In the modern history of credit, we have never seen every component be disrupted and certainly not by a global health crisis? Three big disruptions stand out as being most worthy of our attention in 2021 in the continuing evolution of credit and credit cards.
The Evolution of Credit Cards: 2021 Edition
Going back to its humble origins in 1946 with the Charge-It card issued by Flatbush National Bank in Brooklyn and the Diners Club card a few years later, the credit card’s primary purpose has been to enhance the convenience of transactions. They allow customers to build credit, earn rewards, and simplify big-ticket purchases; all without being linked to a bank account.
As we head into a new year, three big disruptions from 2020 stand out as being most worthy of our attention in 2021 in the continuing evolution of credit and credit cards.
But, in the modern history of credit, we have never seen every component be disrupted and certainly not by a global health crisis. Financial models predicting revenue, costs, delinquencies, and defaults were overwhelmed as sheltering in place and remote activity replaced normal life for most people worldwide. And this will not end anytime soon with lingering effects likely to be seen through 2022 and beyond. Even as the economy generally recovers, we can expect to see surges in charge-offs and small business failures which will impact performance for most issuers in coming quarters.
Regulatory changes, most notably Current Expected Credit Losses (CECL) and International Financial Reporting (IFR) rules, were implemented before the spring pandemic, which ensured credit issuers and markets were decently reserved as the crisis unfolded. While largely under the radar, this issue was critical to performance. Between the reforms of Dodd-Frank and global accounting standards enacted following the economic meltdown and recession a dozen years ago, financial institutions were forced to prepare for severe market stresses by moving many billions of dollars into loan loss reserves. Perfect timing for sure!
New Product Development
The third – and potentially most consequential – event from last year was new product development. Some, like the surge in contactless payments, have been long coming. Others arose simply in response to the environment, such as the huge surge in e-commerce as consumers shifted much of their purchase behavior to the internet. However, the most interesting development was the growth of Buy Now Pay Later lending, a fresh take on installment lending providing a fixed term on a purchase instead of utilizing available credit on a card, with merchants paying an above-market discount to the provider rather than interchange. The growth in BNPL comes against a backdrop of declining credit card balances due to reduced consumer spending, more conservative borrowing as well as stricter line management from issuers.
BNPL: Opportunity or Challenge for Issuers?
According to Afterpay, a primary BNPL provider, it appears online merchants had some happiness during the recent holiday season. In a release this week, the fintech reported, average e-commerce transaction sizes were up 30% over 2019, boosted by major retailers moving Black Friday sales earlier in the season. It also appears that BNPL generated a lift with many providers linking to Apple Pay, Google Pay, and traditional card accounts.
So, should card issuers embrace this trend or push back? Capital One is on record as banning the use of its credit cards to fund BNPL transactions, noting that they “can be risky for customers and the banks that serve them.” BNPL is an easy and transparent way for consumers to conduct a purchase. Credit cards have fees, compounding of interest, and hard to understand penalties. BNPL is different because fees, rates, and payment schedules are clear, explained in customer-friendly terms with no interest charges.
For merchants, accepting BNPL is similar to cards. Merchants pay the discount fee to the provider who settles the transaction directly with the merchant receiving proceeds of the sale regardless of the number of payments made by the customer. Which means the BNPL provider – not the merchant – carries the risk of fraud and chargebacks.
Issuers assume the risk of cardholders not paying their balances, and BNPL does increase that risk marginally since issuers cannot profit from interest and late fees on these transactions. Only interchange. Capital One’s statement that BNPL can be risky for consumers is correct in the sense that consumers can assume debt and all excessive personal debt can be dangerous. However, there is virtually no difference to consumers between a card transaction and a BNPL other than the former could accrue interest and fees on unpaid balances.
It appears that a card issuer’s aversion to BNPL – or providing a BNPL-like option - would be driven more by concerns regarding reduced profitability per transaction than by increased risk, which should be a critical factor in the decision whether to embrace or shun the product. However, many issuers already invest heavily to develop, launch, and manage rewards products which are focused on transacting clients rather than revolvers and, thus, less profitable than other products which drive more interest and fee income. A difficult choice for sure, but any decision to ignore an increasingly popular payment approach to fintech providers needs to be carefully considered, and we intend to watch this trend and others as 2021 business activity unfolds.