How Digital Banks Are Breaking Up Latin America's Finance Monopolies
WHY YOU SHOULD CARE
Banks have enjoyed decades of monopolistic control in Latin America. A growing band of new digital banks is now threatening their hegemony.
By Wesley Tomaselli
Gabriela Franco clutches her phone, frustrated. Her bank in São Paulo is on the other end. She needs to wire money right away to a separate account at her bank. But the representative is telling her she has “to be there — like, physically — at the bank in São Paulo to approve the transfer.”
The thing is, Franco works and lives in Mexico City, and getting to her São Paulo branch in an hour is, well, impossible. The answer to her problems may instead lie in a wave of alternative banking solutions now emerging across Latin America.
Across the 626 million-strong region, banks have enjoyed decades of monopolistic control. In Brazil, a group of six banks were protected by the constitution from foreign competition. In Colombia, two banking giants (Bancolombia and Grupo Aval) control more than half of the sector. Now, a fast-growing group of new digital banks is challenging their domination. With the traditional giants, customers often endure long lines at the local bank branch with hour-plus waits. Then there are the hefty fees that come with wire transfers: Franco is preparing to pay more than $50 for hers. At these new digital banks, doing your banking means five minutes of taps and swipes on your smartphone — often with little or no fees.
They [traditional banks] have obsolete tech … they don’t care about people.
Angel Sahagun, CEO, Albo
The number of fintech companies in Latin America grew 66 percent between 2017 and 2018, according to the Inter-American Development Bank. Many of them are digital banks and lenders. At Albo, a new Mexican digital bank founded in 2016, a prepaid debit card with an app lets customers send zero-fee transfers and read up on free personal finance how-to reports. The idea is to educate. The firm received $7.4 million in funding this January and has 80,000 customers now.
Brazil’s Nubank — which lets users operate a snazzy purple credit card through a simple app, offers zero-fee transactions and competitive credit interest rates — has amassed 5 million subscribers in just five years since its launch. The world’s largest fintech firm outside China, Nubank is now also planning to expand to Mexico. Colombia’s Aflore is formalizing a traditional system of loan sharing called cadena using an app, adding efficiency and transparency into transactions. Their loans are disbursed through more than 17,000 community leaders today. These digital banking startups are forcing the industry’s old guard to look over their shoulders, and provoking regulators to adapt.
“Unless new players come in to challenge the way things are, I don’t see the financial industry having much incentive to change,” says Christine Chang, a director at fintech organization Finnovista in Mexico City.
Those who are already part of the banking system represent only half of the potential market for these new firms. Across Latin America, 1 in every 2 adults does not have a bank account, unlike in the U.S. and Europe, where 95 percent of adults are banked. They want home improvement loans and to send their kids to better schools as much as Americans do yet, for decades, many Latin Americans have been forced to operate outside the financial system because of intolerable costs and rates.
The cadena is one such informal loan-disbursal system. Effectively, it’s a network where if someone needs funds, they come to a local community leader and ask for a loan. Especially in small towns, it’s not unusual for family members to juggle several loans at once with each other and their neighbors. Now, those needing loans come to a designated community leader, who uses the Aflore app to score the borrowers’ credit and supply a pool of funds for the loans.
By contrast, traditional banks — even with little innovation and only the accounts of a slice of the population — have run profitable businesses, according to Paulo Guedes, Brazil’s economy minister. “They have obsolete tech, they don’t care about people and lots of features were profitable but bad for the customer,” says Angel Sahagun, CEO of Albo.
That profitability comes from holding a monopoly. The region’s governments have long allowed the concentration of banking power to be in the hands of a few because of fears that the system might go haywire if the market were too free and competitive. In Brazil, the constitution prohibits foreign investment in the banking sector. That’s why Nubank, which has international investors, needed to ask the president’s office to issue a special decree for its banking license.
“Latin America, in general, has historically been closed to international trade. And therefore, financial penetration has been very low,” says Sergio Olarte, a macroeconomist at Scotiabank in Bogotá. He’s partly referring to the Spanish-enacted 18th-century Bourbon Reforms, which put more power in the hands of the mainland Iberian empire and limited local elites in the colonies across the Atlantic. Part of the reform meant that colonies could trade only with Spain — not with each other. The legacy of protectionism is still palpable today.
But the region has also grown increasingly distrustful of traditional financial institutions. In Argentina during the early 2000s, the government froze accounts and frightened Argentines by preventing them from withdrawing their hard-earned pesos. Now, many convert the peso to home-stashed dollars instead of trusting the banks. More recently in Venezuela, hyperinflation shattered the banking system’s hard-won trust. In Brazil, where inflation during the 1990s went off the charts, customers grapple with high fees and suffocating interest rates on credit card balances. “Trust in the financial system isn’t that great,” says Olarte.
Given that background, regulators are — guardedly, in some cases — welcoming the emergence of the new digital banking challengers. Guedes this year called for more competition in Brazil’s banking sector. Indeed, politicians are slowly coming around to reforming the landscape. In Colombia, the government has set up a regulated playground for new fintech companies to test their products before launching. In Mexico last year, a law was passed regulating fintech companies.
The big banks also are recognizing the threat, and they are trying to adapt. Before he founded Albo, Sahagun was contracted by big Mexican banks to improve their ailing digital infrastructure. “That was where I really saw what was going on behind closed doors,” he says. Colombia’s Bancolombia and Brazil’s Itaú Unibanco have already responded to the new competitors with their own digital payment apps for managing accounts from their customers’ smartphones. They’re having to play catch-up, for once.
For sure, trust will be a challenge for the digital banks as well — especially as traditional customers only slowly begin to gain digital savvy, suggests Chang. “And although smartphone penetration is very high, the majority of people probably don’t fully utilize their phones,” she says. Latin America’s dismal cybersecurity infrastructure could also expose these firms to threats. According to the IADB, 4 out of every 5 countries in the region lack cybersecurity strategies and are therefore vulnerable to damaging cyberattacks.
Still, Latin Americans — like Gabriela Franco — are desperate for alternatives. The battle to wrestle her and millions of others from the old guard is on.