Banks: The digital shakeup

When Juan Parma talks about banking, it’s almost like he’s running a fintech. Agility, efficiency and customer-friendly technology is the future of banks, says the Mexico City-based head of retail banking and wealth management at HSBC for Latin America.

The advance of fintechs combined with the COVID-19 pandemic has sped up this transformation, much like e-commerce with retail. 

In just seven years, Brazil’s Nubank has become one of the world’s largest digital banks with more than 25 million customers. C6 Bank and Neon, also in Brazil, Peru’s InterBank and others are also growing with low-cost products in a market of expensive financial services. The competition is forcing the incumbents to ramp up their digital offerings as the health crisis cuts traffic in branches.

“I need to sound like a fintech. I don't have a choice,” says Parma. “We need to learn from them how to be more agile, how to be more customer-centric and how to use technology better. This business is — and will be even more so into the future — a business of people and technology.” 

The rise of digital banking is striking. In 2020, HSBC's digital transactions surged 75% and its number of mobile banking users shot up 61%, year on year. “We have progressed in a year what would have taken us from three to five years if we were to have continued at the pace before the pandemic,” Parma says. 

More than 40 million people in Latin America and the Caribbean — 6.1% of the 656 million total population — opened their first account during five months of the pandemic, according to a survey by Americas Market Intelligence, a research firm. Online banking shot up to 56% of the banked population from 48% before the outbreak. Of those surveyed, 64% say online banking has become a lasting habit, the firm found. The surge included newcomers opening accounts for e-commerce or to receive financial aid during the crisis.

But how have the banks fared financially? Historically, Latin America has been the world’s most profitable banking market thanks to high fee revenue and interest rates plus steady demand from a young and growing population in a region with a low penetration of financial services (55% of adults had accounts in 2017, according to the latest World Bank data). Banking revenue before the cost of risk expanded at a compound annual growth rate of 12% in constant 2017 exchange rates between 2012 and 2017. That is six percentage points more than the global average, according to McKinsey, a consulting firm.

A setback is that the banks are expensive to operate. Large workforces, powerful unions, extensive branches and toilsome back-office processes have kept their efficiency ratios “very low” compared with Europe and the US, says Jonathan Whittle at Quona Capital, a Washington, DC-based venture capital firm that invests in fintechs.

Until the past few years, high net interest margins and fee income covered up for “a multitude of sins,” he says. But now “the era of making easy money by buying government bonds is over.” 

A focus on efficiency

Banks are trimming costs as fintechs encroach and regulators cut interest rates to increase financial inclusion and reduce the cost of credit, a key for long-term economic development. In Brazil, the region’s largest economy, the benchmark rate has tumbled to 2% from 14.25% in 2016.

To contend, banks built up reserves as a buffer. But a potential second wave of the pandemic and an uneven recovery could fuel loan defaults in 2021 when governments have already used much of their fiscal space for economic stimulus, warns Cynthia Cohen Freue, a Buenos Aires-based financial services director at S&P Global Ratings.

In response, she says banks are looking for low-risk opportunities for growth. A highlight has been investment banking. Businesses have tapped banks to raise financing on the capital markets or to restructure debts, taking advantage of the low interest rates to boost liquidity and reduce financing costs. Brazil, for example, has seen a flurry of IPOs and follow-on offers as investors look for higher yields, while in much of the rest of the region businesses have stepped up bond sales and refinancing deals, including sovereigns and sub-sovereigns.

Ernesto Torres Cantú, CEO of Citi Latin America, says demand for credit surged at the start of the pandemic as companies built up liquidity as a “precaution” in the face of what could happen. Now with more clarity on prevention measures and vaccines, companies have been reducing what they amassed and are starting to look for opportunities for growth through acquisitions or investments. This is reviving demand for credit, he says. 

The retail challenge

The bigger challenge is in retail banking, a focus for many fintechs that with their lean operations can offer low-cost products to compete against banks in niche segments like credit cards, lending and payments.

