The rapid growth in Brazilian fintechs has created a heated debate about their likely impact on incumbent banks.
After the big bang of startups created by financial digitalization, Brazil’s central bank says the number of fintechs has already exceeded 600.
But such rapid growth is unsustainable, even for a banking market like Brazil’s, which has both scale and large profit margins.
Many analysts expect that this rapid process of digitalization will shake out in the next five to 10 years. In other words, by 2025, it should be clear who the winners of this intense phase of banking competition are or will be.
There may not be that many of them.
Some analysts expect the behavioural aspects of mobile phone-based consumerism will lead to the domination of a few super apps – platforms that try to capture as much as possible of their clients’ online activity.
Mauricio Minas, the member of Bradesco’s board responsible for the bank’s digital operations and who oversees Bradesco’s new digital bank Next, subscribes to this perspective.
He tells Euromoney that the idea for his firm is to become “a big super app, because we have to be as holistic as possible, because in the future the winners will be those platforms that provide complete solutions for customers.”
[Fintechs] need to bundle more and more services, ultimately transforming themselves into a bank. But being a bank, especially in Brazil, isn’t an easy task… particularly on the credit side – Eduardo Rosman, BTG Pactual
Eduardo Rosman, bank equity analyst for BTG Pactual, believes this shift will lead to a reversal in the fintech explosion that has splintered the financial market into such a large number of new players.
Fintechs, he says, have largely been one-trick ponies: they have been attracted to the large returns on equity being made by the incumbents on certain products and have aggressively built businesses focused on these products. The best example in Brazil today is the payments business.
Many new companies in that sector have grown quickly – such as Stone and PagSeguro – and this growth has led to successful IPOs in New York.
A report by Moody’s analyst Farooq Khan points out that the three leading players in payments have seen their share of the market fall from 88% to 76% since the fourth quarter of 2016.
Startups, he says, have “led to the dissemination of far more PoS [point of sale] units in Brazil, giving the market greater impetus to the detriment of incumbent banks, which have suffered market-share losses despite being the largest card issuers and dominant players for years.”
Customer-retention challenge
In reaction to this dramatic change, traditional banks have been spurred into offering discounts and even free services.
But analysts are already looking past the attrition of market share and profit margins to ask how fintechs can retain customers in the long term.
Since the provision of products is based largely on price competition, when incumbents respond to match fintechs, will the cross-sell and the desire to have fewer rather than more financial providers reverse the competitive forces against the provider of a single fintech solution?
At the startups, many managers are seeking to evolve their business models beyond, as Rosman calls it, “marginally improving a certain product or service.”
In other words, after successfully unbundling the market, fintechs now face the challenge of bundling in other financial products to maintain their competitiveness.
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Eduardo Prado, C6 |
Once fintechs begin to bundle multiple products, the logical conclusion is to build a full financial offering. But they will very quickly run into a product that will stop many from going any further: credit.
“At the end of the day, [fintechs] need to bundle more and more services, ultimately transforming themselves into a bank,” says Rosman. “But being a bank, especially in Brazil, isn’t an easy task… particularly on the credit side.”
The partners at new digital bank C6 agree.
C6 is headed by ex-BTG Pactual partner Marcelo Kalim (who became co-chief executive with Roberto Sallouti following the arrest of former chief executive André Esteves).
As chief executive and controlling shareholder, Kalim heads a group of around 20 partners (including other BTG Pactual alumni, such as executives Leandro Torres and Luiz Marcelo Calicchio) who have already invested R$300 million ($72.8 million) in the business. That number is expected to reach R$500 million by the end of this year.
C6 believes that being a full-service bank – and therefore offering credit – is a necessity if it is to emerge as one of the winners. The man chosen to lead that progress, as partner responsible for credit, collection, relationship management and analytics, is Eduardo Prado, who met the bank’s founding partners while working for Banco Pan (BTG Pactual bought Pan in 2011).
Previously Prado led Itaú’s retail credit department. He will need all his experience, he admits, because one of the key problems of being a startup bank in Brazil is the adverse selection issue: those coming to seek credit from startups are often higher risk.
“When people see a new bank, it’s a new opportunity, and you have this problem of adverse selection that is thirsty for credit,” he says. “But we have our standards.”
He also says that he doesn’t want to counter adverse selection by reverting to the traditional approach of banks. C6 creates test portfolios of clients who are outside the usual risk parameters.Prado says the bank sets strict limits on financial exposure to these credit experiments. The hypothesis is that by searching these higher risk segments and correlating standard and new metrics, there may be ways to unlock profitable client segments and create customers among an unbanked population.
When people see a new bank, it’s a new opportunity, and you have this problem of adverse selection that is thirsty for credit. But we have our standards – Eduardo Prado, C6
“Most of the team brings experience, but we want to do something different – we have to challenge ourselves,” he says. “We have created an environment that makes it very easy to create test groups of customers, and we have several running. There are some where, as a credit person I wouldn’t normally work, but we created groups to challenge these assumptions to see if there is something we can learn from working with these segments.”
Has it worked?
“If we pay attention to information we may have been letting go, or if we use some data within these experiments that we hadn’t been using, then maybe we can identify a subset of, say, 10% of the group who can become customers with whom I haven’t previously worked,” he says.
The bank is targeting a mix of retail and commercial clients – the latter mostly in the small and medium-sized enterprise sector.
