It's been a fascinating couple of years for the global “BNPL” category with the meteoric rise in usage, followed by equally meteoric rises in valuations for some of the biggest brands in 2021. Followed sharply in 2022, by some of the biggest value “correction” in both public and private markets - just google Klarna and Affirm to see the volatile trajectory these firms have been on.
India has seen its own interesting turn of events in 2022, with the recent announcement of the “Digital Lending Guidelines” by the Reserve Bank of India, specifically mentioning the BNPL product - and finally clarifying how the central bank will view this product from a regulatory oversight perspective.
Like much financial innovation, BNPL is really just the evolution of an age-old financial concept - that of combining credit with payments… in order to make shopping that bit easier and more convenient. Even our parents would be familiar with terms such as “layaway credit”, “installment finance” and in India; “consumer durable finance” or “EMI”. BNPL has become a modern catch-all term that can include any digital credit product of this type - such as checkout finance, digital EMI, or even Cardless EMI….ultimately the same credit tool in a new skin that gives customers the flexibility to split the cost of a purchase at a relatively low cost.
BNPL in India: Digital EMIs, checkout finance!
Essentially, it is a metamorphosed version of one of the earliest and simplest forms of credit. It dates back to the 1850s when American consumer sewing machine manufacturer Singer Corporation had experimented with a “layaway payment” (believed to have taken a cue from a similar concept introduced by piano makers in New York City). It was a spectacular success, as it later turned out to be, turning the company’s fortunes.
In India too, the concept is not new. The world may have woken up to the potential of BNPL a couple of years ago, but India has known it for decades, albeit in various forms. From the very short term (usually 30 days) ‘Khata’ system at Kirana (grocery) stores to the enormously popular “EMI” that now drives 40%+ of all electronics sales in India.
EMI, as the name indicates, enables consumers to equally divide their repayments to clear off the outstanding loan on a monthly basis at an interest rate. EMI changed the way retail lending is done by taking it to the doorsteps of Indian customers, resulting in a massive surge in demand for consumer durables, besides automobiles, realty, and others. And pioneers like Bajaj Finserv, which started 14 years ago, today have a market cap of over $30 billion. They expanded the market and played a huge role in driving the popularity and awareness of EMIs in addressing offline demand.
More contemporary BNPL products are, of course digital in nature and have other features such as personalised or flexible repayments and risk-based pricing.
BNPL/checkout finance makes for an attractive proposition to customers because of the low cost of credit vs. credit cards. This is achieved because merchants and brands/manufacturers typically subsidize the cost of offering credit via the ‘take rate’ they pay to digital credit players which can then be passed to customers.
And why are merchants happy to do that? Because they see high value in the payment mechanism in terms of increasing average order value, increasing customers, increasing conversion at checkout, and increasing repeat transactions. This is why we see some of the most valuable global digital credit players earn a large proportion of their revenue from merchants.
While what Bajaj has done remains remarkable, ‘digital-first’ fintechs have the advantage of going beyond the traditional offerings and enabling access on smartphones and via QR codes or apps (vs. a human agent in the store).
Globally, BNPL/checkout finance solutions are largely driven by the consumers’ need for convenient and flexible short-term credit, particularly among millennials and Gen Z who detest hidden or opaque credit card terms and costs. In India, though, it is a different story.
Why India is a very different BNPL market
Unlike in the other global markets, BNPL/checkout finance in India is as much an ‘access to credit’ product as it is a ‘convenience’ product. Of course, the other benefits of flexibility and convenience are also there, but essentially low credit penetration is one of the major reasons BNPL has found solid ground.
Industry estimates show that there are less than 25 million unique credit card users out of the 80 million credit cards issued (vs. 940 million debit cards in issuance) indicating how restricted credit availability is in India. Developed markets like the US, UK, and Australia have much higher credit card penetration of anywhere between 58 to 66 percent. In India, it is just about 3 percent.
Credit cards have both a demand and supply problem…many consumers are averse to them thanks to horror stories passed on via parents. With their painful approval process, high interest rates and complicated repayments, it's extremely clear that Credit Cards are not the preferred form of credit for the mass market Indian consumer. At the same time, credit cards are only offered to the relatively affluent and “prime” customers of a bank - typically 10% of the current/savings account holders.