In response, banks are closing branches and stepping up investment in new technology. Brazil’s Itaú Unibanco, the biggest bank in Latin America by total assets, has upgraded its apps and digital platforms almost daily during the pandemic. That is in contrast to the previous months-long timelines for upgrades so clients can renegotiate loans and unlock pin codes online instead of in a branch, says Renato Lulia, its head of investor relations and market intelligence. The result was a surge in account openings to 650,000 in the second quarter when branches were closed from a previous average of 250,000 per quarter. The pace held at 500,000 in the third quarter even as branches reopened, a sign of the demand for digital banking, he says. 

Itaú has also invested in Cubo, an accelerator, co-working and engagement center for startups, and Kinea, a venture capital fund. Bradesco, a competitor in Brazil, has created Inovabra, a venture fund for innovation. In Mexico, Banregio has opened Hey Banco, a digital bank, while Banorte has teamed up with Rappi to offer financial services over the Colombia-based courier service’s app, including a Rappi-branded credit card.

More partnerships are expected.

“Over the last five years, maybe 10 years, we’ve moved from a situation where banks were dinosaurs that would become extinct to banks now being a necessary part of the value chain,” HSBC’s Parma says. “Banks have learned that we need to collaborate with fintechs for better customer journeys and things that we are not as good at as they are. And fintechs have learned that they don’t want to play with the burden of regulations that banks have and will continue to have.”

For banks, this means using technology to handle simple transactions so their staff can devote more time to value-added activities, such as advice for complex investment products, Parma says.

Room for growth

There is room for banks and fintechs to grow in the region, which is still low in credit penetration and heavy in cash. 

Technology and regulatory changes have brought down the cost of acquiring clients, such as by issuing an online debit card in a few minutes instead of printing and sending a physical one to a home. This has made it viable to not only increase financial inclusion and e-commerce, which underpins long-term economic growth, but also provide the additional products such as credit, insurance and mutual funds that make incorporating new clients profitable, Torres Cantú says.

“If you are not able to take this to more products that satisfy the needs of the clients beyond the transactional account, it is difficult for this to be business,” he says.

The fintechs, of course, are vying for the same business. While most are still burning through cash to build scale and become profitable, their wiriness gives them a competitive advantage over banks, which are saddled with physical infrastructure and legacy systems that often can’t be adapted quickly.

“It’s not about whether you can compete, but whether you can adapt your structure to this new reality, a reality where you don’t need thousands of people working in bank offices anymore,” says Sergio Furio, founder and CEO of Creditas, a Brazil-based platform for low-cost collateralized loans. “It’s a fight of those who are more innovative and agile and have lower cost structures versus those who have millions of clients.

“The doubt is who is going to be faster to grow,” he says. “Will the incumbent banks be able to innovate and eliminate 80% of their branches or will the fintechs grow first?”

The competition has led to an argument that maybe banks can buy the fintechs to gain their talent and technology.

Furio doesn’t think it will play out that way. For one thing, some fintechs may not be willing to sell as they plan their own IPOs for growth and fear that banks will stifle their entrepreneurial flare.

Instead, he expects an increase in the disruption of the banks by outsiders. MercadoLibre, an e-commerce platform, has expanded into financial services. Amazon, Apple, Facebook and Google are doing the same for new revenue streams. Creditas has expanded into a real estate service, the sale of electronics and solutions for human resources departments.

“Instead of being a financial company, we are a company of solutions for our clients,” says Furio. “The question now is what are the banks going to do. Are they going to continue with financial services at low margins or move into new verticals?”

Not all are so certain that digital technology will bring about the demise of banks as some may have forecast.

At Citi, Torres Cantú says an advantage that banks have over fintechs is the regulation that protects deposits from failure, a key for savers’ peace of mind and the health of any economy. The challenge for banks, he says, is to become more integrated in clients’ everyday lives as “seamless pipes” to move the money they safeguard for them.

Fintechs may also shy away from becoming full-sale banks because of the regulatory burden, preferring instead to collaborate with banks, HSBC’s Parma says. But what remains to be seen is which will lead in providing customer service. “The critical part is where you will end up in the value chain,” he says.

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