- Digitalization of banking will challenge banks lacking the scale and flexibility to adapt.
- Bottom-line profits will suffer due to the rising price competition and investments in technology.
- Brazil's favorable regulatory framework for fintechs has encouraged competition in the financial services industry.
- Fintechs are benefiting from the relatively high smartphone penetration and the "millennials factor".
- Technology is a manageable risk because new technologies are generally available to all banks.
Amid accelerating technology shifts and changing customer preferences, S&P Global Ratings believes that Brazil's large banks are well positioned to defend their market position in retail banking against disruptive tech players. This is because the Brazilian universal banking model, with its one-stop shopping strategy and ability to adapt to adverse conditions, and healthy margins enable the top players to stake their claim in the burgeoning financial technology sector. But in order to keep pace with the speed of innovation to satisfy client preferences, banks need to make substantial investments to remain the banking platform of choice. We expect such investments will most likely dent bottom-line results, but the impact will be more pronounced among Brazil's smaller banks.
Our ongoing bank rating assessments incorporate our four-factor analysis of a banking system's technology, regulation, industry, and client preferences (TRIP). Our findings suggest that regulation and customer preference are the major disruption risks to Brazil's retail banking relative to other major economies (see chart 1). Industry risk for domestic banks is manageable, given their sufficient resources to catch up with innovation and technology, in our view.
Tech Disruption Risks: Brazilian Banks
Regulation and Preferences Promote Innovation
Industry: Disruption Risk | Low
We believe digitalization of banking, along with the open banking reforms, will fuel pressure on smaller banks that lag their larger peers in embracing the new trends. However, we expect dominant industry players, which are able to absorb the investment costs, to overhaul their business models successfully. However, bottom-line profits will most likely slip due to the increase in price competition and investments in technology, and investors will have to get used to banks' slightly lower results.
Five main players continue to dominate the Brazilian banking sector: Itau Unibanco Holding S.A., Banco do Brasil S.A, Caixa Economica Federal, Banco Bradesco S.A., and Banco Santander (Brasil) S.A., which have a combined market share of 72% in terms of loans as of September 2019, while Brazilian commercial banks hold 79% of total assets (see chart 2) and 78% of net income (see chart 3). The Brazilian universal banking model, with its one-stop shopping strategy, including consumer finance, insurance, and asset management, has so far protected major banks from competition from fintech companies that offer a narrow set of products or focus on a niche market. However, banks need to adapt swiftly to digital banking, given that a younger generation is more open to the technological changes. To be successful, such a model implies that customers remain loyal and satisfied with the quality of services and depth of products and services that financial services companies offer. If so, clients won't be drawn to disruptive players. Large incumbents benefit from generally well-entrenched retail franchises, which they acquired after decades of operations throughout the country.
The Brazilian banking sector embarked on the digital transformation process over seven years ago. One main reason was to reduce the cost structure of major banks. Shortly afterwards, the other reason was the need to offset the weaker revenue from corporate loans and increasing provisions during Brazil's 2015-2016 recession, leading banks to focus on efficiency (see chart 4). Thanks to the banks' sound business diversification and margins, they have been able to withstand the deep economic slump and remain profitable. Chart 5 highlights the resilience of Brazilian banks' profitability; return on average assets (ROAA) remains stronger than of the peer group. As such, banks have been, and will continue to do so, investing in technology even amid the increasing competition. Therefore, we consider the disruption risk of the industry to be low, in the same category as for Sweden's banking sector, even though technological capabilities of banks in the latter country are stronger due to their much earlier adoption.
However, the digitalization of Brazil's banks intensified in the past three years amid efforts to improve the operational efficiencies and to insulate themselves from competition from fintechs, and as regulatory measures enabled new players to enter the market. The transformation is evident in the increasing number of transactions performed through internet and mobile phones, along with the sharp reduction of number of branches (see chart 6). According to the most recent data from the largest Brazilian banks, more than 80% of total transactions occur online or through smartphones.
Since their entry into the Brazilian market, some digital disruptors have begun to take market share from the incumbent universal banks, particularly in payment services and consumer finance. This has been facilitated by low switching costs and user-friendly and convenient applications. So far, fintechs in Brazil have focused on serving customers that banks have shied away from, or on products that previously were burdened with the perception of poor service quality or excessive fees, such as credit card processing services to small businesses, credit cards without fees, the brokerage business, or investment platforms.
