Mexico’s Fintech Moment Has Arrived
This is the second in a series of articles that we will publish on Financial Inclusion (see our first article, which focused on the United States, here). In this article, we focus on financial inclusion in Mexico, which we see as a microcosm of the developing world’s underbanked population. Despite a young population, high levels of smartphone penetration, and internet connectivity, over 30% of the Mexican population lacks formal banking products. However, we believe Mexico is at an inflection point as both consumer and SMB consumption patterns shift towards digital in light of the COVID-19 pandemic. We see Mexico as a new hotspot for neobank and fintech activity, as both homegrown and global fintech companies compete to offer financial services to the largest unbanked population in the Americas.
The world made incremental progress in financial inclusion during the last decade. According to the World Bank, 69% of adults globally — 3.8 billion people — had an account at either a bank or mobile money provider as of 2017. This was up quite significantly from just 51% in 2011. An increase in mobile adoption and internet access, coupled with an uninterrupted economic recovery from the 2008/2009 global financial crisis, were among the drivers of this progress.
Despite that progress and significant innovation in financial technology, over 30% of the world’s population remains excluded from the formal financial system. Moreover, gaps between rich and poor, women and men, urban and rural communities, remain strikingly wide. The COVID-19 pandemic is magnifying these gaps across the world as it disproportionately impacts vulnerable populations with a lack of financial reserves and/or limited access to health care.
The World Bank estimates that the pandemic and related economic shutdowns could push between 70 million and 100 million into extreme poverty. This threatens the progress the world has made in financial inclusion as poverty remains the most important leading indicator of a household’s banking status across the world.
Mexico as a Microcosm for the Developing World’s Unbanked
In this report, we focus on financial inclusion in Mexico, which we see as a microcosm of the challenges and opportunities the developing world faces with financial inclusion. A large low-income population, high levels of inequality, a thriving informal sector that is dependent on cash transactions, and a relatively weak formal financial system are all contributors to the global unbanked population. These are all challenges that Mexico struggles with.
In many respects, we are surprised that Mexico has largely flown under the radar for many global fintechs/Venture Capital investors focused on financial services for the underbanked. We believe this will change as successful neobanks/fintechs from India, Brazil and the US look to expand into Mexico. In addition, we expect to see several domestic fintech start-ups successfully scale over the next decade addressing several multi-billion dollar gaps in banking, insurance, home ownership and more.
Below we highlight some of the key factors that make Mexico a representation of the challenges with financial inclusion in the developing world.
(1) Financial Inclusion Remains Elusive for Over 30% of Mexico’s Population
The World Bank estimates that half of the 1.7 billion adults are living without access to a formal financial account and are largely concentrated in seven world economies, including Mexico. Based on the Findex Database, Mexico has the 7th largest underbanked market in the world and the largest in Latin America.
Figure 1: Nearly half of all underbanked adults live in just seven economies
Percentage of the World’s Underbanked by country (2017)
In Mexico, 32% of the adult population (ages 18–70) is unbanked, which is coincidentally in-line with the percentage of the global adult population that is unbanked (31%). While the Mexican population with at least one account at a traditional financial institution increased by two million people from 2015 to 2018, the percentage of underbanked individuals actually remained flat.
Figure 2: Mexico population aged 18 to 70 and its percentage of those who have a financial product, 2015 and 2018
Financial inclusion is an issue across the entire spectrum of core financial service products in Mexico. According to Mexico’s National Survey of Financial Inclusion (ENIF):
- Only 47% of the population has a formal bank account
- Only 40% of the population has a retirement savings account
- Only 31% of the population has a credit card
- Only 25% of the population has an insurance product
Figure 3: Percent of Mexico Adults with Formal Financial Products
(2) Poverty is the Main Indicator of Underbanked Status in Mexico
Poverty is perhaps the single most important driver for the underbanked population across the world. According to the World Bank, the lowest quintiles represent more than twice as many unbanked households as the highest quintiles. This is true even of high-income countries with relatively large numbers of underbanked individuals, such as the US. This gap, however, is much wider in the developing world than in high-income countries.
Figure 4: Poverty-stricken adults are less likely than wealthier ones to have a bank account
Percent of Adults with a bank account (2017)
Not having enough money is the most cited reason for unbanked status across both the developed world and developing world. Legacy bank infrastructure and business practices make formal bank accounts prohibitively expensive for poor households who can’t maintain minimum balances. The lack of access to these formal financial services, moreover, make it difficult for these families to lift themselves out of poverty.
Figure 5: Key reasons for not having a bank account (%,2017)
Poverty is also a key driver for the unbanked population in Mexico, where poor communities over-index in the unbanked population. In Mexico, the poorest quintile is more than 2X more likely to be unbanked than the richest quintile, similar to the global average.
