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Buy now, pay later

In India, Covid has cemented the strain of ‘zero-interest’ digital lending by FinTechs as more and more consumers turn to e-commerce. BNPL is now a prime mover in the matrix of Retail 3.0.

Hyderabad-based techie Prashanth A Susarla is planning to buy a second laptop. An Asus, with a price tag upwards of Rs2 lakh (INR200,000, approx. Dh10,000). Alongside, in the aftermath of #WFH — with dishes being piled up at home as everyone remains locked in — he is eyeing a new dishwasher, the cost for which is around Rs35,000.

Unlike a lot of other Indian consumers who’d pay by credit card — and get into the loop of having to repay dues at the end of a 45-day credit cycle — he will opt for the ‘zero-interest EMI’ being offered by new-age finance companies, and avail of a “digital loan”. He did it previously when he purchased his 65-inch LED television for Rs75,000, and when he booked a holiday on MakeMyTrip for Rs1.25 lakh.

Susarla is among thousands of other Indians who have become part of the hottest trend in the Indian consumer economy: Buy-Now-Pay-Later (BNPL), a FinTech digital lending initiative which addresses credit needs of those beyond the so-called “prime segment”: these consumers reside (mostly) outside big metros, are new to credit, self-employed, with an average annual income of around Rs4 lakh (INR 400,000). The subtext is they have “limited means”.

BNPL has, unlike commercial banks, broken down ticket sizes of zero-interest loans — and still making profits. FinTech companies like PineLabs, Capital Float, Bajaj Finance, among others, are providing access and eased the user experience by doing away with traditional — and, at times, complex — paperwork.

This is an immediate cause of suspicion: how does ‘zero interest’ work? Here’s how. The company throws in an unofficial discount to nudge sales, say, before a festive season, and ups the volumes game. The interest component owed by the customer is adjusted — hence “zero”. The repayment timeline is up to the customer, and the purchase cost is spread out over multiple installments.

The logic of buying into a BNPL scheme, as Susarla explains, is very simple: “The outgo from my pocket is zero, so I can park some of the money which I otherwise would have spent on the purchases elsewhere and earn interest on it.” And he can settle his loan at his convenience (pre-decided between him and the lender).

A new retail roadmap?

As a trend, BNPL accelerated during the nation-wide lockdown last year, fuelled by a new class of consumers who did not want to destabilise tight household budgets. Other than large metros like Delhi, Mumbai, Kolkata and Chennai, the footprint is expanding to Tier-2 and Tier-3 towns. The latest Kearney Retail Index (released last month) revealed that, during the lockdown, smaller cities saw an emergence of first-time online shoppers. Cities in Tier-3 and beyond saw 53 per cent growth in e-commerce volumes, making them the fastest growing “region”.

Not unsurprisingly, over the last one year, there has seen a 100 per cent growth in BNPL coming purely from the non-metro segment. “Earlier, the growth was around 30 to 40 per cent. About 2,500 towns have been added to the consumer map in the last one year,” says Kush Mehra, Chief Business Officer at Pine Labs, one of the leading merchant commerce platforms, serving large, mid-sized and small merchants across Asia, including India, and the Middle East.

A survey of Indian consumers conducted by McKinsey last November confirms that the significant bump in online purchases witnessed during the lockdown is likely to endure. Growth in online consumer purchases in a post-Covid phase could be anywhere between 15 to 25 per cent. The same survey also points out that consumers are gripped with a fear of public spaces — a perception that will only worsen in the aftermath of the ongoing second wave, further spurring a shift to e-commerce.

Digital payment mechanisms like BNPL have accelerated this makeover by extending credit to customers who otherwise did not have access to formal credit due to lack of credit bureau history — by tapping into other metrics like cash flows to generate a risk profile.

At present, there are about 150 million Indians using the banking network to purchase consumer goods on credit; the expectations are that schemes like BNPL will add another 500 million to this base — especially with per capita income in non-metros projected to grow faster than that of metros. And a sizeable chunk of these underserved (on account of not having access to credit) customers would be digitally-savvy millennials who do not possess the capital to make a down payment.

How BNPL works

A recently-released report from Credit Suisse says digital lenders in India, with an active user base of 200 million borrowers, has grown to $10 billion; they now account for more than 40 per cent share in personal and consumer durable loans. BNPL’s model works in three ways. First, it reduces the size of a ticket transaction to as low as Rs5,000, the starting price for a pair of branded shades. Second, it staggers the repayment over several months — compared to the usurious rate of about 3 per cent per month charged by credit card companies on dues. Third, unlike commercial banks, who mostly rely on a strategy of lending against collaterals, nimble FinTechs mine alternate data sources about a borrower to locate and deliver credit to them, while levying a commission from the merchant establishment and the bank as a fee to facilitate credit.

The big spurt in digital lending has come mostly thanks to Aadhaar — the unique 12-digit number issued to all those residing in India — that enable e-KYCs. Consequently, FinTechs can disburse the loan in minutes, often for small ticket sizes for first-time borrowers. By calibrating their risk exposure, digital lenders are able to reduce their delinquency. Further, the pairing of Aadhaar with an inter-operable payments mechanism, such as the unified payments interface (UPI), has provided an impetus to financial transactions.

