Brazil’s securities regulator, the CVM, has launched a study into the country’s flourishing financial technology (fintech) industry, raising the prospect of new regulations that could impede the sector’s growth.
The CVM announced its initiative at the end of August and stressed that new technologies that bring efficiencies to the sector “should be supported and encouraged” but the report will also be the precursor for new regulations, potentially weakening one of the competitive advantages that fintech presently enjoys.
However, with an expensive and heavily concentrated banking system, analysts say that there remains huge potential for start-up companies to compete with the established players on cost.
Since 2014 the number of fintech companies has grown rapidly and Raphael Nascimento, associate director at Fitch in Sao Paulo, estimates there are between 150 and 170 now operating in the country.
“The large banks are still very conservative with their credit portfolios, which opens space for the fintechs to lend at lower rates of interest,” says Nascimento. “These new platforms don’t have much cost and they can be faster and less bureaucratic when approaching the market.”
The established banks have all developed digital responses to fintech – including purely online digital banks for customers. The two leading banks, Itaú and Bradesco, have about 100,000 and 10,000 customers on their digital-only platforms (Itaú iConta and Bradesco Exclusive Digital) respectively, according to Nascimento.
The country’s banks have adopted a low-key rollout of these services because digital banks present a strategic challenge to the established bankers that still have very large physical networks. Their challenge, according to Sergio Furio, founder and CEO of BankFacil, is to migrate customers to the digital banks while cutting the costs of their traditional operation.
“That process started about five years ago,” says Furio. “The banks realise that the marginal cost of a new customer is very low with digital banking but they have created overheads over decades and they will need to accelerate their efficiency programmes if they are to increase their digital customer base.”
The problem facing the Brazilian banks is the ‘cannibalisation’ of the process of developing the lower-cost digital banks. Three of the banks’ largest products are credit cards, overdrafts and personal loans and together these levy interest rates of over 200%. As a country, these products comprise R$180 billion ($55.85 billion) of credit – or roughly 15% of the R$1.5 trillion outstanding credit. Brazil’s system-wide net interest margin is 30.6% compared to 3.1% for the US.
“The problem for the Brazilian banks is if you move away from a high margin business you need volumes to compensate,” says Furio. Replacing much of that R$180 billion of debt that yields 200% on a digital structure would necessitate a lot of volume. “That’s why the banks are migrating their customers to their digital banks as slowly as possible.”
However, there is potential – Brazil’s household debt is an average of $2,000 per customer compared to $34,000 in the US. Brazil’s total debt is 15-times less than in the US and GDP is just four-times smaller than the US.
Despite the entry of fintechs the established banks are not reported to be worried. Even in the US where fintech is more established and with some multi-billion dollar peer-to-peer companies, the established banks still have 99% share of the lending market.
To date the banks have been focusing on technology to reduce their own costs rather than reacting to new entrants that offer consumers lower cost credit. A survey of banks by UBS found that management of Brazilian banks expect mobile banking platforms to lead to cost savings of more than 10% in the next three years and to more than 8% incremental revenue in the same period.
The expectations for Brazil were higher than the global average and so they can also expect higher than the global average increase of 110 basis points in return on equity that UBS predicts will come from mobile banking by 2019.
Nascimento agrees with the assumption that Brazil’s banks won’t look to cut net interest margin as a response to the new competition but argues that there is a precedent for banks to become reluctant players in new lower-cost segments.
“The big banks didn’t want to enter the Consignato (payroll loans) segment when it started in the country because the interest rates were about 15% compared to over 400% for unsecured credit,” he says. “But eventually all the major banks either created their own service or teamed up with a payroll loan lender.”
Fintech companies are likely to retain the ability to undercut the established players but they will have other challenges.
“They may be lower cost but they won’t be able to compete with the larger banks on cost of funding,” says Nascimento. “And there could be problems with delinquencies if they are too aggressive and they don’t have the internal sources of data that the big banks have to manage credit risk. Regulation and asset quality are their biggest challenges.”