Brazil: Digital Finance at the Speed of Light

Less than a decade after the first startups began to challenge the traditional banking ecosystem in Brazil, growth and investment are exploding. Newer fintechs look to dominate specialized segments, and the country's established unicorns, many with a few years under their belts, are expanding to regional horizons. Traditional banks have stepped up to the plate too, unrolling new digital platforms and features. But an increasingly crowded field is leading some to ask whether this new marketplace is creating positive outcomes for consumers and investors after all.

On Your Marks

Historic concentration and high prices within Brazilian banking industry opened the door for fintech startups to challenge the status quo. Even now, the top five traditional banks in Brazil - Itaú, Bradesco, Banco do Brasil, Caixa Econômica Federal, and Santander - still hold 82% of the country's banking assets, and consumers in Brazil face extraordinarily high interest rates - as high as 50% - on loans and credit.

Enter Fintechs. As the sector has grown in Brazil, fintechs have expanded to additional segments - made easier than ever to reach because Brazilians are highly mobile. And though fintechs in Latin America are often associated with targeting previously unbanked populations, a collaborative study by the Interamerican Development Bank and Finnovista found that only 35% fintechs target the 50 million Brazilians who do not have bank accounts but do have access to a mobile phone or internet. Instead, fintechs (and traditional banks for that matter) are targeting millennials seeking cheap and convenient alternatives. Nevertheless, as fintechs expand, more may turn to unbanked Brazilians as untapped potential. NuBank, for example, has followed this strategy in 2019. In an interview this July, Nubank Vice President and Co-Founder Cristina Junqueira contended that much of the difficulty in reaching unbanked small businesses wass due to burdensome regulations and bureaucracy, rather than a lack of interest in achieving financial inclusion.

Government barriers do pose a challenge to growth in Brazil, but the last decade has seen a shift in policy. A slew of the relevant regulations were overhauled and palced under the jurisdiction of the Central Bank in 2013. Among the changes enacted was an elimination of the requirement that fintechs partner with traditional banks to offer financial services. The Bolsonaro administration has also continued on the path of deregulation, encouraging more competition and advocating for more privatization in banking.

Fueling The Fires

Whether it is a case of correlation or causation, Brazilian fintechs have expanded aggressively since 2013's policy changes and show no signs of slowing. Last year saw three Unicorn valuations: PagSeguro; NuBank; and Stone Pagamentos. PagSeguro is a payments platform known for its card reading machines that was valued at $2.6 billion in January of 2018 and is now valued close to $9 billion. NuBank, a totally digital bank, offers digital bank accounts, credit and debit cards, and loans with low or no fees, and was recently valued at US$10 billion. Stone Pagamentos, which offers payment processing services in stores and online, made its initial public offering on the Nasdaq at a valuation north of $8 billion on October 25th.

These well-known success stories have not deterred new entrants. Instead, they seem to have signaled opportunity to entrepreneurs that the Brazilian market contains untapped potential. According to the survey referenced previously, the number of Brazilian fintechs grew by 22% over an eight month period in 2018; the same survey found that 35% of respondents said they were in a growth phase while 31% responded that they were ready to scale. Perhaps unsurprisingly, investors have taken notice. Investment in Brazilian fintech startups has grown rapidly over the last three years, from US$14 million in 2017 to US$40 million in 2018, and finally to US$64 million in just the first semester of 2019.

Gotta Go Fast

Dissatisfaction with the financial services industry in Brazil was not limited to consumers. In June, current finance minister Paulo Guedes decried the traditional Brazilian banks as a “cartel” with "excessive" profits, and called for more competition in the banking industry. But in response to rising challengers in the digital finance space, traditional banks have begun to develop digital franchises of their own. However, fintechs and traditional banks use very different strategies with respect to customers. In conversation with Mondato, Eduardo Jacob, CEO of Brazilian micro rewards service Minutrade, said:

“For [fintechs] the strategy is focused on reducing any friction when getting new consumers, and incentivizing consumer digital behavior... Since bank have been ‘villainized’ for a long time,” digital growth services like micro rewards help them to legitimately build win-win relationships with their clients, reducing friction and building trust.”
Eduardo Jacob, CEO Minutrade

Given that their business practices created the need for a fintech sector in the first place, traditional banks now face the challenge of rebuilding customer trust as they launch digital products to compete with fintechs. Bradesco, for example, launched Next in 2017, an all digital platform targeting millennials and offering lower, digital-exclusive rates. At the time of launch, Bradesco spokespeople emphasized that Next would not try to undercut prices offered by fintechs. However, this strategy proved untenable; Bradesco president Octavio de Lazari admitted in an interview last month that Bradesco initially resisted the model - popular with fintechs - of assuming loss in exchange for market share, but simply couldn't compete without also eliminating fees. Lazari also confirmed that Next will separate and operate independently from Bradesco, in effect becoming a fintech of its own. The story illustrates an important shift in the Brazilian bank industry: because of current regulation, customer expectations, and the culture and design of fintech companies, there is space now only for the fintech model or the traditional banking model -- and very little in between.

