. Let’s break down how each of these factors are impacting the sector and what these models are.

BNPL business models

The industry is largely divided into two kinds of offerings – one that is positioned as a payment method, allowing customers to check-out faster while making purchases with the option of paying later. This includes players like Slice, Uni and LazyPay that offer credit through prepaid cards in partnership with banks. Simpl too, positions itself as a payment product, although its model does not include any card form factor.

The other facet claims that it is solving the problem of affordability by extending the option of paying in EMIs like ZestMoney and Capital Float does. These players disburse the loans directly to the merchants on behalf of the customers, while consumers that avail cards from Slice, Uni etc can use the credit line to make any payments.

Another distinction is based on the tenure of these loans. Some players, akin to the global models, operate on a short tenure such as 30 days or lesser. Then, there are players who have pay in 3 months as their core product. Others have longer repayment tenures of up to 24 months, or more, in some cases.

On the interest rate front, originally BNPL was intended to be zero percent interest. While some players continue to offer products at 0 percent interest (based on the tenure), the winds have been changing now.

BNPL players are also distinguished based on their revenue profiles. Some players depend on merchant tie-ups for revenues, while others depend on customer fees and charges.

The macro impact
The low-interest rate era is behind us and experts expect further rate hikes soon, a factor that directly impacts lending. Besides, rising inflation is a worry and is leading to a dip in customer spends. RBI’s latest consumer confidence survey revealed that sentiments on non-essential spending for the short term and the year ahead remain downbeat – the exact spends that the pay later segment caters most to.

A survey by Deloitte suggests that consumer spending on both discretionary and non-discretionary items reduced by about 18 percent among respondents.

According to Jaikrishnan G, Partner and Head – Financial Services Consulting at advisory firm Grant Thornton Bharat, uncertainty over jobs and incomes over the past two years made people take on debt for their purchases, but that is set to change now.

“The change in consumer sentiment may not impact spending patterns but it will substantially change borrowing patterns. People will again move towards an approach of preserving capital and will see if they can reduce their debt burden,” he said.

“You will naturally see customers borrowing less and less, especially the newest products. All players are likely to see missed targets; a short-term impact is imminent.”

That said, he sees this as more of an outcome from a knee-jerk reaction by customers in the changing environment and not telling of the industry’s health in any way.

However, Grant Thornton Bharat has re-calibrated its growth projection for the industry. In FY22, the firm had estimated BNPL to be a $3.5-billion industry and had earlier projected that it will grow to over $6 billion in FY23. Given the changing scenario, the projection has been revised to $4.2 billion.

However, many expect the impact to be uneven, depending on the kind of offering by the start-up.

“Fintechs that have achieved a certain scale see an improvement in credit costs every quarter, so they may be more resilient to this change. Whereas for early-stage companies that don’t have much of a track record yet, there will be more volatility. Anybody who funds more small-ticket, discretionary transactions may see an impact,” said an industry executive who did not wish to be named.

The other view is that with rising prices, customers may, in fact, look at paying in EMIs as a better option to spread out costs, so that their discretionary purchases are not affected in a big way.

Ganesh Rengaswamy, Partner at Quona Capital which is an investor in ZestMoney said, “Replacement demand is stronger than new demand. Rate change will also be passed on to the consumer. But it will certainly have an impact. The spreads will more or less remain the same and will get passed on to customers.”

Liquidity squeeze
In the past two years, the RBI pumped a lot of liquidity into the market using multiple instruments in order to get the economy through the perils that COVID-19 and subsequent lockdowns presented. Banks too acted in sync and shored up lending, and tie-ups with fintechs were one avenue to push funds into the economy.

Now, the opposite of that is starting to play out. As liquidity is squeezed out, banks will choose better risk-adjusted return places to lend through, analysts say.

“It is likely that the share of bank-funded portfolios in the pay later market will come down in the post-COVID-19 scenario. All bankers are going to focus on their own lending, at least for the next two to three years. Fintech partnerships are going to be limited from a proof-of-concept standpoint of view,” according to Jaikrishnan.

