Buy now, pay later lenders have some swagger, but their revolution is far from certain in Canada

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The recent flurry of deals for buy-now-pay-later lenders, including Square Inc.’s US$29-billion acquisition of Afterpay Ltd., is reviving speculation of widespread disruption in financial services, echoing the hysteria over financial technology startups roughly five years ago.

“This decade is going to be the upheaval of the banking industry,” Sebastian Siemiatkowski, chief executive officer of Swedish BNPL lender Klarna, one of the world’s largest, said on CNBC last week.

The reality: Much like the last round of fintech hype, a revolution is far from certain. The new lenders have taken some market share as e-commerce sales surged during the pandemic, stealing credit card transaction volumes and customer purchase data in the process, but the incumbents, notably banks and credit card companies, are racing to rival them – and these giants hold sway, particularly in Canada.

Two days after Square announced its blockbuster acquisition last week, Bank of Nova Scotia unveiled an instalment payment program of its own, echoing previous launches by the likes of Canadian Imperial Bank of Commerce and Royal Bank of Canada .

Visa Inc., meanwhile, announced a partnership with Global Payments and Desjardins Group in mid-July to launch its own instalment program across Canada. The service will allow buyers to split their purchases into smaller, equal payments over a set period of time.

Buy-now-pay-later lenders have existed for decades, and they offer the types of financing traditionally advertised in television commercials, such as no money down and instalment payments over long timelines.

Historically, the lenders were banks that partnered with retailers through private-label credit card divisions, or were retailers themselves, such as Sears, that had in-house loan programs. But the service lost its lustre because it was cumbersome – customers had to manually fill out forms in store, then wait while the risk department approved the credit. “It was a pretty flimsy process. It was a bit of a hassle,” John Armstrong, KPMG Canada’s national industry lead for financial services, said in an interview.

The new crop of lenders such as Afterpay and Affirm integrate themselves into e-commerce platforms, offering payment instalment plans online and in apps beside the “add to cart” button before a customer decides to check out. The process today, Mr. Armstrong said, “is just dead easy.”

Afterpay, which is based in Australia and has yet to make a profit, watched its volumes grow at an annual compound rate of 105 per cent over the past two years by allowing customers to split their purchase over four, interest-free instalments. In many of its markets, customers only pay a fee if they miss an automated payment, and when that happens, their account is locked until the balance is repaid. (Afterpay does not charge the same fee in Canada).

In Canada, multiple lenders have gotten in on the gold rush, and some have already cashed out. Both PayBright and Flexiti Financial Inc. were acquired over the past eight months. Flexiti’s new loans grew to an estimated US$292-million in 2020 from US$49-million in 2017.

The BNPL threat is worrisome for Canadian banks because credit cards are one of their highest margin products. Yet Canada has historically been a tough market for newcomers to crack. The Big Six banks dominate here, while the U.S. is much more fragmented.

Canadians have also shown to be partial to their banks, taking pride in the way they have endured calamities such as the 2008 global financial crisis in good standing relative to global peers. “The banks have a lot of brand equity,” KPMG’s Mr. Armstrong said.

Complicating matters for startups, the Big Six lenders have learned a thing or two from telecom companies and offer bundle packages that give their customers fewer reasons to try out rival services. It’s partly why cash-transfer apps such as Venmo haven’t taken off here; free Interac transfers are often included in chequing account packages.

Canadians are also obsessed with loyalty programs, and the banks know it – which is why travel rewards cards held such clout before the pandemic. Expect the incumbents to leverage these to keep customers tied to their current cards.

For all the current hype, no one knows exactly how the BNPL market will shake out – in Canada, or globally. For one, these lenders pitch themselves as the consumer-friendly option, but the sector is rife with hidden fees, with some lenders charging harsh penalties for missing payments.

RBC studied the market for two years before launching its product in January, Amit Sadhu, a vice-president at the bank, said in an interview, and decided its best way in was to offer a clean product with no hidden fees. The bank also requires users to repay their loans using their bank accounts, not another form of credit.

Future merchant participation is also a major unknown. BNPL lenders often tout all the retailers they’ve partnered with, but these merchants pay hefty fees, often 2 per cent to 8 per cent of the cost of the item purchased. The hope is that the partnership will expand sales, but if lasting revenue bumps don’t materialize, paying such a huge cut may not be worth it.

And then there’s the threat of tougher regulation. This year, Britain’s financial regulator released its review of the sector and found billions of pounds were being lent in unregulated transactions. Many borrowers also did not realize late payment fees were possible – instead, they thought the services were nothing more than a debit card.

Britain’s watchdog has called for full regulation of the sector, while Sweden, where Klarna is based, introduced legislation to prevent BNPL offers from displaying ahead of low-cost direct payment options online. If more rules emerge, it could slow the sector’s growth, buying incumbents time to catch up.

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