Latin American fintech innovation stifled by market challenges

What’s holding back LatAm’s fintech innovation?

Latin America as a region should be ripe for fintech innovation. As a recent CitiGroup report titled Digital Disruption: How FinTech is Forcing Banking to a Tipping Point noted: “High unbanked population, weak consumer banks and high mobile phone penetration make emerging markets ripe for fintech disruptions.” And there are innovations. From Brazilian start-up BankFacil to award-winning Colombian fintech platform Destácame, there are many examples of Latin American fintech start-ups that are tackling the unbanked with interesting products.

But the challenges are stifling innovation in this crucial sector. Sharath Dorbala, VP products and marketing at Amdocs MFS, explains that regulation and security poses a significant challenge, as in CALA (Caribbean and Latin America Region) most countries still have bank-led regulation in place.

“In these countries, traditional financial institutions tend not to be highly motivated to go after new customer segments, like the unbanked, and so Mobile Network Operators (MNOs) are the ones who lead the mobile money market,” he says.  He adds that many countries with regulations allowing non-financial institutions to offer services, still have stringent Know Your Customer (KYC) requirements, which again hamper people’s ability to sign up to the services.

While in other regions, KYC has been adapted to mobile money and payments and subscribers can sign up remotely for basic services. “And in some cases, under the banner of financial inclusion, regulators are imposing caps and limits in fees for the services, making it unattractive to non-financial institutions to launch services due to a challenging business case,” he says.  He also notes that the countries with enabling MFS (Mobile Financial Services) regulation have seen the greatest reward, for instance Kenya and the Philippines.

This theme was echoed at World Economic Forum on Latin America. “The average person may have $10 in their savings account. And if the Know Your Customer regulation (KYC) is going to cost you $1, nobody is going to serve that market. And if the regulator in the United States is going to fine you $1 million if you don’t do your KYC in Latin America, it won’t work for those people,” Richard Eldridge, CEO and co-founder of Fintech company Lenddo said in Medellin, Colombia earlier this year.

Eric Barbier, CEO and Founder of TransferTo, the B2B mobile payment network, suggests that the main challenge to Latin America’s fintech innovation is without a doubt the regulatory frameworks. In his opinion, many countries have banking regulations that simply do not enable new business models. Latin American countries are generally lagging behind other countries in terms of ease of doing business more generally. The best-ranked country is Mexico in position number 38, while a large country like Brazil ranks 116 and Argentina 121. In most LatAm countries starting a business takes significant time and effort.

“Colombia is a good example of where most of the elements needed for fintech innovation have been developed. For example, the government has realised the need to develop specific regulations for the unbanked with the Financial Inclusion Bill passed in 2014, and is proactively promoting competition both amongst incumbent players and new entrants. The payments industry in Columbia particular is flourishing, with more than 20 new PSPs starting businesses in the last three years,” he says.

DigitalX CEO Alex Karis is quick to highlight what he terms the startling difference in funding available for fintech start-ups in Latin America compared to the United States, especially considering the many Latin American companies emulating the USA-based fintech heavyweights. Karis cites examples in Mexico such as the equivalents of Square (Clip), Digital Currency company, Coinbase (MexBT), and P2P lender, Lending Club (Konfio) all raising money this year. “The total funding for these companies was in single digit millions compared to 10X over the border. Arguably the region has been starved of investor capital due to formal credit not being available to 85% of the population in Mexico,” he says. 

There is some benefit to the smaller funding pot, though, in that for the Latin American fintech start-ups, ideally local success leads to global success. “And with smaller funding rounds, there are much more attractive valuations on offer particularly for investors deploying US dollars. Investment funds are increasingly coming from collaborations of angel, venture and government,” Karis suggests, adding that to bring the larger funding rounds to the region there needs to the provision of personal finance tools and formal credit.

“In a positive feedback loop, it will be Fintech companies creating these tools to make it easier for SMEs to find funding, which will of course lead to more growth and more scalable and investable opportunities for larger rounds. Fintech companies will promote the growth in the financial sector through disseminating useful data and analysing appropriate credit risk.”

He adds that the different cultural habits in Latin America create challenges for fintech companies particularly around retirement. In a 2014 study by Prudential [PDF] only 53% of Hispanics viewed saving for retirement as important compared to 62% of the rest of the US population. “This trend stems from the strong familial values that Latinos hold and they expect to be supported into the retirement ‘golden’ years by their children. This theme was reinforced when the study revealed that the Hispanic population of the USA had less than half the proportion of individuals with an Individual Retirement Account,” says Karis.

