Is Klarna lending responsibly?
Let's see what their annual report tells us…
Buy Now Pay Later (‘BNPL’) agreements have soared in popularity over the last few years. It’s an easy way to order something online and pay for it later — so much so that around 10 million people have used a BNPL agreement in the last year, with an average debt of £176 per customer.
There are, of course, questions around the ethics of such schemes. It’s been argued that users of the scheme don’t fully understand the financial contract they’re entering into. A quick google search will highlight a large number of horror stories too.
The purpose of this article is to delve into Klarna’s financial statements to see what the numbers say. Are they making huge losses on their loans? Do Klarna themselves think their loans are risky? How does their lending stack up against other providers?
The first part of this explains how Klarna works, so feel free to skip that if you already know 👌
What is Klarna and how does it work?
Klarna started life in Sweden and is now one of the fastest-growing providers of BNPL agreements. They’re a fully regulated bank with a few different products, but BNPL is the one we’re focusing on here.
Here’s how it works
It’s actually very simple —when you’re about to pay for a purchase at a participating retailer, you’ll see the option to pay by Klarna. Select that and Klarna will pay for your purchase. They’ll then drop you an email asking you to settle up at a later date.
One of the big pros here is if you’re buying something like clothing which is prone to being returned, the funds never actually leave your bank account until you’ve decided to keep the items.
You may also have the option to split your payment over 3 instalments:
Why is there so much negativity around Klarna?
When you opt to pay via Klarna you’re entering into a financial product which is, in no uncertain terms, debt.
Whichever way you chose to present it, debt always gets a bad rep because of how easy it can be to lose control over. Even more so when the debt product isn’t clearly being labelled as debt.
There should be safeguards in place to ensure that only certain types of person can obtain debt, but in reality, that’s very tricky to work out.
It’s been widely reported that Klarna may not be taking their responsibilities as a lender seriously when it comes to these safeguards. Their UX has also been criticised for making it too easy to accidentally use Klarna.
The numbers reveal more
One way we can verify how responsibly Klarna lends money is by looking at their financial statements and benchmarking them against other lenders.
The theory is this: if Klarna is really lending irresponsibly, their financial statements should highlight an increased level of defaults, losses or impaired debts.
Let’s take a look.
The amounts people owe to Klarna
At their financial reporting date, Klarna adds up all the money they’re owed from consumers and present that number in their annual report.
This number then gets analysed into one of three categories (called ‘stages’) depending on the quality of the loan:
🥇Stage 1: Good quality loans
This is where Klarna expects to receive payment on time. Loans are initially classified as Stage 1.
🥈 Stage 2: Significant increase in credit risk
This is where there’s a significant increase in the risk of the loan not being repaid. Klarna explains that it’s based on the following:
- Cash amounts received from the consumer so far (if the consumer hasn’t paid anything, it becomes riskier)
- How overdue the loan is (the more overdue, the higher the risk)
- Whether the consumer has other contracts with Klarna, and the classification of those loans (if the consumer has multiple loans classified as stage 2 or 3, the current loan becomes riskier)
If a loan is over 30 days past due, it will probably fall into Stage 2 too.
🥉 Stage 3: In default
Loans go into Stage 3 when they are in default. Klarna defines a default as:
Financial assets [the loans] are defaulted when the asset [loan] has been 90 days or more past due without any payments, has entered debt collection or is classified as fraudulent.
Stage 3 loans are therefore a great indicator of how responsible Klarna is with lending. Irresponsible lending has a somewhat objective meaning but, generally speaking, lending to those who can’t afford to pay should lead to a direct increase in Stage 3 loans.
In the year to 31 December 2019…
Let’s take a look at the most recent figures from Klarna and how these loans were classified:
We’ll focus on the number 31,300,571k SEK (all figures are in Swedish Krona and rounded to the nearest thousand). That’s how much they were owed by the public on 31 Dec 2019 (~$3.6bn).