The success of India stack and digitally savvy Indians paved the way for wider and deeper adoption of digital financial services. Rapidly increasing smartphone usage further fuelled the penetration. The pandemic only accelerated it. For perspective: the Unified Payments Interface (UPI), which made digital transactions easy, was already a household name, but it grew to a scale nobody imagined during the pandemic to become the single largest retail payment system in the country in terms of volume of transactions.
Its annual transaction volume is estimated to touch $1 trillion by the end of FY22. Thanks to this robust infrastructure, India has garnered the status of the ‘world’s largest real-time payments market’. UPI is a clear illustration of how innovative products, when made available on robust and agile infrastructure, create value-added consumer-centric services.
India has about 600 million smartphone users and the number is projected to go up to 800-850 million in the next five years. Internet users are also expected to surge to 900 million by the end of 2026. This provides a massive opportunity for scaling digital EMI/checkout finance.
There is also a massive demand for credit in tier-II, tier-III, and beyond. Most of the consumers in these markets are ‘new to credit’ (NTC) or have lower credit scores than urban borrowers, and often look for small-ticket credit for specific needs. But with many not being eligible for a credit card, they have few sources to turn to for safe, transparent, hassle-free, and low-cost credit.
While BNPL offerings such as Pay in 15 to 30 days, Pay-in-4 have gained popularity in global markets, India, as an especially heterogeneous market, has an appetite for more customised and tailor-made products. Given the under-penetration of credit, the use cases are more varied – all the way from online education to medicine delivery to food delivery. This prompted the need to offer checkout finance products of different flavors with different tenures and interest rates.
Indian Regulator sees BNPL/Checkout finance as Credit
India has always been ahead of the curve when it comes to regulation. Its central bank, the Reserve Bank of India (RBI), has closely regulated the lending business and financial products. The apex bank has also defined BNPL (and its predecessor, consumer durable loans) as a lending product in no ambiguous terms, unlike in other developed markets where the regulators have more recently started looking into the industry. The central bank recognized the significance of digitization of traditional lending and payment products and has been enthusiastic about creating an environment that is conducive to scaling them.
While India has one of the most stable regulatory regimes in the world, genuine fintech players have always been in compliance with the regulatory framework exercising due diligence in doing complete KYC of customers and reporting consumer credit information to the bureaus, thus leaving no room for systematic risk. The recent regulatory initiatives such as the Digital Lending Guidelines will further spur the growth of the BNPL industry in the country.
Collaboration is the key
Incumbents (banks) vs fintechs may be a trending conversation, but collaboration is the only way forward to drive financial inclusion in markets like India. Partnerships between “tech” and “fin” enable both parties to leverage the core capabilities of each other and harness cross-industry innovation.
While banks have legacy infrastructure and rigid underwriting models, they have a large consumer base and credibility. Fintechs, on the other hand, have cutting-edge technology, AI and ML-powered risk underwriting models, and the agility to offer end-to-end (onboarding to disbursal to repayment and collections) and tailor-made digital financial products. Therefore, partnerships will be a natural fit and prove essential by removing the numerous friction points that prevent a customer from making lightning-fast purchases.
“Digital EMI” will be an Indian category
India is primed to be the largest digital EMI market in the world with a massive addressable population. According to market estimates, the digital EMI user base in India is expected to reach 100 million by FY26. Another report suggests the industry will see a quantum leap to $45 - $50 billion in gross merchandise value (GMV) by FY26 by growing 15x. Digital merchant payments are expected to shoot up by over eight times and cross $1 trillion by FY26 from the current $285 billion. Digital lending, too, is projected to touch $100 billion in the next four-five years from the existing $20 billion, research estimates indicate.
The meteoric rise of e-commerce and digital payments, aided by the thriving fintech ecosystem, has created a massive opportunity for scaling financial products. This is the reason that even investors from across the globe are betting on the Indian fintech space. The funding boom Indian fintech start-ups witnessed last year speaks volumes of the potential. In the first nine months of FY22, the fintech sector received investments worth $ 4.6 billion, nearly three times the total investments received in 2020 of $ 1.6 billion, according to the RBI.
Reports by independent investment trackers show that around $9 billion was raised by fintech start-ups in 2021 (calendar year). Digital lending tech and payments companies were the most funded segments. While this is expected to continue well into 2022, India’s overall fintech market opportunity is estimated to be $1.3 trillion by 2025.
The massive opportunity ahead and rising demand for access to credit indicates that India will emerge as the largest digital EMI/checkout finance market in the world in the next five years.
NOTE: A previous version of this article was first published on Fintech Futures in March 2022.