Nigel Morris, the co-founder of Capital One and an early investor in buy-now-pay-later companies like Klarna and Aplazo, is sounding the alarm about the increasing use of BNPL services for essential purchases like groceries. This trend, he believes, is a clear indicator of financial struggle among a significant portion of the population.
Statistics show that BNPL services have gained popularity, with 91.5 million users in the United States. Surprisingly, 25% of these users are using BNPL to finance their groceries, a far cry from the luxury items these services were initially marketed for. Additionally, default rates on BNPL loans are on the rise, with a significant percentage of users making late payments.
The lack of reporting of BNPL loans to credit bureaus has created a phenomenon known as “phantom debt,” where lenders are unable to see the full extent of a borrower’s debt across multiple platforms. This lack of visibility poses a potential threat to the financial system, reminiscent of warning signs seen before the 2008 financial crisis.
Recent data shows that a significant number of borrowers are taking out multiple BNPL loans simultaneously, with a large portion of them having lower credit scores. While BNPL debt currently doesn’t pose a systemic threat on the scale of the 2008 crisis, the concentration of this debt among already financially stressed individuals is cause for concern.
Regulatory changes under different administrations have further complicated the oversight of BNPL services, with conflicting reports on the impact of these services on consumers’ financial well-being. State-level regulations, such as licensing requirements imposed in New York, aim to address some of the gaps in oversight.
Morris, an experienced fintech investor, sees storm clouds on the horizon in the form of rising unemployment rates and potential financial strain on consumers. While he stops short of drawing direct parallels to the 2008 crisis, he emphasizes the need for vigilance in monitoring the growing use of BNPL services and its implications for the broader economy. In a recent discussion, a prominent figure in the financial industry highlighted the growing concerns surrounding immigration, tariffs, and the recent government shutdown. These factors have led to a significant decline in investments by small and medium businesses, as people have become increasingly hesitant to engage in financial activities amidst the chaos.
Adding to the economic uncertainty is the looming end of the student loan payment moratorium, which represents a substantial asset class outside of mortgages. With millions of borrowers in default or late-stage delinquency, the potential financial fallout from this situation is cause for alarm.
While the current state of affairs may not yet be deemed a crisis, the combination of various factors such as phantom debt, rising unemployment, and regulatory changes sets the stage for a possible escalation of issues in the near future.
Of particular concern is the impact of Buy Now Pay Later (BNPL) debt on the broader financial landscape. The Federal Reserve Bank of Richmond has warned about the spillover effects of BNPL on other consumer credit products, signaling a potential systemic risk.
One key aspect to consider is that BNPL loans, although smaller in size compared to other debts, often take precedence in repayment. This means that borrowers may prioritize keeping their BNPL accounts current while allowing larger debts to default, creating a ripple effect of financial distress.
The moral implications of consumer lending practices also come into question, with the need for transparency and ethical considerations in mind. The concept of the “mom test,” where a product should be something one would confidently recommend to their own mother, underscores the importance of responsible lending practices.
However, the lack of transparency in BNPL companies’ operations and the absence of reporting to credit bureaus pose challenges for borrowers seeking to improve their credit scores through successful repayment.
As BNPL continues to permeate various sectors of the economy, traditional financial institutions are also embracing this trend, further blurring the lines between unregulated lending and conventional banking. The integration of BNPL services into popular payment platforms like Apple Pay and Google Pay signifies a shift towards embedded financial infrastructure.
The evolution of the financial landscape towards embedded finance raises concerns about potential risks and oversight issues. Entire industries are transitioning into financial services entities, with all the associated complexities and uncertainties.
Looking ahead, the emergence of business-to-business BNPL poses a new set of challenges. As BNPL companies target the trade credit market, the potential for increased debt accumulation and reduced visibility into financial transactions becomes a pressing issue.
The rapid pace at which debt is being packaged and sold in the BNPL market raises parallels with the events leading up to the 2008 financial crisis. The acquisition of multi-billion dollar loan portfolios by major investment firms underscores the magnitude of the debt being generated through BNPL transactions.
In conclusion, the growing influence of BNPL on the financial landscape warrants a closer examination of its implications for consumer welfare, economic stability, and regulatory oversight. As the boundaries between traditional banking and alternative lending blur, the need for responsible financial practices and transparent regulations becomes more pronounced in safeguarding against potential risks and ensuring sustainable economic growth.
My own takeaway from my conversation with Morris and subsequent research is the presence of two potential bubbles, with the AI sector attracting significant attention, while the BNPL sector goes unnoticed. The AI bubble has been making headlines with its massive data centers and venture rounds, raising concerns about its sustainability. On the other hand, the BNPL sector, catering to a significant portion of vulnerable Americans, remains a cause for concern due to its invisibility and impact on consumer debt. As economic sectors thrive, it’s essential to remain vigilant and address warning signs to prevent any future financial crises.
