How would a recession impact BNPL lending?

Bloomberg News

If a sharp stock market selloff and soft jobs report lead to a recession, that could create both opportunity and peril for the buy now/pay later fintech apps that have become a major player in the consumer credit industry.

During periods of economic downturn, consumers rely more heavily on credit products to maintain their household finances, said Ben Danner, a senior analyst at Javelin Strategy & Research. "If the economy sours, we'd expect an increase in new customers and volume at the BNPL vendors. However, this is going to be risky," Danner said.

BNPL lending is already subject to pressure from the Consumer Financial Protection Bureau and other regulators over concerns the loans cause consumers to rapidly accumulate debt and seek riskier loans such as using BNPL for everyday expenses like groceries.

The ability of BNPL fintechs to make sound lending decisions reflects the health of the lenders themselves as well as the overall financial health of consumers.

"The short-term gains at BNPL companies could turn into long-term losses, particularly when you have a large base of customers that are below prime," Danner said. "Credit card companies have plenty of experience with battling through a sour economy and strategize their books to protect from losses." 

While there's no single profile of BNPL users, consumers that are struggling tend to dominate the market. More than half of financially fragile users—those with credit scores below 620, were recently declined for credit, or are at least 30 days delinquent on a loan—use BNPL to cover gaps in household spending, usually for an average purchase of $250, according to the Federal Reserve Bank of New York.

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Consumers with good credit and stable finances use BNPL for larger purchases of about $1,750, usually to avoid carrying a higher credit card balance.  Despite these risks, BNPL lenders could benefit by having accounts with relatively low outstanding balances. The average American credit-card balance was more than $6,200 in the first quarter of 2024, up from $5,700 from the year-ago period, according to TransUnion.

The average BNPL balance is substantially lower. Affirm, for example, reports an average outstanding BNPL balance of $620 per consumer.  But there is overlap. Seventy-one percent of BNPL users also have credit card balances, the CFPB said, versus 40% of non-BNPL users. This means BNPL users are more likely to carry credit card balances over multiple billing cycles, the CFPB said. 

There are also differences in the data involved in decision making between credit cards and BNPL loans. BNPL loans are either unreported or only partially reported to credit bureaus. Most lenders use proprietary data analysis to underwrite BNPL loans. "One of the credit card company's primary metrics is the credit score," Danner said. "BNPL vendors only perform a soft credit check and some form of internal underwriting to see the customer's history, which isn't going to hold the fort with a surge of new customer sign-ups."

Among BNPL lenders, Klarna didn't comment on the latest stock market selloff. The Swedish lender's public relations office referred the question to a social media post from CEO Sebastian Siemiatkowski that was issued before Monday's market rout, titled "How can Klarna do this turn around in a world of worsening macro economics?' Siemiatkowski said Klarna manages BNPL risk by performing real-time transaction underwriting, charging zero or low interest rates and imposing "strict well-defined pay back time in installments."  

Affirm referred a query to a podcast from founder and CEO Max Levchin during which Levchin, like Siemiatkowski, drew attention to the lender's underwriting tech new loan individually.  "Everytime someone comes along and says I'm going to buy something using Affirm, we get a chance to say 'is this a good financial idea' for you or not?," Levchin said in the podcast. "That alone gives us a very fine degree of control. Because we don't charge late fees and compound interest, we're very financially motivated for you to repay the loan that you're making."

Two other large fintechs active in the U.S. market, Afterpay and PayPal, didn't provide comments by deadline. 

BNPL fintech platforms have a far greater use of AI and large language models in evaluating risk than most credit card issuers' platforms, according Richard Crone, a payments consultant, adding the availability of AI-powered data could benefit BNPL lenders. There are other factors that work in favor of BNPL fintechs over credit card issuers, Crone said. "BNPL offers a more responsive customer experience because it is digitally oriented, making it easy to vertically integrate and expand its brand promise as an all-in-one account."

The existence of more banks in BNPL lending could also make the overall BNPL market more stable.

As the BNPL industry matures and attracts more banks, it should be positioned to manage economic weakness, according to Aaron McPherson, a principal at AFM Consulting, who adds that the recent economic news doesn't necessarily portend a steep downturn. "The jobs report reflects growing labor force participation, as well as a decline in job openings," McPherson said. "Overall unemployment is still quite low." And 78% of the S&P 500 firms that have reported earnings for the previous quarter have beaten analysts' estimates, McPherson said. "The economic fundamentals are still quite strong, and the selloff in the markets is exaggerated relative to the job report."