The retail side is designed to provide the bank with cheap funding. There, the strategy has been to offer accounts with free services (including offering no-fee money transfers via text to users of other banks) and then build out a range of additional revenue-generating services. For example, the bank is targeting the affluent segment with a customized Mastercard Black offer.
The bank is also nearing the launch of an investment platform that will offer third-party products – although C6 will retain these products within its platform.
C6 believes it has a lot of opportunity to grow a large portfolio of corporate SME clients, a typically underserved area of the Brazilian market, but a profitable one if the risk can be managed.
Again, Prado expects his experience – and the bank’s innovative experiments with data and risk metrics – will pay off here too. C6 has built a full-service offering for SMEs, with complete payment services.
The bank also has a broker/dealer operation, both locally and in New York, to support individual and institutional investor services.
Standout operation
One senior financial institutions banker in Latin America thinks that C6 is the standout operation in the new wave of digital banks and fintechs.
“I am trying to work with C6 because I like the model,” she says. “My main concern with new banks is always compliance – we need to understand that it has all the checks in place for us to be confident none of its clients is involved with money laundering or terrorism. So far C6 is the only one where I am feeling confident.”
The bank certainly appears more robust in this area. It has gone to the time and expense of creating a technology advisory board that has been populated by MIT academics to benchmark its processes and standards around issues such as data management and cybersecurity. It has also recruited experts to the board such as Stuart Madnick, Eric Grimson, Sinan Aral and Munther Dahleh.
However, the banker’s positive view goes beyond compliance.
“It’s a real bank – they are all ex-BTG and they know banking,” she says. “They are hiring very competent professionals, which is great but also at the same time it’s a concern. They are paying a lot for those guys, so they will need a lot of revenue.
“It also says it is going to compete with the big banks like Itaú and Bradesco, which in theory makes sense because it will have lower cost structure to help this, but in practice it is very difficult to compete with those banks.”
Prado says C6 isn’t necessarily positioning itself as a low-cost provider.
It is difficult to benchmark individual bank interest rates because the only explicit public information comes from the central bank, which only publishes each bank’s highest rates.
“We haven’t benchmarked [our interest rates] yet,” says Prado. “We can infer our competitive position from measures published from the positive credit bureau, and it is something we are going to do.”
He says he expects that C6 rates will tend to be lower than the incumbents’, but “we are not necessarily positioning ourselves as a low-cost or credit in the market.”
Instead the bank’s strategy is to build its customer base by providing complete transparency, serving under-banked segments such as SMEs and “boosting profitability through cost control.”
C6 headquarters: this is what a modern Brazilian bank looks like
Profit-focused approach
Given the backers of the bank are from BTG Pactual and are using their own money for funding, there appears to be a greater focus on achieving profitability than in most growth banking models. Prado won’t disclose much other than the total funding amounts (R$500 million).
He doesn’t give any details about the rate of cash-burn or the target date for achieving profitability. Even the customer base is shrouded in secrecy.
Other than saying the bank converted 200,000 beta testers into clients at its soft launch, information is vague. For example, C6 says that, following sponsorship of a Taylor Swift concert and offering priority ticketing to account holders, the bank saw a 300% increase in account openings.
The bank also says that the number of its accounts in the 18-to-25-year-old demographic grew by 136% between August and September.
Again, without base numbers, it’s hard to get any sense of what such large percentages mean.
Prado declines to reveal internal growth targets to Euromoney. Elsewhere, the bank has been quoted at aiming to have 400,000 accounts by the end of this year.
When asked if the bank’s core focus is growth rather than profitability – in line with the tech startup model – Prado replies: “We do worry about profitability. That’s what makes us different from fintechs – and we are not a fintech, we are a bank and run by bankers. From the first day we have been guided by bankers, and they like to have profits.”
The tricky thing for fintechs that are, for example, successful in payment will be: what’s the next step? You can’t do payments forever – Financial institutions analyst
Such a focus on profitability leads to a discussion of the role of collections within the business model – it’s a distinction that illustrates C6’s profit-focused approach.
“Banks often don’t look at collection as they should – there is a lot of money on the table,” says Prado. “Banks think that it’s easier to just let [bad debt] go, but we think that collection should be part of the relationship cycle. If we can offer a solution to the customer [who is in financial difficulty], then we can win this customer for life.”
Prado says the bank has switched focus from growing what it offers to better customer service.
“If you had visited just four months ago, the mind-set was different,” he says. “Now the customers and the experience of the clients have to be the focus.”
He says dealing with client issues while continuing to build the bank “is a puzzle”.
One answer will be to acquire fintechs. While C6 plans to grow organically, it is also using acquisitions to accelerate the rounding-out of its offerings. For example, it bought a fintech that creates the software that runs payments machines (used in four million PoS in Brazil and that also brought with it a small portfolio of SME clients).
C6 also bought a financial education fintech.
This brings us back to the beginning: the coalescence of fintechs into full banking platforms as they increasingly struggle for next-phase growth plans: are digital banks such as C6 the future-proof answer to fintechs?
As one financial institutions analyst says: “The tricky thing for fintechs that are, for example, successful in payment will be: what’s the next step? You can’t do payments for ever. You need to do credit. So that’s why the C6 model fits better. It has capital. It is open to take risk. It can manage risk. The question is can it grow sufficiently?”
