Buy Now, Pay Later (BNPL) - How It Works, Benefits and Design
Published: 2024-07-13 07:55:37

Buy Now, Pay Later (BNPL) is a form of digital lending. BNPL services offer customers a way to finance their purchases by splitting the cost into smaller, manageable installments, typically without requiring an upfront payment. This digital lending model involves assessing the customer’s creditworthiness, approving the loan, and managing repayments, all through online or mobile platforms. BNPL leverages digital technology to provide a seamless and convenient borrowing experience, making it a subset of the broader digital lending ecosystem.

Buy Now, Pay Later (BNPL in short) services provide a convenient payment option for customers, allowing them to make purchases and pay for them over time.

Here’s a detailed breakdown of how BNPL works, I like to explain in step by step both in business and technical perspective.

Journey
1. Customer Makes a Purchase

The process begins when a customer selects items they want to purchase and proceeds to the checkout on a merchant’s website or physical store. At the checkout stage, the merchant offers BNPL as one of the payment options. The customer then selects the BNPL option to split the cost into manageable installments.

2. Customer Signs Up or Signs In

Once the BNPL option is selected, the customer is prompted to sign up for the BNPL service if they don’t already have an account, or to sign in if they do. Signing up involves providing personal information and agreeing to the terms and conditions of the service. This step ensures that the service provider has the necessary details to perform credit and identity checks.

3. Instant e-KYC and Credit Risk Analysis

To ensure the customer’s eligibility, the BNPL service provider performs an instant electronic Know Your Customer (e-KYC) verification and credit risk assessment. This involves checking the customer’s identity and evaluating their creditworthiness based on various data points, including credit history and financial behavior. This step is crucial for minimizing the risk of defaults.

4. Approval and Payment

Based on the results of the e-KYC and credit risk analysis, the BNPL service provider decides whether to approve the transaction. If approved, the BNPL provider pays the merchant on behalf of the customer, allowing the customer to complete the purchase without paying the full amount upfront. This immediate payment to the merchant helps ensure a smooth transaction and quick delivery of goods.

5. Product Delivery

With the payment process completed, the merchant proceeds to ship the product to the customer. The customer receives the product just as they would if they had paid in full at the time of purchase. This seamless experience enhances customer satisfaction and encourages repeat business.

6. Repayment Schedule

After the purchase, the customer is provided with a repayment schedule outlining the installment amounts and due dates. The repayment period and frequency of installments can vary depending on the terms set by the BNPL provider. This schedule helps customers manage their finances by spreading the cost over time.

7. Customer Makes Repayments

The final step involves the customer making payments according to the provided schedule. Payments can be automatically deducted from the customer’s bank account or made manually through the BNPL platform. These installments are usually interest-free if paid on time, though late payments may incur additional fees.

Key Players and Their Roles
The key players in the BNPL ecosystem include the customer, the merchant, and the BNPL service provider. The customer benefits from flexible payment options, allowing them to manage their finances better. The merchant benefits from increased sales and reduced cart abandonment rates, as BNPL options can attract a wider range of customers. The BNPL service provider facilitates the transaction, pays the merchant upfront, and manages the repayment process, generating revenue through interest, late fees, and merchant fees.

Benefits of BNPL
For customers, BNPL services provide financial flexibility, enabling them to acquire products without paying the full price upfront. This can be particularly useful for budgeting and managing high-value purchases. For merchants, offering BNPL can lead to higher conversion rates and average order values, making it an attractive option to increase sales. Lastly, BNPL providers benefit from building a customer base and generating revenue through various fees.

This detailed explanation highlights how BNPL services work, detailing each step of the process and the roles of the key players involved, providing a comprehensive understanding of the BNPL ecosystem.


