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Tech Disruption In Retail Banking: Financial Inclusion In Mexico Will Remain Low Despite Digitalization


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Tech Disruption In Retail Banking: Financial Inclusion In Mexico Will Remain Low Despite Digitalization


Mexican banks, in general, have kept their risk appetites in check when it comes to retail banking: Their focus has been on middle- and high-income customers, as well as large corporations and small and midsize enterprises with better credit quality. This conservative approach is a response to obstacles such as Mexico's large informal sector, which strongly prefers cash transactions; a high level of income inequality; and the country's inefficient rule of law. All of this means that access to banking services in Mexico is low relative to the access that exists in peer countries throughout Latin America and the emerging markets.

The COVID-19 pandemic marked a turning point for Mexican banks--both in terms of the sector's digitalization and in terms of customer preferences, which are evolving toward digital banking solutions. However, none of this has led to structural improvements to the public's access to banking services. In addition, while bank clients seem to be open to using digital financial solutions, they still show a greater preference for traditional banks because of concerns about fraud and identity theft.

Ultimately, S&P Global Ratings believes that Mexico's large banks are outpacing smaller players in the digital race. Large banks' strong presence in the country, well-diversified business and funding profiles, and sound profitability enable them to invest in their digital infrastructure to cope with tech disruption. On the other hand, small and medium-size banks have a lower base of business, revenue, and funding diversification, and they're currently facing earnings pressure amid high interest rates. As a result, they're struggling to make the digital investments that are needed. The digitalization of banking could open the door to future consolidation within the sector.

In our view, the risk of a change to the Mexican banking sector's competitive dynamics from the emergence of new disruptive players (like fintech companies) is limited. We don't believe fintechs represent a real threat to banks; rather, we expect bank-fintech collaboration to persist. And while competition among banks will intensify through technological innovation, there's little overlap between banks' target customers and those of fintechs, which mostly serve the unbanked sector of the population. That said, if neobanks (fintechs seeking to become regulated entities) truly penetrate the market, they could be more of a threat since they'll bring additional competition in certain business segments.

Our TRIP Analysis Shows That Mexican Banks Face Low Risk From Tech Disruption

We base our current view of Mexican banks' risk of disruption on our four-factor analysis of the banking system's technology, regulation, industry, and preferences (TRIP; see chart 1). In our opinion, the risk of disruption for Mexican commercial banks is relatively limited in the medium term.

Chart 1


Preferences: Disruption Risk | Low

Improving responsiveness to customer needs is a key challenge

The original sin of Mexico's commercial banks has been the Mexican public's low level of access to their services. Today, total credit to GDP is stabilizing at 40%--a low figure relative to the ratios that its Latin American and emerging market peers have achieved (see chart 2)--and the low level of access to banking services hasn't improved even with the implementation of new technologies in the financial sector. This is because of Mexico's large informal workforce, which strongly prefers cash transactions; a high level of income disparity; and its weak rule of law, which makes it difficult for banks to recover collateral.

The commercial banks that do serve retail customers have focused on those with good debt payment capacity--basically, the middle- and high-income sectors of the population. While these clients seem to be open to using digital financial solutions, they still show a greater preference for traditional banks because of concerns about fraud and identity theft, which have increased as artificial intelligence and new technologies have become more widespread. In our view, fintechs are putting more sectors in touch with financial services, but their participation is small.

Chart 2


We see acceptance of emerging technologies among clients of Mexico's traditional banks. Because customers are relying on faster, more efficient channels to carry out their banking transactions, we expect that adoption of new technologies will pick up in coming years. In addition, we think that Mexico's demographics will keep supporting the spread of digital banking solutions (see chart 3). We estimate that about 52% of Mexico's population of 129 million people is between ages 15 and 50, and in our view, this segment of the population is more open to technological change. In fact, around 80% of the people in this group already use the internet. Likewise, many of the most common retail banking transactions--such as money transfers, balance inquiries, and payments of services--are processed through digital platforms.

