Klarna Bank AB is shelling out loans for milk and gas with cash-strapped customers looking for ways to cover basic necessities. Klarna advertises itself as a way to spread the cost when purchasing smartphones and from the latest brands.

Linda Cruz, a mother of four from a small town near San Antonio, Texas, started out using Klarna’s interest-free loans for occasional, large purchases. For example, she got a new air conditioning unit after hers died during a heat wave last summer. But as prices started to rise for essentials, she started using it for groceries, too.

Cruz, 37, is a bail bonds agent and her family’s sole earner. She gets paid bi-weekly and said Klarna is a useful budgeting tool. It lets her take care of her bills when she gets a paycheck.

“I noticed that I could buy essentials with it, and not have to pay everything up front. And it wouldn’t affect my pocket as much,” Cruz said. “When you break it up into the four payments, it’s bi-weekly. And I make sure it’s going to fall on the weeks of me getting my paychecks.”

Klarna extends interest-free loans that let consumers spread payments for purchases over multiple installments, instead of all at once. It makes money by charging retailers a small fee on every transaction and from interest on longer-term loans.

The Klarna model

The 17-year-old company has embraced the shift in the way people use its credit. Co-founder and CEO Sebastian Siemiatkowski runs Klarna. The company has struck partnerships with gas companies such as Chevron Corp. and developed an app that can be used in physical stores at retailers, like Walmart Inc. and Target Corp., as it hunts for new users. But interest rates for its own debt are rising. And Klarna’s burning through hundreds of millions of dollars per quarter. That makes the company more vulnerable to defaults from customers living paycheck-to-paycheck.

“This puts pressure on the Klarna model,” said John Colley. Colley is a professor of practice in strategy and leadership at the UK’s Warwick Business School. As users’ disposable wealth shrinks, “Klarna will be sat there with substantial bad-debt risks. Their customer base is likely to be sub-prime anyway.”

A representative for Klarna disputed the idea that the company’s customers aren’t creditworthy. The representative said credit agencies consider 93% of UK customers prime or better.

But Klarna is particularly vulnerable because higher interest rates, aimed at curbing inflation, boost its own borrowing costs. The prospect of a recession also means consumers will have a harder time paying back their debts.

Borrowing costs

In a recent study looking at the buy-now-pay-later industry in the UK, Barclays Plc bank and debt charity StepChange found that 36% of users say this form of lending has become more appealing since inflation and energy costs began to climb.

“The risk that you are building up is a debt problem that could be exacerbated by the cost-of-living crisis,” StepChange representative Sue Anderson said. The charity has seen an increase in clients that have buy-now-pay-later services as part of their outstanding credit.

“People don’t see it in the same way they see other types of borrowing,” Anderson said. “It is marketed as interest-free, but that doesn’t mean it is risk free.”

“The risk that you are building up is a debt problem that could be exacerbated by the cost-of-living crisis,” said StepChange representative Sue Anderson. “It is marketed as interest free, but that doesn’t mean it is risk free.”

Klarna is a “sustainable alternative” for American consumers who are used to credit card companies with fees and high interest, a company spokesperson said.

“If for decades it made sense to use a credit card to pay for groceries, we believe it’s better value for people to use Klarna’s interest-free products.”

The company had also complained about the StepChange survey, saying that Barclays offers an installment credit product with a 10.9% interest rate and calling the report’s conclusions “hugely patronizing.”

Default rate

Klarna’s net credit losses include defaults. The losses rose to 1.19 billion Swedish kroner ($110 million) in the first quarter of 2022. That’s up about 50% from the same period the previous year. Meanwhile, the platform is burning through cash, losing more than 7 billion kroner in the quarter.

A spokesperson said that absolute credit losses are higher year-over-year because of a surge in new users following an expansion in 2021. Credit losses as a proportion of the total customers spend with its service have declined.

While Klarna doesn’t disclose its default rate, the company evaluates customers’ ability to repay on every transaction and losses are consistently less than 1%, a spokesperson said.

Klarna’s cost of borrowing in the open market has risen sharply in the first half of 2022. A February 2024 floating rate bond has seen Klarna’s discount margin climb to 318 basis points. A discount margin measures the credit spread over benchmark borrowing rates. That pushed the company’s two-year borrowing cost above 4%. And that’s more than double what it was at the start of the year.

Still, for customers like Darrin Givens, a musician and producer from Detroit, Klarna has become an important tool for both discretionary spending and essentials.

“I used Klarna for gas on a trip back home before I made my move from Mississippi to Michigan,” the 32-year-old father of two said. “I stopped at a Chevron and saw that they did Klarna in store and did it through the app. It was fairly easy, and I would do it again.”

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