Brazil is in the midst of a financial technology boom, with scores of startups looking to cut into the market share of the country's highly concentrated financial sector. But regulation over such firms is still in the nascent stages and one player's sudden collapse has raised questions as to whether the sector needs closer scrutiny.
According to Finnovista, an organization that promotes fintech entrepreneurship, there were 377 fintech startups operating in Brazil at the end of May — 1.5x more than in Latin America's second-biggest fintech market, Mexico. One in four of those is engaged in payment and remittances services while 17% are involved in enterprise financial management. Lending and digital banking startups or of smaller size, but are growing fast, according to the group.
The rapid creation of such firms has come partially in response to the dominance of Brazil's five major banks — Banco Bradesco SA, Itaú Unibanco Holding SA, Banco Santander (Brasil) SA, and the state-owned Caixa Econômica Federal and Banco do Brasil SA — who together control around 80% of total assets. Many firms are looking to steal away some of their business by offering better convenience and more attractive rates.
Longer term, the growth for fintech in Brazil is expected to be huge. In a report released in 2017, Goldman Sachs estimated the sector will generate around $24 billion in revenues over the next decade, as the extreme concentration in the financial sector is expected to give way.
"We believe the Brazilian financial system is particularly susceptible," the report's authors wrote.
Such expectations have led an increasing number of investors into the space, both domestic and international. In 2017, Goldman Sachs and Fortress Investment Group LLC granted a 455 million real credit line to Nubank, which offers credit cards and checking accounts through mobile-based platform. More recently, Morgan Stanley reportedly bought about 50 million reais of subordinated bonds from Geru Tecnologia e Servicos SA, an online consumer lender, while Neon Pagamentos SA, a mobile-based credit startup, raised 72 million reais in its series A round of fundraising — the largest amount ever for a Brazilian startup.
More is still to come. XP Investimentos SA reportedly is working with four fintech operations hoping to raise around 600 million Brazilian reais in the third quarter, while several others are reportedly are looking to raise funds through so-called FIDCs, or credit rights investment funds.
A cautionary tale
But amid the growing investor interest, there are still risks. Just days after Neon Pagamentos announced its record Series A funding, its banking counterpart, Banco Neon SA, was ordered into liquidation due to regulatory breaches and the impairment of its "economic and financial situation." While Neon Pagamentos was not part of the liquidation, the shared name and partnership — Neon Pagamentos used Banco Neon to process its checking accounts — caused confusion and consternation.
The liquidation also put a temporary halt to Neon Pagamentos' operations, which it was only able to resume days later under a new partnership with Banco Votorantim SA.
Stéphanie Fleury, director at industry association ABFintech, however, stressed that Banco Neon itself wasn't a fintech company, but rather a very small bank, and pointed to the speed with which Neon Pagamentos was able to source a new partner.
"It was unfortunate that the image of the fintechs was drawn into this, but the fact that Neon recovered so quickly really helped," Fleury said in an interview, noting that the Votorantim partnership formed within 4 days of Banco Neon's collapse.
Regulations in progress
While the sector continues to push forward, the regulatory environment is still very much taking shape.
It was only in April that Banco Central do Brasil released a set of new regulations for credit-focused fintech firms. The new rules establish two new types of financial institutions, peer-to-peer lenders, known locally as SEPs, and so-called direct credit societies, or SCDs, which make loans using internal resources. These companies operate under loan caps and minimum capital requirements markedly lower than those for traditional banks.
Previously, Brazilian credit startups had to partner with a bank to be able to operate with loans, as only regulated financial institutions were allowed to do so.
The regulation was "very well received" by the fintech sector, said ABFintech's Fleury, who expects additional rules for other parts of the fintech space to come.
"But, of course, this is only a start and we have to see if it goes along with the market," she added.
Brazilian business lawyer Rodrigo Vieira, who has closely followed fintechs, believes that the rules set in place so far will help to increase competition in the Brazilian credit market and lower rates.
"The regulation really meets the expectation of the fintech market and it has created a safe environment for the development of credit fintech companies in Brazil," Vieira said.
Big banks fighting back
Meanwhile, the giant banking groups that dominate Brazil are fighting back by launching their own digitally focused products and services.
"Banks are generally following two strategies: Some are creating totally new digital platforms and others are just transforming their own and are becoming more and more digital [over] time," Moody's analyst Ceres Lisboa said in a telephone interview.
She said Bradesco's digital arm Next , is an example of the former, which hopes to attract around half a million new clients in 2018 and is aimed at a younger, tech-savvy generation.
Meanwhile, other banks are swallowing startups or paying them to extract technology, saving costs from developing expensive in-house products. "This [is] helping ... the banks to anticipate some changes and also to work with the fintech companies," the analyst said.
However, Lisboa believes that banks are mainly concerned about competition from fintechs within the payment and investment services space, where lower fees are more of a threat. That may help explain Itaú Unibanco's recent 6.3 billion reais investment in XP Investimentos, which operates a popular online investment platform, to give the bank a 49.9% stake in the firm.
Still, Lisboa cautioned that the transformation to digital banking platforms is a gradual work in progress.
"We don’t know how or when it will end," she added. "Nobody knows where banking will be in 10 years."
As of June 18, US$1 was equivalent to 3.75 Brazilian reais.