As the COVID-19 pandemic pushed more consumers toward e-commerce, point-of-sale installment lending fintechs like Klarna and Afterpay saw their popularity and valuations continue to climb over the past few months. Competitor Affirm even launched a buy now, pay later (BNPL)debit card。

BNPL fintechs allow consumers to split online purchases into multiple payments. According to 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 global consumer spending via e-commerce channels using point-of-sale installments is projected to reach $680 billion by 2025.

"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 in January 2020 from online lenderAvant.

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

According toTechCrunchreports, the startup charges banks a percentage fee for each loan processed through its service, plus an average upfront implementation fee of about $1 million, with the exact amount depending on the scope of services and procurement plan, 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 are also using its point-of-sale service, and Avant will join the platform this year.

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

He added that with Amount's service, banks can launch white-label installment financing programs in months rather than years.

"When you close the technology gap and give banks the technology to compete and win against fintechs, they can ultimately gain an advantage in this category."

Changing customer behavior

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

The appeal of this model appears to be generational. According to research from consumer spending data firm Cardify.ai, Gen Z and younger millennials account for more than 80% of BNPL transaction volume.

"We are unlocking younger audiences and debit card consumers," Klarna's U.S. head David Sykestold 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 are partnering 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 tospend more— they tend to be more loyal. It's directly tied to purchases, and retailers love that," he said.

Rossman added that retailers are also 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 basket sizes, and repeat purchases, it's a trade-off they're willing to accept."

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

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

Banks' advantages

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

"If they already work with merchants through credit cards, proprietary credit cards, or other financial products, they are very well positioned," he said.

Recent e-commerce growth has helpedCitizens Bankexpand the reach of its checkout lending 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'sinvested in and partnered withKlarna before the holiday season last year. Affirm's partners include Shopify, Gucci, Bonobos, The RealReal, and Peloton.

"We're still in the early stages of exploring how important BNPL will be, but the adoption of emerging players by major merchants is already a significant achievement," 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 specific 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 pay it off in installments 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 acredit cardin 2019 that mimics BNPL services by consolidating monthly fees into installment plans and allowing customers to choose repayment terms 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.

There is certainly no shortage of interest in BNPL.Ally Financialexited the credit card business in 2019 to pivot to a point-of-sale model. Traditional non-BNPL payment companies have also jumped in. PayPal launchedPay in 4last fall, allowing consumers to split purchases between $30 and $600 into four payments over six weeks.

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

Meanwhile,the launch of Affirm's debit cardrepresents the most direct challenge BNPL companies have posed 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 tied to buy now, pay later," Rossman said. "It's more like a bank card—you can take it into a coffee shop, electronics store, or clothing store, and you can shop online. There's no friction of reapplying each time. In that sense, I think it competes more directly with the banking industry than previous services."

Conclusion

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

"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 customer base focused on budgeting and credit awareness.

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