An analyst warned that the trend may slow down loan growth in the medium or long term. Other experts urged BNPL service providers to be more selective about offering the option to prevent an excessive number of defaults.

Credit rating agency Pefindo stated that outstanding pay-later debt amounted to Rp 25.16 trillion (US$1.65 billion) at the end of June, up 29.8 percent from mid-2022.

Pefindo's president director Yohanes Arts Abimanyu explained that the significant rise in the use of BNPL was primarily owed to the ease and speed of approval, while the economic recovery after the pandemic also played a role.

Elisabeth Carolina, an analyst at state-owned lender Bank Mandiri said the surge in BNPL related to the growth of online transactions, as many players had connected their services with ecommerce firms.

"Pay later is mostly used for transactions with a small basket size. Some users also use the service to manage their monthly expenses, with a plan to pay the debt before the due date, so they don't need to pay interest," Elisabeth told The Jakarta Post on Wednesday.

Basket size refers to the number of items sold in a single transaction.

Read also: Career, credit risks of 'pay later' schemes spook RI youth

Snowballing effect

Amid the surging volume of BNPL loans, the share of NPLs stayed at an alarming level of 6.78 percent after the first six months of this year, much higher than the banking sector NPL of 2.44 percent in June.

Even peer-to-peer (P2P) lending, another relatively novel financing scheme, performed better in this regard, with bad loans accounting for 3.29 percent of the total in mid-2023.

Bhima Yudhistira, executive director at the Center of Economic and Law Studies (CELIOS), warned that the high NPL level in the pay later segment could result in slower loan growth in the country down the line.

"The value of a [typical] bad loan in a pay later [scheme] is relatively small, maybe Rp 200,000 or Rp 500,000. But the debtors would be blacklisted from the micro credit program (KUR), working capital and automotive financing," Bhima told the Post on Wednesday, adding that the credit history of pay later users could be accessed by banks and other financial institutions.

"Bankers have talked about this in the last two years. There are many people who [could become new borrowing customers], but banks cannot tap into them because of their bad credit scores in the BI [Bank Indonesia] system [now called OJK SLIK] because of pay later loans," Bhima explained.

While outstanding BNPL loans made up a mere 0.35 percent of total credit portfolios in mid-2023, the payment method accounted for a staggering 28.8 percent of the number of credit accounts in the country. Overall, BNPL players have tapped 13 million users, more than double the number of credit cards.

Most of the bad loans in the BNPL sector involve users below the age of 30, Pefindo revealed.

Lenders are banking on that age group as a major source of loan growth.

The data is aligned with a statement from the Financial Services Authority (OJK) that disclosed that NPLs from the pay later segment hit 9.7 percent in April, with 48 percent of those coming from users between 20 and 30 years of age.

Institute for Development of Economics and Finance (INDEF) researcher Nailul Huda questioned BNPL players' willingness to keep disbursing money to young people on usually low incomes.

"[Why is it that] the average salary of young people in Indonesia is only around Rp 2 million [per month], but their debt from the pay later [schemes] could be more than Rp 10 million?" Nailul questioned.

Better credit scoring

Celios' Bhima also warned that the rise of NPLs in the pay later segment would make financial institutions, the sources of funds for BNPL players, more cautious about lending money.

"They would be worried [that the high NPL rate] could be a loss they need to bear," Bhima said.

To prevent the surge in bad loans, Bhima suggested the regulator mandate credit insurance for pay later loans, so that more parties would be monitoring the sector. He also urged the authorities to be less liberal in disbursing licenses for new BNPL services and to improve the credit scoring mechanism for existing players.

"They [BNPL players] could implement geographical risk [mitigation]. For example, if banks detect a high NPL from a certain area, then pay later players should refrain from entering the market," Bhima opined.

Read also: Bad loans, limited growth blight P2P lending business

Bank Mandiri's Elisabeth opined that, as a new industry, it was normal for BNPL players to focus on widening the market and offering simplicity in their loan disbursement processes. The high NPL level is the result of that effort, according to her.

"The industry is relatively new and there will be a learning curve. Hopefully the industry can find a better way to [ensure] NPL levels are more manageable," Elisabeth said.

Nevertheless, Elisabeth agreed that the service providers should improve their market segmentation. For example, employees whose salaries could be automatically deducted for debt payments, may be a safer target segment for them, she added.