The provided diagram titled “How Does Buy Now Pay Later Work?” outlines the sequential steps involved in a Buy Now Pay Later (BNPL) process.
Now lets find out, with simple explanation of each step in the diagram:

Customer makes an online purchase at a merchant site: The process begins with a customer selecting products and making an online purchase on a merchant’s website.
Merchant offers BNPL as a payment option at checkout: At the checkout stage, the merchant provides the customer with the option to choose BNPL as a payment method.
Customer signs up/signs in to the BNPL service providing platform: The customer either signs up for a new account or signs in to an existing account on the BNPL service provider’s platform.
Payment is debited from the BNPL platform: Once the BNPL option is selected and approved, the payment for the purchase is debited from the BNPL platform. This means the BNPL provider pays the merchant on behalf of the customer.
Product is delivered to the customer: The merchant processes the order and delivers the product to the customer.
Instant e-KYC and credit risk analysis is done by the BNPL service provider: The BNPL service provider performs an electronic Know Your Customer (e-KYC) process and conducts a credit risk analysis to assess the customer’s creditworthiness.
BNPL service provider approves the credit: Based on the results of the e-KYC and credit risk analysis, the BNPL service provider decides whether to approve the credit. If approved, the customer can proceed with the BNPL payment plan.
Customer pays the balance to the BNPL service provider at the end of credit period: The final step involves the customer repaying the BNPL service provider. The customer pays the outstanding balance as per the agreed credit terms at the end of the credit period.
Business Use-Cases for Buy Now, Pay Later (BNPL) Systems
Buy Now, Pay Later (BNPL) systems offer versatile financing solutions across various industries, enhancing customer satisfaction and driving sales.

In e-commerce platforms, BNPL increases conversion rates and average order values by providing flexible payment options. Retail stores can enhance customer loyalty and attract budget-conscious shoppers by offering BNPL at the point of sale.

The travel and hospitality sector benefits from increased bookings and revenue by making travel more accessible through installment payments.

Healthcare services can improve access and manage cash flow by allowing patients to finance medical procedures. Educational institutions can boost enrollment and retention by enabling students to pay tuition fees in installments.

Subscription services, luxury goods, automotive industry, home improvement, and event ticketing also see significant benefits. BNPL reduces upfront costs, making products and services more attainable, driving sales, and fostering customer loyalty.

System Design To Incorporate In Architecture
To design a comprehensive BNPL system architecture and incorporating best practices for modern, scalable, and secure systems, lets create a detailed architecture. This system will include various components and services, focusing on modularity, event-driven architecture, and robust integration.


Full Version

Mermaid Diagram

Key Components:
Frontend Components
The Customer Portal is the interface through which customers can browse products, sign up for BNPL services, apply for loans, and manage their repayments. Technologies: React.js (for building the user interface), Redux (for state management), Tailwind CSS (for styling), and Next.js (for server-side rendering and static site generation).

The Merchant Portal allows merchants to integrate BNPL services into their checkout process, manage transactions, and view analytics. Technologies: React.js, Redux, Tailwind CSS, Next.js are scalable options.

The Admin Portal is used by administrators to manage the BNPL system, monitor performance, handle customer and merchant queries, and perform configurations. Technologies: React.js, Redux, Tailwind CSS, Next.js. Backend and Microservices components are involved.

Loan Origination System (LOS)
Manages the loan application processwa, including customer sign-ups, application submission, and initial verification. Technologies: Node.js (runtime environment), Express.js (web application framework).

Decision Engine evaluates loan applications using predefined business rules and machine learning models to perform instant credit decisioning. Technologies: Node.js, Express.js.

Loan Management System (LMS) Manages active loans, including disbursements, repayment schedules, and the overall loan lifecycle. Technologies: Node.js, Express.js.

Collections Service Handles payment collections, sends reminders, and manages overdue payments. Technologies: Node.js, Express.js.

Product Service Maintains a catalog of BNPL products, including terms, repayment schedules, and interest rates. Technologies: Node.js, Express.js.

Consumer Service manages customer profiles, including KYC (Know Your Customer) data and credit information. Technologies: Node.js, Express.js.