We consider that in the short to medium term, large banks can compete by replicating the product offerings and services that e-banks offer, while collaborating or partnering with fintech firms. After largely skirting major damage from the country's recent economic crisis, incumbent banks have demonstrated their ability to cope with challenges and continue to dominate the industry.
Regulations: Disruption Risk | High
We consider that a supportive regulatory framework has prompted this emerging slice of the sector to boom, fostering competition. The Brazilian central bank (known by its Portuguese acronym of BACEN) has made substantial progress through a number of initiatives to reduce the cost of credit and widen access to the financial system, given Brazil's lower credit-to-GDP ratio than of global peers (see chart 7).
In 2013, BACEN implemented regulations to establish non-discriminatory treatment of participants in relation to payment arrangements, enabling merchants to choose the institutions for the deposit of funds, along with the mechanisms for protecting their receivables. The changes allowed non-banks to operate in the payments space without the need to interact with a bank.
In 2018, BACEN introduced regulations to allow fintech companies to broaden their product offerings by allowing them to extend credit directly to borrowers without the intermediation of banks. Moreover, upstart financial firms with a narrow range of products and low complexity have lighter regulatory requirements than traditional banks, in line with the segmentation approach for prudential regulation implemented in January 2017.
In April 2019, BACEN has laid out plans for implementing the open banking model, which would allow the institutions to exchange and share customer data. Open banking will initially apply to the country's largest 12 banks. Subsequently, other institutions will be enrolled, at BACEN's discretion. BACEN expects to implement the open banking model in the second half of 2020.
In July 2019, BACEN and the National Monetary Council issued supplementary regulation regarding the Positive Credit Report (Cadastro Positivo in Portuguese) in order to create a more detailed risk profile. This initiative aims to shift from the negative-only credit risk information, such as payment delinquencies, to the automatic inclusion of all citizens' credit score and payment data in the Positive Credit Report. Anyone wishing to opt out could do so by making a request to the database managers. In October, BACEN authorized four companies--Boa Vista, Quod, Serasa, and SPC--to operate this pool of data. In November, banks began providing customer data to the four designated entities. In addition, retailers, public utility providers, fintechs, and other lenders will be able to provide bill-paying history to the database.
Regulation in Brazil has been so far friendly to digital disruptors. However, as they expand their operations and their client base surpasses 1 million, financing the further expansion could become an obstacle. This not only due to complying with additional regulatory, accounting, and reporting requirements, but also in securing funding and enhancing cyber security systems for more complex business operations.
Preference: Disruption Risk | High
We believe demand for digitalized banking in Brazil is rising primarily because of the convenient and speedy use of services, lower costs as opposed to the high fees that traditional banks charge, and the relatively low access to credit. Fintech firms are also benefiting from the relatively widespread ownership of smartphones and the "millennial factor", given that younger customers are more keen on digital banking solutions. According to the Instituto Brasileiro de Geografia e Estatistica - IBGE, about 25% of Brazil's population is between 20 and 34 years old, which creates significant demand for digital financial operations.
|Some examples of the success stories of digital finance in Brazil|
|Nubank||Since 2013, Nubank has been offering no-fee credit cards through its digital mobile platform amid increasing banking fees for retail customers. Nubank has shown outstanding client growth capacity compared to other finance companies operating in Brazil thanks to a successful branding strategy and high net promoter score levels. The company's client base has surged above 20 million at the end of 2019 from 6 million in 2018, which places it as the seventh-largest credit card provider, the largest non-bank lender in terms of total assets, and is one of the top 50 financial institutions in Brazil. In 2017, Nubank launched its proprietary loyalty rewards program (Nubank Rewards), as well as a digital account (NuConta), which more than 10 million clients use. Last year, the company began offering personal loans and took its first steps to expand its operations outside the country, opening offices in Mexico and Argentina.|
|XP Investimentos||XP Investimentos deeply influenced investment activity in the Brazilian market since it started operating. The company started as an independent brokerage firm by offering classes on investments in stocks and bonds, along with its brokerage services. According to its listing filing to the U.S. Securities and Exchange Commission, its assets under management totaled R$350 billion ($84 billion) at the end of September 2019 as a result of a 90% annual growth in the previous five years. The company's activities include asset management, insurance broker, and since 2019, banking operations. In 2017, Itau Unibanco Holding S.A. acquired a 49.9% stake in the company, and the latter is planning to launch its IPO on the Nasdaq stock exchange.|
