Why Apple’s BNPL efforts could mark a ‘tipping point’ in lending

Apple Inc.’s expansion into buy-it-now, pay-later financing could be just the start of an attempt to shake up the traditional payment system.

The consumer electronics giant has already dabbled in other financial services businesses, including through its Apple Pay payment technology and a co-branded credit card made with Goldman Sachs Group Inc. GS,
However, Apple’s AAPL,
BNPL launch, announced in June at its WWDC developer eventis notable because the company decided to take on the lending functions itself through a new internal finance arm.

The effort suggests that Apple may have bigger financial ambitions down the line and may seek to disrupt not just the BNPL market which encompasses players like Affirm Holdings Inc. AFRM,
and PayPal Holdings Inc. PYPL,
but also the broader landscape of banking and financial technology.

“This could be a tipping point in consumer lending,” said Tom Noyes, managing partner of Starpoint LLP’s advisory business and Citibank veteran.

For Pay Later, Apple relies on installments from Mastercard, a card giant program that allows lenders to make installment offers to customers, and Apple’s new finance arm will retain state lending licenses. Goldman will be the issuing bank, but “in name only”, according to Noyes, since the smartphone giant is creating a new lending entity Apple Financing LLC to make credit decisions.

The creation of an Apple Loan Unit is “very big news,” Noyes continued, but also a bit of a “back to the future.”

Prior to Visa Inc. V,
and Mastercard Inc. MA,
emerged and created open-loop cards that could be used almost anywhere, stores would offer their own credit to customers in a closed-loop model, Noyes said. Now Apple could be moving towards the best of both worlds: its upcoming open-loop Apple Pay Later product will allow consumers to split purchases into interest-free chunks at any retailer that accepts Apple Pay, but the company could also see its expansion into lending to help customers better finance the purchase of iPhones and other Apple devices.

By making it easier for consumers to afford devices, Apple could boost sales, expand its ecosystem and offer a type of BNPL financing that is gaining momentum, especially among young consumers, despite some concerns that it can lead buyers to spend beyond their means.

Apple is also said to be exploring the creation of payment processing technology and infrastructure, said Bloomberg. And in the longer term, through loans and other efforts, the company could look for opportunities to eat away at the traditional banking system given the economics of card transactions.

When consumers make credit card purchases at any merchant, that retailer will pay their bank a discount rate, which means the retailer does not receive the full price of the item purchased. Then, the merchant’s bank divides this discount fee into interchange fees paid to the card-issuing bank, discounts for Mastercard or Visa, and an amount for itself.

Because Apple is a massive retailer, its card fees add up, and the company may see opportunities to reduce what it pays by becoming more involved in the transactional process itself.

“The reason banks exist is as a person who vouches for you and takes risks in transactions,” Noyes said. “Today Apple, Google and Amazon know you better than any bank, and they’re all looking for ways to improve the way the financial services you need are delivered.”

Instead of paying card fees while its customers are also racking up credit card interest, Apple could look at the current financial system and realize that it “could grow this business just through expense savings,” said Apple. added Noye.

He noted that emerging markets such as India and Brazil have payment systems without the fee models Americans are used to. “In the United States, we have to start preparing for the days when the exchange is zero,” Noyes said.

Even if such a move were to prove successful for Apple, the question remains whether other retailers could realistically follow the company’s lead in financial services and lending.

“It takes a pretty big organization to do that,” Noyes said. He pointed out that Target Corp. TGT,
has seen strong adoption of its RedCard, although it sees this happening more on the debit side.

Amazon.com Inc. AMZN,
and Google GOOGL from Alphabet Inc.,

have shown growing ambitions in fintech, but they seem less likely to build their own in-house lending businesses.

As it stands, Amazon has its Amazon Pay digital wallet and is working with Affirm to offer installment payment options. And payouts would appear to be “a natural evolution of Google Wallet,” but possibly cohorting with an existing player, said Jordan McKee, principal research analyst at 451 Research, part of S&P Global Market Intelligence.

“I think Apple will be somewhat unique…in terms of offering this kind of service entirely in-house and lending its own balance sheet,” McKee said. “I expect others to partner with existing providers and traditional financial institutions.”

Some banks, for their part, tried to get ahead of the BNPL threat by themselves offering a variation on the trend. Citi, Chase and American Express Co. AXP,
have options for consumers looking to split certain purchases into installments.

Financial institutions are “watching the BNPL closely because they realize that while it may not pose a threat to the credit card side of the business today because the primary users are more young and flow-centric, there is a real possibility that as these young consumers who grew up on BNPL grow older, they may never graduate,” McKee said.

A younger consumer whose first credit experience is Apple Pay Later might eventually switch to an Apple Card rather than a credit card from Citi or Bank of America Corp. BAC,
he offered.

McKee also focuses on the broader implications for the BNPL market, which has been through a tough time with rising interest rates, rising credit risk and shrinking spreads. Affirm, which offers both interest-free and interest-bearing installment products, has seen its shares fall nearly 80% so far this year.

While Affirm, privately held Klarna, Block Inc.’s SQ,
Afterpay and PayPal are among the big names in the industry, there are also a host of smaller players. For Block and PayPal, BNPL is only part of the overall business, and Affirm and Klarna have expanded into adjacent areas such as content discovery and banking-like products including debit cards.

“The BNPL provider that only does BNPL is in a rush,” McKee said. There is a “growing need for consolidation” or a move into adjacent areas in hopes that a more diverse company “could fend off newcomers to the space like Apple”.

BNPL services make money in various ways. The typical interest-free offer is merchant funded, meaning retailers will give BNPL companies a portion of the value of the transaction in exchange for making consumers more willing to make a purchase. Interest-bearing BNPL options are more like traditional loans in that consumers earn the right to pay over time.

Apple itself does not charge merchants a fee for Apple Pay Later. A Mastercard spokesperson said “fees for the program are value-based and shared by lenders, acquirers and the network.”

According to Francisco Alvarez-Evangelista, advisor at Aite -Novarica Group.

His research indicates that consumers generally prefer interest-free offers. But BNPL companies may be increasingly motivated to make more interest-bearing loans for economic reasons.

Unlike established players, Apple isn’t necessarily looking to make Pay Later a major revenue generator. More likely, the company sees opportunities in lending to add rigidity to its business and keep consumers locked into the ecosystem, Alvarez-Evangelista said.

“A big player like Apple can come in and disrupt the space and say, we know the competitors are going for the interests, but let’s step back and go for the irrelevant,” he said.

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