As the COVID-19 pandemic pushes more consumers to e-commerce, point-of-sale installment lending fintech companies like Klarna and Afterpay have seen their popularity and valuations rise in recent months. Competitor Affirm even launched a buy now, pay later (BNPL)debit card。

BNPL fintech companies allow consumers to split online purchases into multiple payments. According to management consulting firm Oliver Wyman, such services facilitated $20 billion to $25 billion in transactions in the U.S. last year.

That figure is expected to grow. Fintech research firm Kaleido Intelligence found in September that by 2025, global consumer spending via e-commerce channels using point-of-sale installments is projected to reach $680 billion.

"The point-of-sale and buy now, pay later space is taking market share from the traditional proprietary credit card space," said Kevin Lewis, chief revenue officer at digital banking services provider Amount. Amount was spun off from online lender Avant in January 2020.

Amount's strategy is to provide proprietary BNPL services to traditional banks. It partners with banks rather than merchants, embedding point-of-sale financing interfaces into banks' existing systems.

According to TechCrunch, the startup charges banks a percentage fee for each loan processed through its service, plus an average upfront implementation fee of about $1 million, though the amount varies by scope of services and solution, an Amount spokesperson said.

The fintech, which raised $140 million last year, is working with TD Bank to enable the bank to offer consumers installment options in online purchases at its merchant partner NordicTrack. Lewis said four undisclosed financial institutions also use its point-of-sale service, and Avant will go live on the platform this year.

"Banks need a completely different underlying infrastructure to participate in this space, so they have to find a solution to get to market," Lewis said.

With Amount, banks can launch their own white-label installment financing solutions in months rather than years, he said.

"When you close the technology gap and arm banks with technology that can help them compete with fintechs and beat them, ultimately they can gain an advantage in that category."

Shift in customer behavior

Lewis said consumers' growing subscription mindset has fueled BNPL's popularity.

According to research from consumer spending data company Cardify.ai, the model's appeal appears to be generational—Gen Z and younger millennials account for more than 80% of BNPL transactions.

"We are unlocking a younger audience and debit card consumers," David Sykes, head of Klarna in the U.S., told The Washington Post. "After the 2007-08 global financial crisis, younger consumers in particular have become more skeptical of traditional banks and credit card companies."

Retailers also seem to favor the BNPL model and partner with point-of-sale fintechs to boost sales, said Ted Rossman, an analyst at Bankrate and Creditcards.com.

"There's really a lot of data showing that these customers tend to spend more—they tend to be more loyal. It's directly tied to purchases, and retailers love that," he said.

Rossman added that retailers are willing to pay higher fees for this feature.

"Typical credit card interchange fees are 2% or 3%. Buy now, pay later companies typically charge retailers about 5% or 6%," he said. "But when retailers see data on repeat customers, larger transaction sizes, and repeat purchases, they're willing to make that trade-off."

According to The Wall Street Journal, citing Autonomous Research, payment volumes at the top four companies in the space grew more than 50% in the first nine months of 2020.

"It's worth watching how this evolves. I think it's a perfect storm for buy now, pay later right now—the pandemic, convenient shopping, and people being very averse to debt," Rossman said.

Banks' advantages

Lewis said banks with existing merchant relationships may have a competitive advantage in entering the BNPL space.

"If they already work with merchants on credit cards, proprietary credit cards, or other financial products, they're in a very strong position," he said.

Recent e-commerce growth has helped Citizens Bank expand the reach of its checkout loan products. Major technology partnerships such as Apple iPhone financing and Microsoft Xbox All Access loans have helped the bank develop new customer relationships.

On the retail side, Macy's invested in and partnered with Klarna before the holiday season last year. Affirm's partners include Shopify, Gucci, Bonobos, The RealReal, and Peloton.

"We're still in the experimental phase of how important BNPL will become, but adoption by major merchants is a significant achievement for emerging players," said John Grund, managing director of payments at Accenture.

Lewis noted that banks' lower cost of funds from deposits and larger balance sheets may differentiate them from BNPL fintechs.

However, Grund expects banks' response to the space to be cautious.

"We expect banks to be precise and cautious—for example, evaluating BNPL merchant by merchant," he said.

Several banks have launched services that allow customers to repay certain transactions in fixed installments.

Citigroup, the largest U.S. credit card issuer, launched Citi Flex Pay and Citi Flex Loan in 2019. The former allows users to choose a purchase and repay it with fixed payments and a fixed annual percentage rate (APR); the latter allows cardholders to borrow from their credit line and repay in installments at a fixed APR. JPMorgan similarly launched My Chase Plan and My Chase Loan in 2019.

Challenger bank Upgrade launched a credit card in 2019 that mimics BNPL services by consolidating monthly fees into installment plans and allowing customers to choose repayment periods of 24 to 60 months.

The card's underwriting technology uses machine learning to analyze FICO scores, credit history data, income, employment, and debt-to-income ratios, and also considers alternative data such as utility payment history and cash flow analysis.

Interest in BNPL is certainly significant. Ally Financial exited the credit card business in 2019 and shifted to a point-of-sale model. Traditional non-BNPL payment companies have also entered the fray. PayPal launched Pay in 4 last fall, allowing consumers to pay for purchases of $30 to $600 in four installments over six weeks.

However, not all banks are so bullish on BNPL. Capital One last year prohibited customers from using its credit cards to repay buy now, pay later debts.

Meanwhile, Affirm's debit card launch represents the most direct challenge BNPL companies have made to the banking industry, Rossman said.

The card allows customers to choose to pay upfront or in installments.

"This is the first debit card directly linked to buy now, pay later," Rossman said. "It's more like a bank card that you can take into a coffee shop, electronics store, or clothing store, or use for online purchases. There's no friction of reapplying each time. In that sense, I think it competes more directly with the banking industry than previous services."

Key takeaways

Grund said that although the BNPL market remains a relatively small segment in the broader U.S. payments ecosystem, incumbent banks should pay attention to the next-generation consumer trends reflected in the space's growth.

"This dynamic, such as paying in four installments, appeals to younger consumers with digital-first preferences, many of whom watched their parents fall into credit card debt during the financial crisis and are now cautious about credit card debt," he said.

Grund noted that nearly 80% of consumers using BNPL link purchases to debit cards, a trend pointing to a budget-conscious and credit-conscious customer base.

"Banks should watch for further changes in consumer behavior and the appeal and importance of seamless, integrated customer experiences to consumers and merchants," he said. "Additionally, banks note that merchants, after decades of pressuring banks and networks to lower fees, are at least in the short term willing to pay BNPL providers."