The regulatory framework for Buy Now Pay Later (BNPL) firms underwent a significant transformation with the roll-out of RBI’s digital lending guidelines in December 2022. These guidelines reclassified BNPLs as Lending Service Providers (LSPs), enabling collaborations with regulated banks and NBFCs to offer bundled loans. However, the RBI’s actions didn’t conclude there, as further guidelines were unveiled in June this year, aiming to scrutinise lending relationships between digital lenders, BNPLs included, and NBFCs.
At the heart of these guidelines lay the practice of first-loss default guarantees (FLDGs), which digital lenders traditionally extended to cushion against potential non-performing assets (NPAs). Preceding the RBI’s intervention, these guarantees spanned a spectrum from 20% to a complete 100%, affording lending partners a buffer against the risks stemming from bad loans. However, the new regulatory framework mandated that defaulted guarantees be capped at a mere 5% of the entire loan portfolio.
While many industry observers appreciated the new guidelines for fostering more responsible lending practices, concerns emerged regarding the feasibility of the 5% FLDG cap for BNPL players. These apprehensions are especially pertinent for BNPLs catering to consumers with limited or no credit history, who are often categorized as high-risk borrowers.
The BNPL sector comprises various lending models, encompassing revolving credit lines tailored for smaller online transactions to instalment-based structures tailored for more substantial purchases. A notable dimension of the concern revolves around the creditworthiness of customers engaging in lower-value transactions and the sustainability of covering the costs linked to such transactions.
Rising expenses
A prominent aspect characterizing the BNPL sector has been the notable surge in marketing expenses over time. Despite these substantial investments, profitability remains elusive for most BNPL apps. The imposition of the 5% FLDG cap, alongside escalating marketing costs and the challenges associated with securing funding, has spotlighted the financial fragility of numerous BNPL startups.
This evolving regulatory landscape, coupled with the shifting financial landscape, has also catalysed changes in the investment landscape. Among the multitude of fintech deals recorded between 2015 and 2023, a considerable proportion has targeted online lenders, encompassing the BNPL segment.
VC evaluation
However, the introduction of the 5% FLDG cap has prompted venture capitalists to reevaluate their investment strategies within this sector.
The future trajectory of the BNPL industry hinges on how these startups navigate the intricate web of new regulations and chart a course towards sustainable growth. With funding becoming scarcer and the cost of capital escalating, it’s plausible that the sector may witness a process of consolidation and a reconfiguration of its players.
Many BNPL companies had focused on scaling operations without adequately addressing the challenge of bad loans. With the increasing cost of capital attributed to the FLDG cap and a tightening funding environment, venture capitalists are progressively redirecting their focus towards the quality of a company’s loan portfolio, possibly resulting in industry consolidation.
