At the end of March, Apple launched Apple Pay Later in the US, its much anticipated buy now, pay later (BNPL) service, which will allow consumers to spread payments of between $50 and $1,000 over six weeks.The programme will rival BNPL incumbents including Klarna, Clearpay and Affirm who have, until now, dominated a market in which payments are expected to reach almost £420 billion in 2023.

While fintechs in the space are yet to become profitable, this move highlights the continued influence of underlying factors that previously drove the growth in BNPL, and more broadly, that of embedded finance.

The younger generations are one such factor. Not only has Kearney’s research repeatedly revealed that millennials and Gen Z are more comfortable consuming credit when it is disguised as something else, but that BNPL credit is also much more accessible to younger people than other forms of credit.

To get traditional credit, you are more often than not required to have a minimum credit score. With the current regulation, most BNPL services do not require this, and there is therefore no need for a consumer to have built up a good credit rating. Particularly as BNPL services become integrated more and more seamlessly into checkout processes, younger generations are increasingly exploiting the ease with which they can access this ‘credit in disguise’.

Recent changes to the macroeconomic environment have also impacted the use of BNPL and the outlook for its growth and adoption. On one hand, higher interest rates and the cost-of-living crisis increases the attractiveness of the BNPL product for customers – acting as a tailwind. In fact, a study by Forbes Advisor found that 70% of BNPL users were paying through BNPL more often as a direct result of the cost-of-living crisis.

However, on the other hand, the very same factors could act as headwinds for the sector as higher funding costs, potentially higher impairments, and a slowdown in customer discretionary spend impact the top and bottom lines of the BNPL players. For a sector that relies on a business model which targets consumers on a smaller budget, there is a high risk that many customers will not be able to keep up with repayments.

So while the cost of living issues are driving the increased uptake of BNPL, the industry needs to ensure that customers are protected, which means they need to assess affordability and appropriateness of the product. If it can do this, underlying demand offers potential for real growth in the sector.

How are financial institutions reacting?

Larger banks are clearly aware of the need to engage with the BNPL market and the growth of embedded finance in order to keep up with the more agile challenger banks and fintechs, which are starting to draw away younger customers. This is demonstrated by the fact that in 2022, Virgin Money announced a BNPL credit card, NatWest launched a BNPL credit scheme and Monzo unveiled a BNPL product with a £3000 limit. While there are many financial institutions that are still to reveal where they stand on future plans for BNPL, entry into the market by these larger players is adding to the pressure currently being experienced by BNPL market leaders.

Although not as agile as their fintech competitors, one of the major advantages that the larger banks have is that they already have a sizeable and loyal customer base, and a stable, lower cost deposit base.  However, many of the larger banks also grapple with legacy tech stacks that make integration into the payment journey more difficult. Additionally, their internal processes, such as underwriting, are often slow and thus negatively impact the customer experience.

Something that we may see in this space is increased M&A activity, as the established players look to acquire key capabilities and BNPL players look to address their funding challenges. However, this will very much depend on how new regulation impacts the viability of, and risk associated with, BNPL products.

While there will almost certainly be measures implemented to increase consumer protection at some point, the huge scope of the regulatory change agenda, including the Edinburgh reforms could mean delays in the legislation coming through.

In the meantime, we see the BNPL offering grow as banks and fintechs alike work to meet the ever-changing needs of their consumers.