To understand what is going on in the financial services industry, we need to step back and look at the wider perspective. Granting credit is based on trust and the relationship between the lender and the customer. This business has been the monopoly of banks for a long time.
Banks have owned this local and very personal relationship, historical customer data, and access to a cheap capital base. The ones who have established a bank know exactly how complex this process has been made for newcomers. In terms of entry barriers, it has been a well-guarded market.
Open Banking and Buy Now, Pay Later to Innovate Financial Services
Open banking and other similar rules are slightly but consistently hindering the monopoly of banks on data. These make entering the financial services market easier and more flexible to innovators. All that big technology companies need to do is:
teach their algorithms to trust the customer by processing available data;
get necessary regulatory approvals.
Getting these approvals from the local financial services authority (FSA) is a time-consuming process that will take a couple of years. The authority needs to approve everything from the team and technology to the business model.
Having settled these questions, a risk diversification strategy must be created. Offering BNPL services is a perfect entry point to the financial market as you can build a diversified portfolio without too much risk concentration. In essence, it is like issuing small-ticket loans, that is smaller loans with a higher interest rate. If a customer defaults, financial service providers will have less to lose per loan. It is also easier to manage risks for small loans to many than for large loans to a few. That is exactly the path some big tech businesses are following these days.
Buy Now, Pay Later Services Are Here to Stay
Mind-blowing amounts being paid for BNPL service providers reflect the enormous potential this market holds. Square buying Afterpay proves that it bought a couple of years’ head start with this transaction. Square will also probably gain a significant edge on leveraging its existing payment data in bringing new financial services to the market.
On the other hand, Apple seems to be setting up its own system from scratch, which will be a difficult and long journey even for them. The complexity lies in the regulatory environment, which differs in each country. They need to get approvals from every single local FSA to operate in a respective country. Local rules may vary in details starting from advertising rules and requirements for down payment to conditions on issuing credit. But also, the methods for analysing customer creditworthiness to comply with responsible lending, detecting and preparing for fraudulent activity, managing different ways of signing, complying with local court practices for collecting the claims, etc. are different.
Future Providers of Financial Services
Soon, we will see how other large technology companies react to this market shift. It will be tough to reason to shareholders and VCs why they are not working on BNPL offerings.
I predict that ten years from now, technology giants or banks who have transformed into that will take over and consumers will use financial services offered by them. I wouldn’t narrow this down to only buy now, pay later services, I think the impact will be much wider. I would include payments, mortgages, car leases, and all the rest you can imagine. The competition is ruthless, and we will soon see who is going to be the next one jumping on the bandwagon.