Financial Inclusion and the fintech trends in Latin America
Updated: Apr 2, 2021
Our previous article “An introduction to Financial Inclusion” described the state of financial inclusion on the global stage and the importance of collaboration of the different stakeholders in order to improve it. We also explored how fintech companies, which provide digital solutions to financial problems, can also offer innovative solutions to financial exclusion. We will explore here how this is particularly true in the Latin American region.
The state of financial inclusion in Latin America
In Latin America, around 50% of the region’s population is excluded from the formal banking sector: 46% of the adult population does not have a bank account and only 12% of the population have savings in a formal financial institution [1]. Because Latin America has historic hyperinflation, economic volatility (the values of the stock market vary a lot) and poor credit infrastructure, banks often overprice the risk with high charges and interest rates. Some banks even require you to be in the top 20% income bracket to access their services and most bank cards and credit cards come with endless hidden fees that are especially taxing on the poor [5,6]. Additionally, opening a bank account often requires a lot of documentation (e.g. employment, citizenship, etc.), in contrast to lax requirements in other countries, like the United States, where most banks will allow you to walk in and open an account [5].
On the customer side, underbanked consumers find the costs of financial services to be too high or that the existing services are not good enough. Consequently, they rely on alternative methods of financing or stick to cash transactions: 61% of the Latin American population still pays their bills with cash [3]. These customers do not use banks unless the financial products and services offered are easy to understand, use and access and contain a significant value proposition [1]. This opens up a huge opportunity for innovative financial institutions to step up to the challenge. That’s where fintechs come in.
In Latin America, around 50% of the region’s population is excluded from the formal banking sector: 46% of the adult population does not have a bank account and only 12% of the population have savings in a formal financial institution [1]. Because Latin America has historic hyperinflation, economic volatility (the values of the stock market vary a lot) and poor credit infrastructure, banks often overprice the risk with high charges and interest rates. Some banks even require you to be in the top 20% income bracket to access their services and most bank cards and credit cards come with endless hidden fees that are especially taxing on the poor [5,6]. Additionally, opening a bank account often requires a lot of documentation (e.g. employment, citizenship, etc.), in contrast to lax requirements in other countries, like the United States, where most banks will allow you to walk in and open an account [5].
On the customer side, underbanked consumers find the costs of financial services to be too high or that the existing services are not good enough. Consequently, they rely on alternative methods of financing or stick to cash transactions: 61% of the Latin American population still pays their bills with cash [3]. These customers do not use banks unless the financial products and services offered are easy to understand, use and access and contain a significant value proposition [1]. This opens up a huge opportunity for innovative financial institutions to step up to the challenge. That’s where fintechs come in.
In Latin America, around 50% of the region’s population is excluded from the formal banking sector: 46% of the adult population does not have a bank account and only 12% of the population have savings in a formal financial institution [1]. Because Latin America has historic hyperinflation, economic volatility (the values of the stock market vary a lot) and poor credit infrastructure, banks often overprice the risk with high charges and interest rates. Some banks even require you to be in the top 20% income bracket to access their services and most bank cards and credit cards come with endless hidden fees that are especially taxing on the poor [5,6]. Additionally, opening a bank account often requires a lot of documentation (e.g. employment, citizenship, etc.), in contrast to lax requirements in other countries, like the United States, where most banks will allow you to walk in and open an account [5].
On the customer side, underbanked consumers find the costs of financial services to be too high or that the existing services are not good enough. Consequently, they rely on alternative methods of financing or stick to cash transactions: 61% of the Latin American population still pays their bills with cash [3]. These customers do not use banks unless the financial products and services offered are easy to understand, use and access and contain a significant value proposition [1]. This opens up a huge opportunity for innovative financial institutions to step up to the challenge. That’s where fintechs come in.