Here’s a different view of that number (it’s in the bottom right corner):
We can see that:
- 3.2% of their loans are Stage 3 (988,480 / 30,774,926)
- 5.7% are Stage 2 (1,769,548 / 30,774,926)
- 91.1% are Stage 1 (28,016,898 / 30,774,926)
From this alone, we can’t really tell if they are lending responsibly or not. We need to benchmark 🪑
Benchmarking Klarna against other banks
We can look at the risk profile of loans against other banks that offer unsecured lending products. Here’s how they stack up:
As we can see, Klarna doesn’t actually fare too badly in the comparison. Their Stage 3 loans fit nicely between Lloyds and Barclays. Stage 2 loans are also pretty reasonable.
When compared to one of their closest competitors, Afterpay, it would appear that Klarna are lending less responsibly. Their stage 3 loans are 3 times higher than Afterpay.
This might be down to the sheer size difference — Klarna’s total loans are ~£2.7bn whereas Afterpay’s are~£448m. There’s also the fact that Klarna operates in more markets than Afterpay (particularly relevant where credit defaults are more common in certain countries).
What about loans that Klarna has given up on collecting?
Another key thing that identifies responsible lending is the number of loans that have no reasonable expectation of recovery. These loans are removed from the balance sheet, decategorised from the above stages and written off to the profit and loss.
This also happens when loans are sold to third party debt collectors.
You can see above that Klarna wrote off 1.6bn of loans against their total loans of 31.3bn (5.2%).
Again, this doesn’t tell us much so let’s compare it to other banks:
The above does hint towards less responsible lending — it’s saying that Klarna had to write off more loans than the other banks — but it’s not massively off. Klarna are probably lending much smaller amounts on average than unsecured loans at Lloyds and Barclays, so writing off loans could make more commercial sense than trying to collect them.
One thing that’s worth mentioning is that the write-offs are the trailing 12 months whereas the loan balance as at the year end. The loan balance is growing fast, so if we were able to work out Klarna’s actual write off rate on a monthly basis, we might see that it’s actually higher than 5.2%.
What other factors go into responsible lending?
Of course, those numbers are only half of the story. There are other elements that should be factored into the decision on responsible lending.
(1) Pre-purchase checks — does Klarna verify that borrowers will be able to pay?
Here’s what Klarna say on this:
In order to mitigate the credit risk from individual consumers, the Group uses proprietary scoring models to perform an applicant’s credit assessment. Model inputs consist of a number of purchase related data points, such as purchase amount and the specific merchant from which the purchase is made. This is combined with historical internal customer payment and credit behavior history and external information, to produce the scoring models.
(2) Clear communication
Being clear on what type of agreement a customer is entering into should be a key priority for a responsible lender. If you search through Klarna’s website, you’ll see that they are trying to be clear about what happens in various scenarios. Here’s a great article demonstrating their aim of providing clarity.
(3) The experience…
Part of Klarna’s pitch to retailers is that the average retailer sees a boost in sales when partnering with Klarna (reportedly 25% — 30%). That’s one hell of a sell for the B2B business, but how are they delivering that uplift?
One of the very plausible reasons is that the average consumer spends more when paying via Klarna because they know they don’t need to pay for it now. That’s encouraging the consumer to take on more debt.
There are also reports of retailers using Klarna as the default payment option, or running competitions that you can only enter if you shop using Klarna. That again encourages people to take on debt, whether they realise it or not.
The verdict
Benchmarking the current loan book, it doesn’t give any major suggestions that Klarna is lending irresponsibly. If they were, we’d expect to see a much larger % of loans in stage 2 and 3. They’re lending a bit more aggressively than Afterpay, but that’s most likely due to scale.
The loan write-offs are cause for concern. This could be simply a case of Klarna refining their processes for scale, or it could be an indicator that historical loans had been made less responsibly than current loans.
Lending will always be one of those industries that attract negative publicity much easier than positive publicity, but that’s just the nature of the beast.