Chart 3


But while digital transactions are gaining ground in Mexico, cash remains king. The strong preference for cash transactions within Mexico's large informal labor market--estimated to be about 55% of the labor force--explains the low level of financial inclusion in the country, and we don't think the digitalization of the financial sector will change much on that front. According to Mexico's central bank, more than 80% of the population used cash as their main means of payment in 2022. And around 40% of all transactions in Mexico's economy are in cash--significantly above Thailand's 34% and Brazil's 26%.

We view this as a double-edged sword for Mexico's banking sector. On one hand, we believe the clients it serves wouldn't want to migrate to nonbank or fintech competitors, leading to a lower risk of disruption. But on the other hand, the growth potential of new clients will continue to be limited in the future, and the low level of access to banking products will persist.

Chart 4


Chart 5


We also think the digitalization of the Mexican banking sector won't cut into banks' broad base of branches. Branches will continue to be a key tool for deepening product offerings to their captive customers and gaining access to new ones (see chart 6). In addition, banks also need branches to bring customers from rural sectors--which account for more than 20% of the total population--into the financial sector. Therefore, we expect that branches will continue to coexist with digital solutions, even as they grow at a slower pace.

Chart 6


Industry: Disruption Risk | Low

Mexican banks are in good shape to develop digital infrastructure

The Mexican banking sector is well positioned to deal with the emergence of fintechs. It's dominated by the country's seven largest commercial banks, which together have about 80% market share by loans and deposits. This concentration, stringent regulations, and the partnerships among large and medium banks for sharing infrastructure (such as ATMs) will continue to be significant barriers for new entrants, including potential disruptors. Moreover, the banking sector's sound profitability--reflected in the above-average net interest margins in Mexico relative to other emerging markets, as well as in adequate efficiency levels--will allow banks to keep developing their digital capabilities. In contrast, fintechs (which mainly focus on offering lending and payment solutions) will continue to struggle with funding access amid tight financing conditions, and they will reduce their operating expense structures to make their businesses more efficient and profitable.

Chart 7


Digital strategies are becoming increasingly relevant in the banking sector, and the adoption of financial technology will improve banks' long-term business and financial profiles. While competition from fintech start-ups could threaten the profitability of existing financial institutions, we think commercial banks and fintechs will continue to be collaborators, instead of becoming rivals. The mix of commercial banks' and fintech companies' strengths could offset their respective weaknesses and result in a deeper, more efficient financial system. In our opinion, fintechs that want to compete head-on with banks will need a banking license to level the playing field, but regulatory costs will be a limitation for many of those players.

In Mexico, foreign-owned banks are leading the banking sector's digital transformation. In our view, the scope and depth of a bank's technology investments depend on ownership and size. Large foreign-owned banks are developing new business strategies to adapt to customer needs and new digital standards, and they're taking advantage of the knowledge they acquire globally and the technological infrastructure that their parent companies are developing. Large domestic players are closely following their footsteps in the digital race.

Chart 8


In general, these are the digital trends and strategies we're seeing:

  • Some banks are requesting new banking licenses to operate their own digital banks. We think that, in the future, these banks will apply what they learn from their digital banks to their traditional bank structures. One of the main challenges they would have to face, however, is to avoid competing with themselves.
  • Other players have decided to operate their digital business as an additional unit. These banks seek to take advantage of their current infrastructure (ATMs, alliances with convenience stores for payments, etc.), as well as their brands and their large customer bases.
  • Some fintechs are seeking to become regulated entities--either banks or other kinds of entities. These fintechs are also known as neobanks. This would allow them to access core customer deposits and compete with banks in the lending business, improving their generally weak earnings profiles. The few players that are in this category could, as a result, conquer certain market segments and compete with universal banks in those segments while capitalizing on their competitive advantages (such as user-friendly applications, or their ability to use customer data and provide tailor-made solutions to clients at competitive prices).
  • Some retailers are creating their own fintechs. It's highly likely that they'll request banking licenses to develop these business units.
  • Tech enterprises that are collaborating with banks are doing so through joint ventures, providing solutions that strengthen banks' business structures.

