BNPL: how buy now pay later works and where the risk sits

BNPL, buy now pay later, is a form of short-term consumer credit offered at the point of sale, and it has grown rapidly because it is simple for the customer and profitable for the provider. The customer buys a product and pays in instalments, typically three or four payments over six to twelve weeks, usually with no interest if paid on time. The merchant is paid in full by the BNPL provider at the point of sale, minus a fee, and the provider collects the instalments from the customer. The provider bears the credit risk, the fraud risk, and the funding cost, and earns the merchant fee plus late fees from customers who miss a payment. The largest providers are Klarna, Afterpay and Affirm, and the model is now offered by banks and card schemes as well. Why BNPL exists is that it increases conversion for merchants and gives customers a way to spread the cost without a credit card. A merchant that offers BNPL typically sees higher conversion and a higher average order value, because the customer can buy a more expensive item and pay over time. The customer likes it because it is interest-free if paid on time and does not require a credit card application. The provider likes it because the merchant fee is higher than a card interchange fee, typically 3 to 6 percent, and because it acquires customers cheaply. The regulator concern is that BNPL is credit, and customers who use multiple BNPL providers can accumulate debt that no single provider can see, which is why the United Kingdom and other jurisdictions are bringing BNPL into regulation. The parties are the customer, the merchant, the BNPL provider, and the funding source. The customer selects BNPL at checkout and is credit-checked by the provider, usually with a soft check that does not affect the credit score. The merchant offers BNPL through the provider integration and is paid in full, minus the fee, when the customer completes the purchase. The BNPL provider pays the merchant, collects the instalments, and bears the loss if the customer does not pay. The funding source, which may be the provider own balance sheet or a warehouse facility from a bank, provides the money to pay the merchant before the instalments arrive. The card scheme is not involved, because BNPL is not a card payment, although some BNPL providers issue a virtual card to process the transaction. In practice the BNPL flow works like this. A customer buys a GBP 300 jacket and selects pay in three instalments. The provider runs a soft credit check and approves the purchase. The customer pays GBP 100 immediately, and the provider pays the merchant GBP 300 minus a 4 percent fee, which is GBP 288. The customer then pays GBP 100 in 30 days and GBP 100 in 60 days. If the customer pays on time, the provider earns GBP 12 from the merchant fee. If the customer misses a payment, the provider charges a late fee, typically GBP 6 to GBP 12, and may report the missed payment to a credit reference agency. If the customer never pays, the provider writes off the GBP 200 it is owed, after deducting any late fees collected. A worked example shows the economics. A BNPL provider processes GBP 10 million a month in purchases. The merchant fee averages 4 percent, so revenue is GBP 400,000. The funding cost is 1 percent, so the cost is GBP 100,000. The credit loss rate is 1.5 percent, so the loss is GBP 150,000. Operating costs are GBP 80,000. Profit is GBP 70,000, which is a margin of 0.7 percent. If the credit loss rate rises to 2.5 percent, the loss becomes GBP 250,000 and the profit becomes a loss of GBP 30,000. This is why BNPL providers are obsessed with credit scoring: a one percentage point change in the loss rate can turn a profitable month into a loss, and the loss rate is the single most important number in the business. What happens when BNPL goes wrong is a customer harm issue, and the regulator is watching. If a customer uses BNPL with multiple providers, each provider sees only its own exposure, and the customer may accumulate debt it cannot repay. If the provider does not perform adequate affordability checks, it may lend to a customer who cannot pay, and the customer may be charged late fees that compound the debt. The United Kingdom Financial Conduct Authority has consulted on bringing BNPL into regulation, which would require affordability checks, clear disclosure, and access to the Financial Ombudsman Service. A BNPL provider that does not prepare for regulation will face a costly remediation. The operational and accounting implications are that the BNPL provider must run a credit decisioning system, a collections system, and a funding facility. On the ledger, the amount owed by the customer is a receivable, the amount paid to the merchant is a payable that is settled immediately, and the credit loss is a provision that must be updated as the portfolio ages. The funding facility must be sized for the peak, because a BNPL provider that cannot pay its merchants on time loses them. The accounting team must also track the merchant fee as revenue, the funding cost as a cost, and the late fees as revenue, and must ensure that the revenue is recognised correctly: the merchant fee is recognised at the point of sale, while the late fees are recognised when they are charged. The finance team must also manage the funding facility, because the provider pays the merchant before it collects from the customer, so it needs working capital. For a business analyst, BNPL is a credit and collections subject. You must specify the credit decisioning rules, the affordability checks, the instalment schedule, the late fee rules, the collections workflow, and the reporting. You must also specify the merchant integration, the settlement timing, and the reconciliation between the merchant payments and the customer collections. A common gap is failing to specify the affordability check, because the regulator will ask for it, and a BNPL provider that cannot show its checks will be found wanting. Takeaway: BNPL is not a payment method, it is a credit product, and the credit loss rate is the business. Further reading: the Financial Conduct Authority BNPL consultation for the regulatory direction; Klarna and Afterpay merchant documentation for the operating model. Last reviewed 7 November 2026. A provider that grows fast without pricing the credit loss is buying volume with its own capital, and the capital runs out.