Neobanks won’t solve LATAMs problems
Deep dive into why neobanks can’t be the only answer.
In Latin America, approximately 70% of the population over the age of 15 are unbanked or underbanked. Historically, opening a bank account in LATAM has been a challenging process where you face complicated requirements. You need a proof of employment, citizenship, and other financial paperwork to qualify for an account. Unfortunately, in some cases you need to fall into the top 20% income bracket to access financial products (debit/credit card) which include an unattractive set of hidden fees that target the poor [A]. This draws stark contrast with that of the United States where you can simply walk in, open an account and deposit that same day.
In my discussion with a Latin American entrepreneur from Mexico, Cesar Salas from Midas Technologies, I learned that in places like Mexico, there is a “sense of classism”. Certain types of information, like financial literacy, is excluded from the public and reserved for the top 18%. These people who fall in the top 18–20% are those who have a paper trail or a well-documented financial history. Those are the customers that Neobanks have been acquiring. Not the unbanked.
The figure above from 2016 shows that the target customer for fintechs are mostly the underbanked rather than the unbanked.
Problems facing Neobanks
- Market saturation — There are probably 12–13 neobanks currently targeting the LATAM region. Only 18% of the Mexican population uses a debit card. For credit card, its 9%. So neobanks are saturating a market of 18%. Its a very finite amount of consumers that already have these cards. Questions that arise: Out of the customers they have acquired, how many have previously held a bank account in the past? Do these customers have multiple accounts at different neobanking platforms (Albo, Nubank, Cuenca, Bnext, Rappipay, Fondeadora, etc.)? How do they interact with the platform and with their cards?
- Informality + lack of trust + culture = High CAC — Fintechs already face a high acquisition cost due to incumbent banks having a strong relationship with their customers. For US banks it costs on average, $500 to acquire a customer. LTV is $250 per customer + per product offer. It’s essential for a bank to cross-sell you into other financial products like lending, mortgage, credit card, etc. That is how they make a profit at the end of the day. For neobanks entering the LATAM region, there is no doubt that the customer acquisition cost is going to be higher. The reality is that the Latin American people in these informal markets appreciate cash more than any other form of payment. Since the start of the pandemic, cash usage has increased, not decreased. In Mexico, the amount of banknotes and coins in circulation has grown by 18.5% despite the expectation of the economy to contract by roughly 8% [B, C]. It doesn’t particularly matter where you could be shopping, whether rich or poor areas, people still prefer cash. Its common in LATAM to try an stretch that final dollar by going to 3–4 stores before purchasing, to see where you can get an item the cheapest. This type of informal negotiation between the buyer and seller can only happen in a cash-based economy. Its really hard to change that aspect of their lives. It is a part of the culture and tradition. This is something that investors and neobanks fail to understand about the informal market.
- Merchants still prefer cash — 92% of merchants don’t accept cards. Most neobanks are unable to issue credit products. They are overly reliant on debit card interchange fees for revenue. Debit cards generate much lower interchange fees than credit cards. It’s not enough for fintechs to make money off of interchange fees. Frequent and consistent debit/credit card use is vital to the success of neobanks. Which cannot happen in an informal market where merchants prefer cash over card.
- Onboarding friction — One of the questions that has gone on to plague my mind with doubts for neobanking is, “How do customers deposit their cash into their new accounts?”. After doing some quick research, I found that besides conducting a wire transfer, depositing cash is an option for users but it comes with a price. Users have the option of going to a selected self-service store (7-Eleven & Oxxo) and paying a fee anywhere between $10-$20. Is that something that people are willing to do? How far is the nearest self-service store? These questions are deeply connected to the idea of neobanks serving the 18% that already have a bank account to transfer money from. Once again, that 18% is not considered unbanked. Let’s do a brief case study: In china, Wechat is a big deal. China is the country with the most unbanked (224 million adults). They love to use cash. People can look at Wechat as a success story or you can look at it as something that has not really moved the needle. The only way to activate your Wechat wallet or Alipay wallet is to open a Chinese bank account [D]. The users that are activating these mobile wallets are the same people with bank account to begin with. There is still a heavy reliance on the local government banks to get people who are unbanked to start banking. The first step to the financial inclusion strategy should be to get every individual into a unique ID network. A digital identity system would allow for the replacement of multiple ID documents, tax compliance, and the satisfaction of KYC requirements [E].
What’s Next?
Neobanks and other fintech platforms need to take a minute and re-evaluate what needs to happen to reach that final goal of financial inclusion. We need to stop investing in more accessible versions of old ideas for effectively the same price to the same consumer. Business models need to be thoroughly questioned. Both Monzo and Starling bank have recently announced that they would being charging fees for certain services that they had previously offered for free. Monzo has opened 4.4 million accounts but lost over $152 million in 2019 [F]. Startups will need to establish profitable revenue streams from their account holders.
Trust is the most valuable currency that this market holds. As we see these technological advances, we must be weary of the cybersecurity risk that comes with it. There will be a huge increase in online banking fraud which can only harm the progress towards trust in these mobile platforms and institutions. With debit card fees being extremely low, “neobanks will need a very high ratio of transaction volume to fraud claims in order to recover fully the cost of the investigation and resolution of fraud claims” [F].
I think the focus of entrepreneurs and investors need to be on the infrastructure, trust, and education part of the financial inclusion journey. We need POS systems for merchants, anti-fraud protection, a digital identity network, alternative credit risk models, etc. Financial inclusion won’t happen overnight, but with the right minds and resources, we can finally formalize that unbanked sector in Latin America that represents an estimated $34 billion.
Pre-seed Shoutout
Midas is a solution that I believe truly tackles the problem of informality in LATAM. MIDAS is a platform that gives users an added value to their cash purchases by generating “MIDAS” loyalty points which can later be traded for more products or services. Through this process, they collect consumer information and trends, developing a clear “cash consumer” profile. Through their data engine, they are able to provide key insights on the “cash consumer” for producers and retailers, and start providing financial services to the cash (informal) consumers.
REFERENCES & FURTHER READING
[A] — Nathan Lustig, “An overview of neobanks in Latin America”, Fintech Futures, September 2018
[B] —Enrique Quintana, “In Mexico, we like money…cash”, El Financiero, December 2020
[C] — Noe Torres, “Bank of America sees Mexico economy contracting 8% in 2020”, Reuters, April 2020
[D] — Josh Summers, “How to Add money to Wechat (Domestic & International)”, Travel China Cheaper, November 2020
[E] — Carlos Cantú and Bárbara Ulloa, “The Dawn of fintech in Latin America: landscape, prospects and challenges”, Bank for International Settlements, November 2020
[F] — Cyril Lalo, “Have Neobanks lost their DNA?”, Finextra, December 2020