Partner Onboarding Service registers new merchants, manages their profiles, and facilitates their integration with BNPL services. Technologies: Node.js, Express.js.

Paylater Service Provides core BNPL functionalities during the checkout process, including initiation and approval. Technologies: Node.js, Express.js.

Notification Service sends notifications to customers and merchants about application status, payment reminders, and other updates. Technologies: Node.js, Express.js. Cloud Services (AWS)

Technology Stack
In this study, selection of tools to be incorporated via dedicated Amazon Services to simulate ideal infrastructure and tools. Lets list down the required components of technical stack.

API Gateway manages API requests, providing API management functionalities and integration with AWS services and AWS Lambda executes serverless functions for various backend operations, reducing infrastructure management overhead.

Amazon DynamoDB provides a NoSQL database for storing transaction data with fast and predictable performance and Amazon RDS (PostgreSQL) manages relational database operations for transactional data that require complex queries.

Amazon S3 offers object storage for storing documents, reports, and other static content.

Amazon EventBridge facilitates event-driven architecture by managing events and enabling services to communicate via events.

Amazon SQS provides message queuing for decoupling services and ensuring reliable communication.

AWS Fargate runs containerized applications without managing the underlying servers.

AWS WAF protects web applications by filtering and monitoring HTTP requests.

AWS Secrets Manager securely stores and manages sensitive information like API keys, database credentials, and other secrets.

AWS IAM manages identity and access control for AWS resources.

Integration Layer
In this study, IBM API Connect is chosen for its comprehensive API management, advanced security and compliance features, scalability, and performance. It seamlessly integrates with various backend systems, provides robust analytics and monitoring tools, and supports developer engagement through an easy-to-use portal. Its flexibility in deployment (on-premises, cloud, or hybrid) and cost-efficient API monetization and management make it ideal for the complex needs of financial services and digital lending systems.

IBM API Connect manages and exposes APIs to external partners, providing API lifecycle management.

Enterprise Service Bus (ESB) integrates with on-premises core banking systems, handling legacy SOAP/XML communication.

On-Premises Core Banking Services
Finacle API is chosen for this study, per it is robust banking capabilities, seamless integration with core banking systems, and advanced security features. It offers high scalability, performance, and compliance with financial regulations. Additionally, Finacle API provides comprehensive analytics, easy developer onboarding, and flexibility in deployment options, making it ideal for modern banking needs.

Finacle provides core banking functionalities such as account management and transaction processing. Technologies: Finacle API.

KYC Services
KYC (Know Your Customer) services are essential for compliance with legal and regulatory requirements, preventing money laundering and fraud. They help financial institutions assess and manage customer risk, enhancing overall security by verifying customer identities. Ensures customer verification and compliance with regulatory requirements.

Additional Tools and Services
Docker containerizes applications, ensuring consistency across development, testing, and production environments. Technologies: Docker.

Kubernetes orchestrates containerized applications, managing deployments, scaling, and operations. Technologies: Kubernetes.

Terraform manages infrastructure as code (IaC), ensuring consistent and reproducible infrastructure deployment. Technologies: Terraform.

Jenkins facilitates continuous integration and continuous deployment (CI/CD), automating the build, test, and deployment processes. Technologies: Jenkins.

Grafana and Prometheus provides monitoring and alerting capabilities, offering insights into application performance and system health. Technologies: Grafana, Prometheus.

These components collectively ensure a robust, scalable, and secure BNPL system, leveraging modern cloud infrastructure and best practices in software architecture.

Conclusion
This BNPL system architecture ensures a robust, scalable, and secure solution by integrating modern cloud services with legacy on-premises systems. Key components include customer, merchant, and admin portals, various microservices for loan processing and management, and essential AWS services for API management, data storage, and security.

The integration layer and core banking services ensure seamless operation and compliance, providing a comprehensive, efficient BNPL solution.