Why Visa and Mastercard are suddenly keen on installment lending

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Financial industry heavyweights are taking note of the rapid rise of new borrowing options that offer shoppers an alternative to the decades-old credit card.

PayPal, Visa, Mastercard and Citigroup have all made recent moves that reflect the impact of emerging products from the likes of Affirm, Afterpay and Klarna.

Those loan products, which are often grouped together under the “buy now, pay later” umbrella, allow shoppers to make fixed installment payments, rather than tapping into a revolving credit line.

Earlier this week, San Jose, Calif.-based PayPal, which has long offered a line of credit to online shoppers, announced a new option called Pay in 4. It largely mimics offerings from Klarna, Afterpay and others — allowing U.S. consumers to finance purchases of $30 to $600 with four interest-free payments over a six-week period.

Last week, San Francisco-based Visa announced a partnership that is meant to enable shoppers in India to make installment payments when they swipe Visa-branded cards. In July, Visa and Silicon Valley-based ChargeAfter unveiled a similar pilot in the U.S.

And on Monday, Mastercard, of Purchase, N.Y., announced a partnership with QuadPay, another firm that offers 0% financing on small-dollar purchases that borrowers pay off in four installments.

“This is kind of a new choice for consumers,” said Mitch Ferro, the CEO of Mastercard Vyze, which offers participating merchants a choice of loan offers to extend to particular customers. “I think it’s just a really easy-to-understand-type product for the consumer.”

The new wave of installment loan products can help merchants by boosting their sales. The benefits for consumers are less clear-cut.

Consumers typically pay either 0% or an interest rate that is lower than the rate on credit cards. But late fees can pose a risk for borrowers who cannot afford their payments. The installment loans can also add to consumers’ overall debt loads. In a recent survey of Americans by the personal finance site The Ascent, 14% of respondents said that they have used “buy now, pay later” services because their credit cards were maxed out.

Incumbents in the consumer finance industry also face a tricky calculus. Payment networks like Visa and Mastercard get a small cut of each transaction whether it happens on a traditional credit card or a digital-era installment loan. Card-issuing banks, which collect interest when shoppers revolve their debt, may have the most to lose.

But those banks are now facing pressure to respond to the rapid growth of installment lending, which has gotten a boost from the recent surge in e-commerce transactions during the pandemic.

“It’ll very clearly start eating into bank territory,” said Andrés Ricaurte, a senior vice president at the technology services firm Mphasis.

At the end of June, Afterpay, of Melbourne, Australia, reported having 5.6 million active U.S. customers, up from 1.8 million a year earlier. San Francisco-based Affirm has reportedly been preparing for an initial public offering.

Banks that issue store-branded credit cards, especially cards that can only be used at one particular retailer, may face the most immediate threat. Such cards have traditionally been used more frequently by customers with relatively low credit scores, an audience that overlaps with the young-adult segment that is frequently targeted by the “buy now, pay later” companies.

In a July research note, analyst John Hecht of Jefferies noted that foot traffic at traditional brick-and-mortar retailers that are key partners of banks that specialize in store-branded credit cards declined sharply in the second quarter of this year.

“While in-store retail declines during the pandemic, e-commerce has thrived,” Hecht wrote. He argued that online point-of-sale financing from companies like Affirm and Afterpay will continue to become more popular over time.

The rise of digitally focused installment lenders gives shoppers more choice than they previously had, said AJ Stocker, a former executive at the credit card issuer Alliance Data Systems.

“My point of view is that it’s just another option that they can choose from depending on their situation,” said Stocker, who is now vice president of strategic consulting at Kobie Marketing.

Ricaurte, a former executive at American Express, argued that credit card-issuing banks are not well positioned to make rapid credit decisions like their new competitors do, in part because of how their data is structured and how their risk policies work.

By contrast, the upstart lenders use a limited amount of information that their prospective customers provide, plus insights gained from their users’ digital footprints, to determine in real time whether to approve an application, he said.

“They have a ton of very recent data, which some might argue is more relevant than whether you defaulted three years ago,” Ricaurte said.

One bank that has begun to adapt is Citi. Last month the New York-based bank announced that it will allow eligible credit card holders to split the cost of most Amazon purchases over $100 into equal monthly payments.

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