This is an update of my earlier article here about the potential dangers of the BNPL craze especially among Gen Z consumers. I had highlighted a possible future where indiscriminate pumping of BNPL loans to young, financially naïve and immature consumers would bring upon a credit crisis much like the one following the 2008 financial meltdown, brought about by indiscriminate lending of mortgage loans to consumers with questionable credit worthiness.
The reason this new product seems attractive to loan origination firms is the option of “offloading” the default risk from their balance sheet. Just as banks “packaged” mortgage loans into tradeable securities that could be bought by investors, so too in BNPL the annuity payments could be packaged into tradeable securities by deft financial engineering. As the market for BNPL increases I foresee more of such financial engineering strategies being used since lenders look to offload the credit risk inherent in these loans to buyers of the risk.
This has an eerie similarity with the mortgage loan packaging that took place before the 2008 financial crisis kicked in. Mortgage originators, banks, Credit rating agencies, and institutional investors (who should have known better) took part in this feeding frenzy, trading exotic derivatives which were dependant on mortgage payments being regular and low on default risk. But defaults did happen as banks took their eye away from sound credit risk management guidelines, and this one link caused the entire chain to unravel, causing a huge worldwide crisis.
Just recently the well respected private equity firm KKR announced that it had bought upto 40 Billion Euros worth of BNPL loans from Paypal Europe. BNPL, which saw dramatic rise during the pandemic among millennials and GenZ who were sitting at home and shopping away merrily, is seeing signs of slowdown amidst high interest rates, uncertain economy, jittery job market and high inflation. As a result, BNPL loan origination companies are seeing red flags in their balance sheet due to uncertainty of cash flows from these loans. Many of them are therefore looking to offload this credit risk to other investors.
How many companies join PayPal in this flight away from risk remains to be seen. Given the uncertain global economy I see this flight to safety spread from Europe to the US and across the world. Even Indian companies like Myntra, Nykaa, etc who have been at the forefront of BNPL could potentially suffer. The big banks like Axis Bank, ICICI, Kotak Mahindra all have jumped on to the BNPL bandwagon with a view to prevent the more tech savvy smaller players from stealing market share. Will we see a Déjà vu of the credit default driven financial crisis of 2008? We can only wait and see.