An opportunity for the development of fintechs
Financial exclusion in Latin America contrasts with the robust technological development existing alongside it: i) the region’s population that used a smartphone in 2018 reached 64%; ii) internet connections made by mobile phones are expected to reach 90% by 2022 [4]. Mobile phone penetration and the rise of products designed around the customer open up opportunities for innovative solutions that address large-scale financial exclusion. For example, let’s look at an innovative type of bank called a neobank. Traditional banks are not tailored towards the young, interconnected Latin American middle class. This shows an obvious gap in the market for products that serve people with a smartphone, but that have no access to credit cards or bank accounts. In answer to this, neobanks offer fully mobile, no-branch distribution models with more services than traditional banks [5]. A popular example is Nubank, a digital bank that taps into Brazil’s large, young customer base whose average age is 32 years old not to mention Nubank’s requirements are much lower than those of traditional banks. Their website explains that you need to be at least 18 years old, a resident of Brazil, have a CPF (registered card containing an non-transferable number proving your identity) and a smartphone. More importantly, no credit check is required. With more than 8.5 million customers, Nubank is now the largest digital bank outside of Asia and the highest-valued, private digital bank in the world [4].
Fintechs can also increase the financial inclusion of small- and mid-sized enterprises (SMEs), which represent 90% of companies in Latin America. It is almost impossible for SMEs to obtain a loan due to, for example, the inability to pass a credit history check. Some fintech companies, like the online lending platform Konfio, in Mexico, have developed alternative scoring systems thanks to algorithms that can analyse credit risk innovatively. Consequently, fintech companies can make informed decisions, broadening SMEs’ access to bank loans even when they have little to no traditional credit. Fintechs like Konfio help provide faster loans and enable companies to develop their businesses.
Whereas Latin America’s banking system is made of major banks in each country that have high market shares and set high annual interest rates, fintech firms provide alternative funding options that offer lower interest rates with an easier and more intuitive user experience. For example, TiendaPago offers microcredit for short-term capital to small, local businesses through agreements with large distributors so as to finance and insure the inventory of products that are key to the businesses [1].
Fintechs can then contribute to solving the problem of financial exclusion in Latin America. But what are the different types of fintechs and how developed are they? Let’s have a look.
The landscape of the fintech industry in Latin America
In 2018, 1166 fintech startups were reported in 18 countries of Latin America and the Caribbean, distributed between 11 business domains, as shown in Figure 1. The most represented domain is payments and remittances (22%) due to the increase in mobile phone usage (67% in 2017) and the need for cheaper, more efficient payment solutions at a time where electronic commerce is booming. The second most common domain is lending (18%) due to the lack of credit history, making it difficult to use normal banks, as previously explained. 15% of startups are geared to enterprise financial management, which is justified by SMEs’ need to follow the shift to digital finance. Digital banks come last with 2,2% of business domains, but it is also growing the fastest [1].
Figure 1: Segment analysis
The distribution of startups also varies geographically, as illustrated in Figure 2. Brazil is the region’s economic powerhouse and home to some of the most innovative players with 380 startups in 2018. It is followed by Mexico, Latin America’s second-largest economy, battling Brazil to become the dominant fintech hub with 273 startups. Colombia is far behind with 148, closer to Argentina (116 startups), which, with the Argentinian long history of economic booms and busts, is a fertile environment for fintech growth. Chile is the smallest of the five but has seen rapid growth of fintech players in the last 18 months [2].
Figure 2: Distribution of fintech startups in Latin America
The stages of development also vary: 64% of these startups are at advanced stages of development, 37% in growth and expansion stages, and 27% are ready to scale up (see Figure 3). This is not very homogeneous between countries, with Argentina and Brazil driving up the number of developed startups. It’s also interesting to note that only 32% of startups have expanded beyond national borders and most of them have only reached two countries, with only 14% reaching more than ten countries, usually the US, followed by countries in Europe and Asia.
