Challenger banks like Nubank, C6 Bank and Neon Bank are riding high on the fintech boom in Latin America, but they are not alone. The region’s innovators are hard at work developing technology that can help financial services firms tap into new customer bases and a wealth of profit to boot.
Of course, fintech entrepreneurs in Latam are not alone in having enjoyed massive growths of late. A rapid digitalisation of life has swept over the globe and fintechs have been at the forefront of this change. In many emerging markets across Asia, the Middle East and Africa, alternative financial institutions have overtaken traditional payment infrastructure to provide tailored banking solutions for the masses.
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According to GlobalData’s analysis, more than half of the global tech unicorns that exit today operate in ecommerce, cloud or fintech, with the last boasting the highest sum of aggregate valuation at over $529bn as of August 2021.
Despite the fintech evolution happening across the globe, Latin America stands out in terms at the rate of investment in the industry. Venture capital in Latam’s fintech scene in the first half of 2021 already surpassed last year’s total by $4.7bn, driven by a significant increase in big deals of over $50m. The funding boom on the continent is a tour de force, with investments having doubled consistently every year since 2016.
The international capital market clearly has an appetite for the region’s growing fintech scene. But why and why now?
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By GlobalDataHigh margins, low penetration
A few overlapping factors have led to the rapid development of fintechs in Latin America, including low banking penetration, high interest rates, favourable regulation and, the latest global development no one can ignore, Covid-19.
Since last year, digital-only banking has increasingly become the preferred route for banking, predominantly among millennials because of the widespread usage of smartphones.
Low banking penetration and underutilisation of formal financial services aided the fintech boom in Latin America. Traditional banking systems in the region are highly concentrated, resulting in higher fees and transaction costs.
André Faria, Latin America advisor at opening banking company Volt, tells Verdict there is a saying in Brazil: “The best business to have in the world is a well-managed bank in Brazil. The second-best business one could have in the world is a poorly-managed bank in Brazil.”
His comment highlights a trend that has dominated not only banks in Brazil but across South America. Incumbent banks have historically enjoyed notoriously high margins. The two biggest banks in Brazil, Itaú and Bradesco, generally earn returns on equity of around 20%. In comparison, banks in the US typically enjoy half that number. In European rate is around 6%.
However, there are signs that the Latin American incumbent banks’ power may be waning with the rapid rise of alternative banking platforms in the region.
Unbanked population
With the help of technology, fintechs have provided universal and round-the-clock access to financial services, bridging the gap between the unbanked and the financial system. This detail plays a paramount role in Latin America, a region where a large part of the population has been left out of the traditional banking ecosystem.
According to GlobalData’s thematic analysis, nearly half of the entire Latin American population is unbanked. Moreover, only 113 million out of the 625 million people in the region reportedly have credit cards.
It can be notoriously difficult to open an account with banks requiring in-person appointments for minor changes in certain areas. Inadequate documentation is also often a blockade for people wanting to open a bank account.
Neobanks, alternative payment systems and digital wallets have paved the way for more bespoke banking that fits the needs of a large, hitherto neglected section of the population.
“I think [fintech] is doing two things; it’s enabling people that may not have had a bank account, but it’s also bringing people into the payment ecosystem,” Mark Stannard, chief business officer at mobile payment service Boku, tells Verdict. “And it’s also a monetary ecosystem for people that didn’t want bank accounts.”
This has also been particularly beneficial for people in remote parts of Latin America, for who travelling to physical branches can be difficult or even impossible.
“The existing banking infrastructure does not work for everybody, particularly if your banking infrastructure is in a remote part of Latin America and you are dozens of kilometres away,” Stannard argues. “But if you’ve got connectivity and you’ve got one of these other payment instruments that is effectively enabling you to make those payments and collect funds, then it brings you into the broader banking ecosystem.
“That’s why these payment types and these wallets are often getting their banking licenses because it’s a bank that actually works for you,” he adds.
Alternative payment methods have also become hugely beneficial for informal businesses and small and medium-sized enterprises (SMEs), which form a large part of Latin America’s GDP.
Yet, SMEs in Latam have historically found it particularly difficult to access formal bank loans. The World Bank estimates that the finance gap compared to potential demand stands at 87% for the region. This gap is even larger when micro and informal enterprises are taken into account.
The monopolistic behaviour exhibited by big banks has caused consumers to lose trust in the traditional banking ecosystem. “We have been let down by every single institution during these last couple of years and I think that’s making people rethink their trust,” says Faria.
Given this sentiment, people have been more willing to adopt alternative payment methods, which created a significant opportunity for the fintech industry, a reality that foreign investors are now grasping. In the first half of 2021, four of the top 10 deals in Latin America were secured by neobanks.
Change in regulation
Regulators are also increasingly addressing the unfair privileges long-held by incumbent banks. Especially in Brazil, new banking laws have been in favour of a more dynamic fintech scene. The Central Bank of Brazil has been pushing the concept of open banking since 2019 in hopes of bringing more competition and interoperability to a historically highly concentrated sector.
Simply put, open banking refers to a way in which consumers are in charge of their financial data and who has access to it, enabling them to move the data from traditional lenders to new startups.