|Banco Inter||Banco Inter is a niche bank that shifted its operations to online. Banco Inter ended 2019 with more than 4 million customers (annual growth of 180%), which has widened its geographic diversification, increased the number of transactions and product range on its platform, and reduced its borrowing costs. After its IPO and SoftBank Group Corp.'s purchase of a minority stake, Banco Inter launched its new smartphone app that offers more than 60 e-commerce networks in addition to its financial services. The multi-functionality mirrors Alibaba’s app that's widely used in China and elsewhere in Asia.|
|Next||Brazil's second-largest bank, Banco Bradesco, launched a digital bank, Next, in 2017. Its business model is based on creating value for the customer, instead of hard selling products. Many traditional banking products feature on Next's platform, but they have been rebranded as “objectives”, along with service offerings such payments for transportation and food delivery through third parties. The bank also offers discounts for other types of services on its platform. The bank expects to reach 3 million customers by December 2020.|
|Big Tech||In Brazil, Big Techs’ financial services account for a small slice of the industry. However, investments in the financial units of these companies are rising rapidly, especially among large e-commerce platforms and digital service providers. This is starkly different from peer countries, such as China where Big Tech is driving the fintech revolution.|
|Regardless of the segment in which they operate, global and regional technological companies are entering in the Brazilian financial market. For instance, the Argentine company, Mercado Libre currently has about 33% of Brazil's e-commerce market. Growth prospects of its financial services subsidiary, Mercado Pago, are higher than for the parent's retail business. The unit started out offering services such as digital wallet, QR code, and credit cards, but it's planning to expand to investments, lending, and insurance. Moreover, other digital service providers such as Uber, Rappi, and iFood, are also looking into partnerships and other ways to offer financial services to their increasing customer base in the region.|
Technology: Disruption Risk | Moderate
We don't view technology as the main risk for Brazilian banks because it's generally available to all banks, but the speed of implementation varies and creates a divide between adopters and laggards, especially due to traditional banks' legacy IT systems. New players will have a competitive edge for years to come thanks to much lighter and agile systems, in our view. However, large banks are more experienced in dealing with fraud and cyber security risks than fintech startups. Moreover, given that the banking industry has been one of the most profitable ones in Brazil, it has had the capacity to invest in technology to keep up with the advances, and overhaul business models to meet new customers' preferences.
According to the U.N.'s Global Digital Access Index, which measures the overall ability of individuals in a particular country to access and use new information and communications technology, Brazil ranks 56th of 157 countries. The U.N. indicates that the use of digital technologies by individuals and corporations is relatively widespread in Brazil.
According to the World Economic Forum's Global Competitiveness Report 2018, Brazil ranks 72nd out of 140 countries (see chart 8). The ranking incorporates the analysis of the following factors: human capital, agility, resilience, and innovation. Based on this analysis, Brazil is the leader in Latin America in the innovation capability but remains below its potential. This is because of insufficient integration of policies and coordination between the public and private sectors.
Technological Disruption Poses A Moderate Risk To Credit Quality
Overall, we view a limited threat of disruption among major Brazilian banks in the short term, aside from the ongoing need to invest in technology amid rising competition that's weighing on bottom-line results. We believe large banks' embrace of new technological platforms, superior capacity to invest, and the universal banking model will help preserve their dominant market share. However, smaller banks will find increasingly difficult to keep up with these trends. In the medium term, we expect competition to intensify and profitability to fall until the benefits from cost reduction through digitalization level off. This will likely lead to further consolidation among the struggling banks and fintechs. Our ratings on Brazilian banks already capture the challenges ahead.
- The Future Of Banking: Will Retail Banks Trip Over Tech Disruption?, May 14, 2019
- Tech Disruption In Retail Banking: China's Banks Are Playing Catch-Up To Big Tech, May 14, 2019
- Tech Disruption In Retail Banking: German Banks Have Little Time For Digital Catch-Up, May 14, 2019
- Tech Disruption In Retail Banking: France’s Universal Banking Model Presents A Risk, May 14, 2019
- Tech Disruption In Retail Banking: Swedish Consumers Dig Digital--And Banks Deliver, May 14, 2019
- The Future Of Banking: Research By S&P Global Ratings, May 14, 2019
- Fintechs Step On The Gas As Brazil Unveils Open Banking, May 8, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Cynthia Cohen Freue, Buenos Aires +54 (11) 4891-2161;|
|Secondary Contact:||Rafael Janequine, Sao Paulo (55) 11-3039-9786;|
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