Figure 3: Level of maturity of fintech startups in Latin America
Due to the increasing number of startups developing in Latin America, the competition has also become tougher: nine out of ten startups fail to survive beyond three years due to lack of funding, strong competition or inability to adapt successful models to a different target audience. Over the 703 fintech startups interviewed in 2017 by the Inter-American Development Bank, 85 stopped trading in the following 12 months. The highest failure rates are seen in Guatemala (33%), Peru (19%), followed by Brazil and Colombia (14% each). Personal financial management is the worst segment and also has the lowest growth rate. This shows fierce competition and market saturation, as well as the difficulty faced by entrepreneurs to find a viable, sustainable business model that would enable them to scale up. The lowest failure rate belongs to the financial management enterprise segment. This proves, once again, the strength of SMEs and the market’s demand for access to solutions that provide more efficient management. Interestingly, the trading and capital market segment also has one of the lowest failure rates, which highlights the increase in sophistication and maturity of stock exchanges in Latin America [1].
In all industries, mobile phones and data have been the two major actors for development. Accordingly, the main technologies used by the fintech startups are mobile and apps (21%), big data and analytics (19%), and application programming interfaces (APIs) and open platforms (17%) (more information in Figure 4). This confirms the trend of mobile phones for financial transactions and the growing importance of using data to improve and adapt products or services to the specific needs of customers. The tendency of open platforms reflects the digital transformation towards an open banking system in which consumer needs are emerging: simpler and more instantaneous services with greater transparency in the treatment of personal data [1]. This will be further explained later on.
Figure 4: Main technologies of fintech startups in Latin America
Now that we have examined fintech trends, we need to put this information into perspective and ask ourselves how does Latin America’s fintech market compare to the rest of the world?
The support of foreign investors
Fintech has spread globally over the last decade taking roots in various hubs, but, until now, Latin America had been lagging behind. However, fintech is now one of the hottest markets in the Latin American technology ecosystem and has piqued the interest of many foreign investors [2]. Nubank, mentioned earlier, recently raised a mega-round of funding ($400 million) from the US investment firm TCV [4]. Other examples include Uala and Albo from Argentina and Mexico, respectively, who also received significant foreign investment due to the fact that they cater to millions of unbanked people [5]. In the second quarter of 2012, Latin American fintech startups secured $481 million, which is 69% of the total amount raised by the region in 2018. This value outpaced the sums raised by both Chinese and Indian fintechs for the first time [2]. It comes as no surprise then that investments are higher than ever: with the presence of investors doubling between 2013 and 2017, and 25 new investors in Latin America in 2017. The highest percentage of startups with external funding are in Chile (88%), followed by Brazil (78%) and Venezuela (67%) (see Figure 5). Brazil leads in terms of venture capital investment, followed by Colombia and Mexico [1].
Figure 5: Investments in fintech startups in Latin America
Authorities have enacted fintech-friendly regulations and the presence of international investors has made the region an attractive investment space, in contrast to the UK or the US, where the markets are more mature; successful startups are harder to identify and the competition is tough [2]. This shows the importance of the environment in order for fintechs to develop and the rise in investments can be cultivated and maintained with new regulation. Stronger collaboration between stakeholders is also a crucial aspect for the development of fintech for financial inclusion. This will be elaborated upon in our next article about the collaborative environment of the fintech industry in Latin America.
[1] Inter American Development Bank, IDB Invest & Finnovista, Fintech: Latin America 2018: Growth and Consolidation, Oct 2018
[2] Mekebeb Tesfaye, “LATIN AMERICA FINTECH LANDSCAPE: An inside look at 5 of the most innovative regions propelling the LATAM fintech market to surpass $150 billion”, Business Insider, Dec 30, 2019
[3] Juan Beck, “The need for financial inclusion in developing countries”, ACI, October 14, 2019
[4] Diego Caicedo, “What’s driving the digital banking boom in Latin America”, Crunchbase News, September 8, 2019
[5] Nathan Lustig, “An overview of neobanks in Latin America”, Fintech Futures, September 2018
[6] Finextra, “Latin American banks and fintechs are racing towards financial inclusion”, November 6, 2019
[7] Asli Seven, “Fintech’s potential for financial inclusion in emerging markets”, Holland Fintech, December 10, 2018