The push towards open banking has been a trend across different countries and has benefited challenger banks. Under its model, a variety of direct-to-consumer fintech business models have become more viable.
According to GlobalData’s thematic analysis, more interoperability will likely lead to more disruption in the traditional financial sector. The combination of elements of fintech, property tech and health tech could render entire processes, products and even provider types irrelevant. The favourable regulatory climate in Brazil has, in fact, spearheaded commercial incentives, argues Faria.
“The ecosystem is moving around,” he says. “The companies in Brazil are not moving, which is a paradox, but they are not moving as fast as the regulators.”
“We are never ahead of the curve,” Faria adds. “Yet, amazingly, regarding fintech regulation and the overall dynamics of the market, we are ahead of the curve for the first time.”
Final push: Covid-19
The Covid-19 pandemic has accelerated the fintech trend in Latin America. As people were locked at home, the drive to find innovative ways to banking was accelerated.
While cash remains the preferred method of payment in Latin America, businesses shutting down prompted an increase in acceptance of digital and online payments. A large section of the population tried out digital banking for the first time due to restrictions in physical in-person payment methods.
“I think the pandemic has really been an accelerator,” says Stannard. “What what’s going to happen, maybe over half a decade or six or seven years happened in around 18 months.”
Online shopping also saw a significant boom, which in turn fuelled the adoption of digital payment methods. Stannard explains how these two sectors mutually support each other in a “virtuous circle”.
“It’s both fuelling growth off of each other. Ecommerce is fuelling these new payment types, and the growth of these new payment types is fuelling ecommerce because it’s bringing in new middle classes that are emerging.”
Of course, cash payments, as well as traditional card schemes such as Visa and Mastercard, still dominate the global payment ecosystem simply because of their vast international networks. Still, card issuers are likely to lose out significantly from the changes being brought about by mobile payment companies, with their already stretched revenue streams from transaction fees only. They will likely come under more pressure as payments, in general, move further away from cards and cash.
For many consumers, “being digital-first meets their needs,” says Stannard, who predicts that both cash and traditional credit card payments will see a decline across Latin America. In fact, like in many other developing regions, many consumers in Latin America went straight from cash to mobile and skipped the credit card evolutionary step.
Of course, traditional payment infrastructures are not going to disappear. “The one thing I’ve noticed from my history lessons is that banks have existed back to Sumerian times in 3000 BC,” says Stannard. “I do think that banks are incredibly good at evolving with the time. They’re learning from the tech companies.”
Competition is also on the rise among fintech companies in the region. Right now, Brazil – spearheaded mainly by its superstar challenger bank Nubank – is leading the pack, but competition from, for instance, Mexico and Colombia is on the rise.
This will be a challenge for neobanks trying to find their place in the market. “I think we’re going to see more niche operations or even some neobanks overshooting a little bit or overgrowing,” Faria predicts.
He adds: “If anything, I think we’re going to overshoot in the other direction, and there are going to be a bit too many [fintech companies], and then we’re going to see a little bit of consolidation. So, we’re going to reach 200 and then maybe scale back to 50. That’s how I see it playing out for the next five to ten years.”
Contenders and trends to keep an eye on
Brazil is leading the Latam fintech surge, having secured eight of the top 10 deals in Latin America in the first half of 2021. The country’s fintech superstar, Nubank, recently announced its plans to go public on the New York Stock Exchange and the Brazilian B3 stock exchange, according to US Securities and Exchange Commission and Brazilian Securities and Exchange Commission filings.
The neobank is aiming to raise $3bn through an initial public offering (IPO) which could see the company valued at around $50bn. This would make Nubank more valuable than Brazil’s largest incumbent, Itaú Unibanco.
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Rappi is another platform worth mentioning. The delivery app was founded in 2015 in Colombia and quickly became a success across 250 cities in nine South American countries. In 2018, the company became the second unicorn, a privately held company valued over $1bn, born in Colombia. There are also rumours that the company may soon seek to go public.
Recently, Rappi said that it had sought regulatory approval to operate as a digital bank in Colombia by early 2022. If authorised, the company plans to extend its financial service to other countries through an app it calls RappiPay.
Leading Argentine ecommerce platform, MercadoLibre, also has a mobile wallet business valued at US$2bn, which operates a loan business to sellers. It has the advantage of sitting on large amounts of platform data on consumers, which it uses to provide more granular credit ratings than are available through traditional lenders. According to GlobalData’s analysis, 30% of its credit is offered to customers deemed too “high risk” by traditional banks.
According to Stannard, the amalgamation of digital payment apps with food delivery, ride-hailing and ecommerce will become a growing trend across the global fintech market. “One of the things that we’re looking out for are things like super apps. Super apps like WeChat, which is basically being used for many different things. Having a payment instrument built into that means that they’ve literally got hundreds of millions of users in place.”
Arguably, this is only the beginning of the fintech revolution. It is still too early to predict who the ultimate winner will be as the market in Latin America is still taking shape. Anything could happen when it comes to the region’s fintechs.
“The only thing that doesn’t surprise me anymore is that I’m constantly surprised,” Stannard concludes.