“The concept of BNPL has existed for a long time,” argues Monica Jasuja, a product management executive in the payments, FinTech, financial services space. “What FinTechs are doing is to provide scale. And they are exploiting the demand potential which commercial banks failed to do earlier.” For FinTechs, BNPL is a greenfield opportunity to tap the unaddressed credit needs of millennials, she adds.

Cracking the FinTech code

The same Credit Suisse analyst report reveals a staggering growth in online lending. It estimates that in the last seven years, the annual compound rate of growth of digital borrowing was 43 per cent. The bulk of this increase has been enabled by bringing in new borrowers — through schemes like BNPL — into the business of formal credit. “They (FinTechs) have gained more than a 40 per cent market share in new personal loans and 20 per cent plus in unsecured retail loans,” the report said.

Madhusudanan R, co-founder of YAP, the start-up which raised $10 million in a Series B funding in March, and which provides the operating system for FinTechs, explains: “The credit bureau tracks 400 million consumers. Credit cards have only been allotted to 30 million and yet credit availability is 10x of this. This gap is being serviced by FinTechs, by aligning credit with an individual’s salary.”

This is unlike commercial banks who loaned money only after securing collaterals against loans. FinTechs are tapping alternative sources of information to build a credit profile of a person. While information provided by credit bureaus like Cibil are the starting point, they mine information on a host of other parameters including monthly cash flows and an individual’s annual tax returns. Often while a young borrower would not be able to put up a collateral, their cash flows are sufficient proxies to their credit worthiness.

“It is a win-win. The consumer has access to credit which can be repaid in interest-free EMIs. The company sees a sale conversion. And FinTech gets access to data about the consumer to enable them to underwrite what is an unsecured line of credit,” says Madhusudanan.

The new generation of borrowers are mindful about protecting their credit record: a good credit history can be leveraged for larger loans in the future. For FinTechs, this works out perfectly as they can keep their customer acquisition cost to the minimum and expand their portfolio by lending to existing credit-worthy customers.

Aparna Ramachandra, founding director of Rectify Credit, a credit advisory firm, says, “The proportion of those willing to con the system and default on their dues is very low. We find that often they default because they are unaware of the costs on delaying credit card repayments. So when they approach us to repair their credit history, they are a key stakeholder. Our strike rate is 99 per cent in restoring the credit history of borrowers.”

The future of digital lending

According to the Kearney retail report, the expansion of India’s consumer economy beyond metros will pick up over the next few years. The new cities on the horizon include Surat, Vishakhapatnam, Raipur, Faridabad, Kozhikode, Mangalore and Jabalpur. These, the report says, will drive the next wave of retail growth: “Most retailers today are looking beyond the top 100 cities to fuel their growth.”

Significantly, it adds, “The pandemic revealed another interesting plus of India’s smaller cities: resilience. The impact of Covid-19 on retail activity [brick-and-mortar and online] has been less severe in Tier-2 and smaller cities than it has been in Tier-1 and metro cities.” It’s with this backdrop in mind that Madhusudanan avers, “Credit consumption in India is at a point of inflection. We are not even scratching the surface. At present, the size of the consumer credit market is about $300 billion. This will grow 3x in the next three years.”

Clearly, there is huge untapped potential for BNPL “especially if one was to include the offline market where at present only a third of the $35-40 billion transactions are financed,” according to PineLabs’ Mehra. “We [his company] process 90 per cent of BNPL transactions carried out by the brick-and-mortar stores, and are expecting a bigger push to the BNPL trend.” His projection is that their volumes will grow to $4 billion in 2021-22, compared to $2.7 billion in 2020-21.

However, there are two important caveats to be handled for the blueprint of Retail 3.0 to roll out and take flight. One is the long overdue passage of the data privacy law, currently pending in Parliament. This will ring-fence an individual’s data and companies will have to obtain their consent — either for single or multiple use — before using it. At the moment, most platforms harvest personal data by luring consumers with free-of-cost social media services, sometimes without consent, and then using them to pitch products or services.

Second, closely linked to the privacy law is the Account Aggregator (AA) platform created by the Reserve Bank of India (RBI). The AAs, several of them have already been licensed by RBI, will mediate between companies and individuals on the use of financial data; once the process falls in place in entirety, companies’ use of a customer’s financial data will come under an additional layer of scrutiny.

With the AA network fully operational and the privacy law in place, the architecture of a loan service provider will be set. Along with other forms of lending, it will also give fresh impetus to FinTechs operating in the BNPL space.

As Tanya Naik, Head of the Online and Omnichannel Business at Pine Labs, put it, “Retail 3.0 will blur offline and online retail. As a payments company, we need to ensure our products are flexible enough to adapt to this change. For instance, you may want to avoid standing in queue at a Starbucks. Instead you would order it on the app and pick it up from the nearest store — thereby fulfilling an omnichannel experience.”

A retail version of farm to fork.

(Anil is a journalist based in New Delhi, India. He tweets at @capitalcalculus)