Bradesco's experience entering the space may serve as a cautionary tale for other banks who wish to go digital. Santander - another traditional bank in Brazil - announced in July that it would launch "Sim," a digital microcredit loan platform. Sim was set to launch this September, but as of late October has yet to do so. Santander president Sérgio Rial also noted that the bank has already invested in Creditas, who would be Sim's primary competitor. While this may seem counterintuitive, Rial says that the thinking is that "Sim will compete with Santander itself." So Santander is playing both sides by continuing to operate as one of the biggest banks in Brazil while simultaneously acting as a “growth incubator for new businesses in the midst of the rise of fintechs.” Rather than severing its ties to its digital arm like Bradesco, Santander has adopted a strategy that promotes the development of fintech both within and outside of the Santander brand.

The same month that Santander announced Sim, Itaú announced iti Itaú, a mobile payment platform for businesses and consumers. Customers will be able to register any credit or debit card with the app to make immediate purchases or money transfers. The app will eliminate the need for both physical cards and the machines that read them, as it operates by scanning QR codes. This suggests Itaú is angling to compete in payments - currently the segment with the most growth and highest concentration of fintechs. Itaú says iti will be available for download in the third trimester of 2019.

In correspondence with Mondato, Thiago Charnet, director of technology for Itaú, said that traditional banks in Brazil are facing increasing competition from several sectors, including fintechs. He noted that while Itaú is launching more digitial products like iti, the bank has also made changes to its physical services such as Itaú Lab and Rede storefronts, each offering a new models of customer service.

Physical branches and customer service may in fact prove to be primary differentiators between big banks and fintechs. In the case of 100% digital banks like NuBank, for example, customers must withdraw cash from ATMs run by other providers, and there is no physical location for customers to get help or personalized advice. Moreover, Charnet cited the culture changes between traditional bank and fintech environments when describing Itaú’s strategies going forward in a changing industry:

"The first [part of the strategy] is the adoption at scale of a data-oriented culture. The second is to constantly evolve our technology platform so that we can deliver customer value with ever increasing quality and speed."
Thiago Charnet, Director of Technology, Itaú

Banco do Brasil shares this perspective. Tiago Cruz Alexandre, the digital director of Silicon Valley Labb - Banco Do Brasil's office in Silicon Valley specifically dedicated to fintech solutions - spoke with Mondato about competition from fintech startups and changes in the industry.

Cruz said that he sees fintechs as opportunities rather than competition. "The way we look at it, fintech startups are something that can be cooportative and help with final solutions to customers and clients,” he said. “One example of that is our initiative here in Silicon Valley where we have rounded up startups with the facilities of Plug and Play, but also in Brazil with partnerships with Conta Azul that we developed back in 2017. We think that all these players can present for us an opportunity to partner or develop together." For competition. the bank instead seems to look to the commercial banking industry. According to Cruz, "We have solutions and products developed in house, and for now the strategy is to achieve better customer satisfaction and to be putting our clients in the best position in the commercial banking sector."

Now Entering Hyperspeed

As traditional banks dip their toes into fintech territory, fintechs are increasingly competing to provide the other financial services traditionally offered only by these banks. Startups are entering more diverse segments, while more established fintechs are expanding their target markets and product lines. NuBank, for example, started as a digital-only credit card and has since expanded to offering digital bank account and now a debit card. NuBank is also going regional. It has opened an office in Mexico City, and plans to expand into both Mexico and Argentina next year.

NuBank has reportedly sought US$1 billion for its next funding round to support regional expansion. In June, NuBank seemed close to a deal with Japan's Softbank. By July, however, buzz diminished after it was reported that the two companies disagreed over the amount of funding and the value of NuBank's proposed market. The fallout with NuBank and other losses this year on Uber and WeWork have not stopped Softbank's ambitions in Brazil: according to TechCrunch, Softbank's investments in Brazil in September totaled more than all venture capital investments in the country in 2016. For their part, NuBank did not let their falling-out with SoftBank slow them down, raising $400 million from the American firm TCV in July to reach a $10 billion valuation.

Braking Was Never An Option

Traditional banks and fintechs alike in Brazil will soon face new challenges from foreign players looking to compete for the Brazilian market. German digital bank N26 is currently the largest European fintech, and earlier this year launched in the United States and announced plans to enter Brazil. London-based Revolut also partnered with Visa this year to scale globally to 24 new markets - including Brazil. These are merely two international fintechs entering the Brazilian ecosystem this year, but the major financial backing and global reach exhibited by both suggests that more entrants could be on the horizon.

Expectations for the potential of fintech in Brazil have been building over the last decade, leading to a proliferation of startups and new digital platforms from big banks which offer Brazilians more choices than ever for their financial needs. Today, as money pours in, competition heats up, and customer attitudes toward tech continue to change, banks will need to take a stronger stance to defend their territory. With enough funding to sustain themselves, hungry fintechs will be able to undercut prices in their quest for market share.

According to Itaú's Thiago Charnet,

"The use of cutting edge technology like AI, cloud and blockchain to automate processes, which in addition to reducing costs, will also allow the redirection of efforts towards more strategic activities."
Thiago Charnet, Director of Technology, Itaú

Given the rate of growth over the last half-decade, and in the last two years in particular, 2020 will likely see ongoing expansion in all directions when it comes to digital finance in Brazil. At the end of the day, it will be up to Brazilian consumers to choose which among the plethora of digital financial services actually makes sense for them. Good value, accessibility, and perceived stability are high priorities, whether offered by a big bank, a homegrown fintech, an international newcomer, or someone else altogether.