The lack of interest in specific types of financial services could also come down to trust, Karis muses. “In a region where trust for financial institutions has been traditionally low, following the debt and currency crisis of the 1980s, acquiring customers can be difficult. Trust can also be built through favourable regulation for consumers and enterprise. The financial system needs regulatory oversight, but it needs to smart regulation with revised but clear rules that are proportionate to risk and allow for innovation and growth.”

Despite this, though, the fintech industry seems set to continue growing in Latin America, pushed by many actors of the ecosystem and initiatives like the Fintech Regional programme of NXTP Labs. The programme offered visibility, mentoring and acceleration to start-ups with the ultimate aim of turning them into the “most disruptive solutions for the financial and banking industry of Latin America”. It spanned Chile, Argentina, Colombia, and Mexico.

This initiative has resulted in some interesting start-ups, such as Afluenta, which is transforming financial services by connecting people seeking credit with people that are in the position to provide financing.

“At the same time, most of the banks in Argentina and the rest of Latin America are investing in this industry, not only internally – setting up innovation areas and teams, opening their APIs, and so on – but also investing directly in start-ups as VCs,” Pablo Ruiz, Fintech Regional Program Director at NXTP Labs says.

Of course, the region itself is extremely diverse, home to over 40 countries, each with its own ecosystem. The top six, Argentina, Brazil, Chile, Columbia, Mexico and Peru made up around 85% of GDP according to the IMF. It is no coincidence that almost an identical share of the Latin American smartphone users come from these same countries via statistics from Emarketer.  

According to Karis, the shape of the fintech landscape in Latin America is still under development, but there are some exciting changes that provide a crystal ball of what is possible. The FinTech Radar by Finnovista highlighted the growth rates of fintech start-ups in Colombia as “spectacular”. Furthermore, there were over 70 innovative companies in sectors such as payments and remittances, loans and financing. In Brazil, the largest country in the region by population and GDP, the Reporte Fintech Lab showcased over 130 enterprises on its radar in areas including bitcoin and the blockchain, a sector that has generated enormous funding and buzz in the USA. 

Ruiz explains that one of the challenges in the region is the management of cash (which generates many security and logistic issues), the need of efficient loans, and risk analysis. “I’m sure that we’ll see more start-ups that provide solutions for these problems in the near future,” he says. “These challenges can be addressed as banks open themselves to innovation and the regulatory agents keep on loosening their regulations.”

For Karis, the best example of a huge barrier being removed is in Cuba. As the Obama led government broke away from the decades long embargo between Cuba, a potential fintech gold mine may open. AirBNB and Stripe were two of the biggest fintech names that announced moves into the country while Western Union now offers remittance services after the regulatory and policy changes allowed both Cubans and non-Cubans to send remittances to the island nation. Highlighting the remittance opportunity, the International Money Transfer & Payments Conference (IMTC) held their first event in La Havana, Cuba in late June this year. These are all positive developments in Karis’ view.

In addition, many LatAm countries are beginning to address the regulatory issues, with El Salvador, Guatemala, Bolivia, Paraguay, Colombia and Peru having specific regulations around financial inclusion. The results can be seen in the increase in multiple mobile/electronic wallet operators launching services in the past few years, Barbier of TransferTo points out.

Incentivising innovation is also increasingly popular, with Argentina investing in a number of such programmes such as the Technology District in Buenos Aires that provides tax incentives and preferential rate financing for technology companies. Argentina’s new administration has recently communicated its goal to transform the economy into a “cashless” system. As part of this initiative regulations will change and incentives will be provided for new fintech services. Uruguay’s free zones also offer tax incentives and have attracted a number of financial services software companies as a result.

Barbier cites Ecuador as a good example of where the government has addressed the problem directly. “With a dollarised economy the cost of cash is significant and the government has developed the ‘Dinero Electronico’ [Digital Money] ecosystem, now re-branded as ‘Efectivo desde mi celular’ [Cash from my cell],” he says. The platform is managed by the Central Bank but it is an open system, which any financial institution and merchant can be part of. The system provides low rates for consumers and also a tax incentive with a 4% VAT refund for purchases made through mobile accounts.

There is innovation, despite the challenges. Ruiz concludes: “We see that the innovations coming from LatAm in areas like blockchain are as creative as the ones that are being formed by the rest of the world. There is a lot of creative potential in the region and several problems to be solved which generates a rich ecosystem, regionally.”


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