Chart 9


So far, big tech companies haven't represented a real threat to Mexican banks. This is because of domestic regulations aimed at preserving stability in the banking sector, preventing big tech companies from pushing into traditional lending and deposit-taking. These companies have accumulated significant amounts of data on clients and have established global brands that would win customers' trust, so they have the potential to achieve scale easily. Looking forward, they could seek alliances with large and midsize players in Mexico, similar to what has happened in other jurisdictions.

Small niche banks may face a higher risk of disruption from the digital transformation of the banking sector. This is because of their small scale, high business concentration relative to that of larger players, and squeezed profitability that leaves little room for them to invest in technology at the pace that digital evolution and customer needs demand. This puts significant pressure on their funding costs, especially in a time of high interest rates, as they're generally dependent on wholesale funding. Because of all of this, banking digitalization could open the door for future consolidation in the banking sector.

Regulation: Disruption Risk | Low

Stringent regulations limit competition from innovative emerging players

The fintech sector has a clear regulatory framework through the Fintech Law. Mexico's finance ministry, central bank, and banking regulator enforce the country's Fintech Law, which provides legal certainty about the sector (for customers, investors, and other market participants) and helps fight money laundering and fraud. In our view, regulatory requirements related to the Fintech Law represent barriers to entry that should discourage disruptions that could affect Mexico's financial stability. Since the Fintech Law was enacted, we've only seen a small number of new fintech start-ups request licenses, reflecting how regulation can weigh on these companies. The growth rate of new start-ups in Mexico has slowed, and other countries now see Mexico in the rear-view mirror.

We think fintechs that want to compete head-on with banks will sooner or later end up operating under different parts of the law, or even applying for banking licenses, in an effort to level the playing field. However, heavy regulatory costs will limit new entrants. Currently, just about 10% of all fintechs based in Mexico are regulated by the Fintech Law.

Mexico was a pioneer in fintech regulation, but now it's moving slower than its peers. There are initiatives to implement more technological innovations in the financial sector, but there are also bottlenecks that don't allow technological advancement to keep up with advancements in other countries. In our opinion, Mexico's financial authorities have sought to support the fintech sector's development, but these efforts have been carried out in a controlled and cautious manner, to preserve financial stability and avoid disruptions to banks.

The central bank has taken a cautious approach toward cryptocurrencies. As of today, they're not considered legal currency, and so they're not backed by the federal government or the central bank. While regulators don't expressly prohibit the use of cryptocurrency (it is legally possible to use them), both the finance ministry and CONDUSEF (Mexico's National Commission for the Protection and Defense of Users of Financial Services) have repeatedly warned the public about the risks associated with virtual assets, such as high volatility and possible monetary losses. Moreover, they've made it clear there's no guarantee that consumers or businesses that acquire this type of asset can recover their money.

Mexican financial authorities' awareness of cyber risks is increasing. The central bank is promoting actions that will allow Mexican banks to strengthen their awareness of, and capacity to respond to, cyberattacks. These risks, along with fraud and identity theft, which have increased as AI and new technologies have become more widespread, affect customers' confidence in adopting digital banking solutions.

Chart 10


Technology: Disruption Risk | Moderate

Large banks' tech capabilities limit the risk of disruption and strengthen competitiveness

Fintechs are breaking paradigms by adapting and rapidly reacting to customers' needs through innovative technologies such as application programming interfaces (APIs), big data, cloud, and AI. Even if fintechs don't represent an immediate risk to the banking sector, traditional banks haven't ignored their strengths, and so they're adopting and implementing these new technologies. By doing this, they're improving their long-term competitiveness. We expect this trend to persist in coming years.