Revisiting models

For newer business models that saw a pick-up only in the past year or so, a reset is underway. Even before the RBI’s directive, Slice was reconsidering its core ‘Pay-in-3’ interest-free offering. Moneycontrol had reported on May 25 that the company is restricting the product only to those players with a good credit score and repayment history.

The company also updated its terms and conditions on June 27 in line with the move saying that will levy 36 percent interest per annum if repayment is not done in one installment.

“Some of the high-growth companies have now been through the 12-month cycle of collections and delinquencies. It is natural for any lending product to have a pilot test, followed by a course correction, and then come back in a stronger manner,” said an analyst who wished to remain anonymous.

“BNPL companies are maturing in terms of qualifying customers and the processes involved. After the initial push for numbers and volumes, large players are looking at whether this can be done in a more methodical or controlled manner,” he added.

Regulatory lens

Of the two camps, the players that facilitate credit through prepaid cards were recently told by the RBI that loading these cards with credit lines is not permitted, casting a doubt on the core offerings by these players.

While Slice and Uni are awaiting more clarity on the move by the RBI, Moneycontrol had reported quoting sources that PayU’s LazyPay is looking to shift to pure credit cards. In the meanwhile, Uni too has stopped issuing new cards after the clarification.

For others, the worry is RBI’s increased scrutiny of customer complaints and the reasons thereof. According to industry sources, companies including pure-play BNPL players like ZestMoney, Capital Float etc. are becoming more cautious.

The focus overall is more on being compliant and transparent, which could slow down the fast pace of lending seen over the past year.

“Earlier, experience was at the forefront. Now, experience, compliance, cost, and quality, all weigh equally. That is something that could come in the way of how quickly they used to grab the market,” said Jaikrishnan.

RBI’s worry is that customers do not understand new business models and any misstep could lead to them being overleveraged. For instance, many customers did not realise that Uni and Slice cards are not credit cards. Moreover, they did not know that the ‘pay later’ they were accessing was in fact a personal loan.

In case of late repayments, many customers may see a major impact on their credit scores. In the past few months, scores of users took to Twitter to complain that they were not aware that the product is a loan, others claimed that a wrong click on these apps can replenish unwarranted credit lines.

A recent study by Dvara Research that assessed the offerings of all major BNPL players said that terms and conditions of these companies are misaligned with key customer protection regulations, and contravene key conduct obligations. Customers are at a risk of unknowingly incurring debt, borrowing credit that is unsuitable for them, and being subject to aggressive debt collection practices, the study said.

Rengaswamy said, “It is always prudent to be more transparent. In the fintech funding boom we have not seen that happening. Hopefully, we will see a more transparent, sensible messaging and product positioning.”

Industry voices added that there is heightened activity backend for all players in terms of focusing on improving the reporting of data to bureaus, filling in the blanks regarding customer data, wording of products and increasing resource allocation towards compliance.

A fintech founder who did not wish to be named, said, “We are going to see pressure both in terms of margin, and also in terms of regulatory scrutiny on the unregulated model that positions it purely as payments.”

According to RBI’s guidelines, banks and NBFCs are encouraged to report credit information to all bureaus, namely CIBIL, Equifax, Experian and High Mark. However, multiple analysts have pointed out that the frequency of data reporting by fintechs is lower than required at the moment, and there is discrepancy in reporting to all credit bureaus by a few players.

Dvara Research’s study says that there is some uncertainty about whether BNPL providers report BNPL transactions to credit bureaus and thus help them (customers) build their credit history.

“This is because BNPL providers do not categorise their products as a loan as they do not charge interest until the customer defaults,” the report adds.

While the right guidelines and positioning are still under discussion and macro factors still at play, Grant Thornton Bharat’s Jaikrishnan sums up what customers need to know, “We need to understand that BNPL is not the same as the credit book that we used to have with the neighbourhood shopkeeper. If people are under the impression that that has now gone digital and we are calling it BNPL, no, that's not what it is.”

Another fintech founder concludes by saying what lending businesses must keep in mind while choosing customers – the ability to repay as well as the intent to repay.

“We can never gauge the intent. But the ability to repay will take a beating if the tough macro situation lasts long. In such a situation, companies with good portfolios will survive, while others will struggle,” he said.