The following is a guest post by Michele Tucci, MD Americas & Chief Strategy Officer at credolab.
Fintech has given consumers access to innovative products, such as Buy Now Pay Later (BNPL) and earned-wage access (EWA).
The EWA concept is simple and compelling. It gives employees access to money they have already earned, usually via third-party apps or payroll providers, ahead of their regular payday. However, while both these products are helping millions of people meet their short-term financial needs, they also raise issues about consumer debt.
EWA providers are convincing themselves that the excellent earnings data they get directly from employers make up for “thin files,” where there is minimal understanding about the person accessing the money.
Just because you can see employees’ accrued income does not necessarily make them suitable subjects for early payments. And what if the employer goes belly up between any early payment and the actual pay run? That removes the employee’s ability to repay the advance.
The impact on any individual of providing early access to earned income may range from entirely benign to a sure pathway to the debt crisis. Responsible providers need a lot more insight before handing over money.
The BNPL canary in the coal mine
With BNPL, the warning signs are already evident. According to Juniper Research, global spending on BNPL is set to reach $437 billion in 2027, with harmful debt levels more than 70 times worse than with credit cards. BNPL is running at $19.2 million per $1 billion, compared with $270k per billion for credit cards, according to payments intelligence provider Fraugster.
Warning bells are going off all over the world. UK debt charity Stepchange, to take just one example, has reported that over half of consumers using BNPL are finding it hard to keep up with repayments. And regulators are concerned too.
In Australia, the Australian Securities and Investments Commission (ASIC) has also expressed concerns about the potential risks of BNPL and has called for greater regulation of the sector. And in the UK, the Financial Conduct Authority (FCA) has announced plans to introduce new regulations for BNPL services, citing concerns over the potential for consumers to accumulate unmanageable levels of debt.
Is EWA setting up the same cycle of high-risk debt?
The positive case for EWA
The global EWA market is relatively new and less well-established than BNPL. However, it is increasing and is used by employers, including Walmart, Pizza Hut, Brewdog, JD Sports, Berkshire Hathaway, Bupa, Virgin Care, and Adecco.
Demand from employees is intense. In the US, where it is already well established, surveys show that nine out of 10 employees want flexible pay.
A 2022 report by the world’s largest payroll service provider, ADP, showed that 76% of employees said it was important for their employer to offer EWA. The same ADP survey also found that 82% of employers that did not provide EWA said they were interested in adopting it.
EWA is being offered as an embedded app to employers by platforms such as Revolut. The employee can see in the app exactly how much they have earned then and how much they can access. App providers have different models, with some charging a flat fee per loan, sometimes covered by the employer.
For employers in various industries, from hospitality to retail to healthcare, EWA is an additional benefit they can offer employees at a time when skills are hard to find, offering a way to increase employee financial wellness and job satisfaction.
It can help employees live paycheck-to-paycheck, enabling them to avoid high-interest loans or credit card debt. By providing this benefit, employers can demonstrate their commitment to the financial well-being of their employees, which can increase job satisfaction and loyalty. By providing employees with more financial flexibility, employers can also help to reduce stress-related absenteeism and turnover.
EWA can also be used as a recruitment and retention tool, as it can make an employer more attractive to prospective employees and help to retain current employees. Offering EWA as a benefit can differentiate an employer from competitors, especially in industries where wages are lower or variable.
EWA can also provide cost savings for employers by reducing the need for paper checks and payroll processing. Employers can reduce the administrative burden and costs associated with traditional payroll processing by offering electronic access to wages.
On a road to unsustainable debts?
Like BNPL in its early days, many now argue that EWA is “not really lending.” It’s a mere cash advance. The logic goes that it’s yours because you have already earned money – not a loan.
There is debate about this among industry experts and regulators. It’s a matter of interpretation and may depend on the specific business model of each provider. However, regardless of how EWA is classified, regulators and providers must ensure that appropriate consumer protections are in place to prevent excessive debt and protect vulnerable consumers.
EWA and BNPL can provide short-term financial relief to consumers, but they also share several common factors that may lead some consumers to take on excessive and unaffordable debt.
Firstly, these products’ ease of access and convenience can be a double-edged sword. It may encourage some consumers to use these products more frequently than they should without considering their long-term financial situation. In the case of EWA, it could leave an employee with little or no actual income on “payday” to cover larger monthly bills.
Secondly, both EWA and BNPL often come with interest rates and fees, which can quickly accumulate and make the debt unaffordable for some consumers.
Thirdly, without proper reporting to the bureaus, individuals can stretch themselves too much financially and get into unmanageable indebtedness.
Fourthly, the marketing tactics used by EWA and BNPL providers can encourage consumers to overspend. For example, BNPL providers may offer limited-time discounts or promotions that encourage consumers to buy more than they would normally. EWA providers may also advertise their services as a way to “get ahead” financially without adequately explaining the potential risks and drawbacks of not getting the full salary at the end of the month. In this sense, could EWA foster a culture of financial illiteracy, where people can avoid taking careful oversight over their finances?
Lastly, the psychological factors associated with debt can also contribute to excessive and unaffordable debt. Some consumers may feel compelled to take on more debt due to a sense of urgency or pressure, such as the need to pay for unexpected expenses or keep up with social expectations. This can lead to a cycle of debt that is difficult to break.
Some experts have raised concerns that the ability to access earned wages early could lead some consumers to become overly reliant on EWA and to take on more debt than they can realistically afford to repay. This is particularly true for consumers with low incomes or those who are living paycheck to paycheck, as EWA may encourage a cycle of borrowing that can be difficult to break.
If the EWA industry is not careful, it might lead to another consumer debt problem.
Consumer debt can have a significant impact on the financial well-being of individuals, leading to negative outcomes such as lower credit scores, increased financial stress, and higher default rates.
The APA notes that financial stress can lead to a range of negative health outcomes, including depression, anxiety, and physical health problems.
EWA providers and super apps like Revolut need to be responsible for ensuring that on-demand pay is genuinely good for employees.
A more responsible approach is to blend accrued earnings with other forms of insight – credit bureau data and behavioral analysis.
This may mean partnering with fintechs to help them better understand employees’ and hourly workers’ ability to repay.
For example, EWA providers may be better able to prevent risks around rising “non-sufficient funds” fees or debt cycles by using alternative credit scoring. And that’s something that really would be good for employers and hourly workers everywhere.
In the absence of these cross-checks by providers, it is important for consumers to carefully consider their financial situation and the risks associated with these products before using them.
If EWA is going to fulfill its potential as a financial product, providers need to ensure that their marketing and lending practices are transparent and responsible and that they take steps to prevent excessive debt.
Michele is the Chief Strategy Officer and Managing Director in North and Latin America in credolab, a well-established Fintech startup developing bank-grade digital scorecards and data enrichment solutions with 150+ clients in over 38 countries. Michele has conducted business in 47 countries and has in-depth knowledge derived from nearly 22 years in cards, payments, consumer lending, and digital products. Prior to joining credolab in 2018, he worked on international consulting assignments, product management and business development roles with the likes of Capital One, MasterCard, Intesa Sanpaolo Bank, and Telecom Italia Mobile.