Still, the Mexican banking sector is divided between early adopters of new technology and laggards. The largest banks have the financial capacity to upgrade their tech infrastructure. Furthermore, large foreign-owned banks benefit from their parent companies' knowledge and experience digitalizing subsidiaries in other countries and regions. Smaller players, on the other hand, are more exposed to technological disruptions and competition from new players.

Chart 11


When it comes to technology, fintechs are becoming a relevant ally for banks. We've seen several examples of bank-fintech collaboration--through acquisitions, joint ventures, or even outsourcing services--aimed at boosting banks' business capacity through new digital solutions. We believe these types of collaboration are win-win situations, as they combine the entities' strengths. Such collaborations take the best of both--fintechs have sound expertise in technology and innovation, while traditional banks have large-scale customer databases with information going back years--putting them in a stronger position to compete.

For instance, we've seen banks invest in fintechs that provide payment solutions. This has allowed these banks to obtain information about the cash flows of potential clients who are currently unbanked, which gives the banks greater visibility into their ability to pay. This way, they gain access to new clients while limiting the credit risk they're willing to assume.

Mexico's financial authorities--along with the country's banks--are making efforts to improve digital banking conditions. In September 2019, the central bank launched CoDi (Cobro Digital), a real-time e-payments system, with the aim of discouraging Mexicans from using cash and bringing more customers into the financial system. Today, CoDi is still struggling for relevance, and it hasn't been as successful as its Brazilian counterpart, PIX, which was launched more than a year later (see chart 12). Currently, just 2% of Mexicans use CoDi, while 65% of Brazilians use PIX.

Part of why CoDi has had a lackluster adoption rate is because it requires a bank account, and as of 2021, only 49% of Mexican adults had one. And many bank account holders would withdraw cash soon after receiving some, reflecting the extensive use of cash as a day-to-day means of payment. Another reason for CoDi's low adoption is its lack of interoperability. In Brazil, about 800 firms offer PIX, including banks, fintechs, and government institutions; in contrast, CoDi is limited to just 35 registered banks (about 70% of the total number of banks in the system).

Chart 12


During the first quarter of this year, the central bank implemented a new digital payment service, Dinero Móvil (DiMo). It allows for the transfer of money to other people just by entering their phone number. This new solution takes advantage of mobile phone penetration in Mexico--about 80% of the population has a mobile phone--and it promotes transactions away from cash payments. However, there is a downside that DiMo shares with CoDi: For DiMo to work, the 10-digit phone number must be linked to a bank account. This is why we believe future adoption of this tool won't be a game changer in the market over the next 12-18 months.

Mexico's Large Banks Are Well Positioned To Face The Risk Of Technological Disruption

In our opinion, investing in financial technology is necessary for Mexican banks to support their business and financial profiles; failing to adopt these innovations will result in a loss of customers and an erosion of bottom-line results due to pressure on noninterest expenses. This also means that a failure on this front could hurt a bank's creditworthiness and pressure issuer credit ratings. Eventually, smaller domestic banks that fall behind or can't cope with costly IT investments could be more vulnerable to rating downgrades if it compromises their business franchises, stability, or financial results.

We believe that the risk of technological disruption for Mexican banks is limited compared with the risk faced by financial institutions in other emerging markets--such as Brazil and Thailand--where fintechs are rapidly gaining market relevance. Meanwhile, fintechs in Mexico will continue to struggle with funding access amid tight financing conditions and will reduce their operating expense structures to make their businesses more efficient and profitable. For these reasons, we expect that banks and fintechs will continue to collaborate in coming years.

In several emerging market countries, the digitalization of financial systems has helped to promote financial inclusion. But in Mexico, we do not expect a significant or structural change. Mexico's large informal sector (which strongly prefers the use of cash), income disparities, and weak rule of law will limit the extent to which financial services reach more sectors of the population. Only structural change in this regard could change our perspective.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Alfredo E Calvo, Mexico City + 52 55 5081 4436;
Secondary Contacts:Juanjaime R Romero, Mexico City +52 5550814441;
Andrea Limon, Mexico City;

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