Figure 6: In Mexico, the only group where the majority has a bank account is the richest quintile
In addition, Mexico has wide gaps in account ownership between rural and urban communities. This gap is on average 15 percentage points across all core financial products and 12 points in a traditional bank account (again, in line with the 13% gap we see between rich and poor across the world).
Figure 7: Mexico rural communities are significantly less likely to have core financial services products than the urban population
Percentage of adults that have a core financial services product (rural vs. urban, 2018)
Source; ENIF, 2018
(3) Youth and Women Are Overrepresented in the Underbanked Population
Young individuals are also disproportionately underbanked across the world. Nearly one-third of the world’s underbanked are between the ages of 15 and 24. These individuals are likely to be out of the workforce or early in their careers with lower earnings power. In developing economies, moreover, there is generally less availability for family-based accounts or accounts tailored for young students/professionals.
Figure 8: Three in 10 unbanked adults are between the ages of 15 and 24
Adults without an account by age group (%,2017)
As in most of the developing world, the penetration numbers are much lower for Mexican women and youth. The penetration rate for individuals 15 years and older are nearly 10% points lower across all core financial products (bank account, insurance, credit, retirement account) compared to the adult population. With respect to a formal banking system, Mexico has one of the lowest penetration for youth in Latin America and worldwide. Only 37% of Mexico’s population ages 15 years or older have a formal banking account.
Figure 9: Percentage of people 15 years and over with a banking account
In addition to youth, women are disproportionately unbanked. According to the World Bank Findex, women are 1.3X more likely to be unbanked than men. This gap somewhat narrowed over the last decade in high-income economies. In developing economies, however, this gap has sustained over time. According to the World Bank, 56% of the world’s unbanked are women, 12 percentage points higher than men.
Figure 10: Gender gaps in account ownership have persisted over time.
Adults with an account (%)
Similarly in Mexico, women are more likely to be excluded from the formal financial system. Only 63% of women ages 18 and over have at least one core financial product, compared to 72% of adult men. This nine percentage point spread, moreover, has remained consistent over the last decade. Only México City has achieved parity in account ownership, though most regions still show a gap in account ownership between women and men.
Figure 11: Women continue to trail men in account ownership across most Mexican regions
Percentage of population from 18 to 70 year with a financial product by region and gender
(4) Large Informal Sector Contributes to Cash dependency
Many countries in the developing world have a thriving informal sector, which represents a sizable share of their GDP. This informal sector runs mostly on cash, which makes it very difficult to track flows and payments. This in turn, makes it difficult for banks to access credit risk for both individuals and businesses that engage in cash based transactions.
The informal sector is a particularly stark challenge for Mexico. Over 25% of Mexico’s GDP is derived from the informal sector. In addition, around 57% of the country’s workers are employed under informal arrangements, which can lead to a higher dependence on cash, lower employee benefits and lack of important employee protections. A large informal sector in Mexico’s economy is one of the leading reasons why Mexico’s economy is dependent on cash. As a result, only 35% of businesses in Mexico accept card payments.
Figure 12: Percentage of businesses that accept card payments, by sector
According to the Dallas Federal Reserve Bank, cash made up 93% of Mexico’s transactions, well below the levels in Canada and the US. This is a key reason why traditional financial services fail the majority of the population in Mexico. The use of cash makes it difficult to track payment and income data and create risk assessment scores that drive traditional credit underwriting models. Without a steady record of wages and payments, many individuals and SMBs are unable to build up traditional sources of credit.
Figure 13: Cashless payments in Mexico, the U.S., and Canada
(5) Banking sector has little incentive to cater to low-income segment
Like much of the developing world, the banking system in Mexico has quite a turbulent history, including a period of nationalization in the early 1980s and a currency crisis in 1994 that threatened systematic failure (for more history, read here). Today, Mexico’s banking sector is dominated by large foreign bank giants, which injected the necessary capital in order to dampen the effect of the “peso crisis”. But the combination of a consolidated banking sector and weak contract enforcement have limited the availability of credit in the marketplace to the mid-to-high income segments. The top foreign banks are actively providing consumer and housing loans where the credit is backed by collateral. Business credit is more readily available for the enterprise segment of the market, leaving a large gap in SMB lending.
Figure 14: Portfolio concentration of the 5 banks with the highest balance, compared to the total portfolio of commercial banks
The general lack of competition enables the Mexican banking sector to be very profitable catering to the high-networth individuals and enterprises. The general fees, commission structures and high interest rates, make the formal banking sector prohibitively expensive for low income individuals. In addition, there is very little incentive for the traditional banking sector to create products for the low-income/unbanked segment, particularly in rural communities which lacks a lot of the traditional retail banking infrastructure found in urban areas.
According to the CNBV (Mexico’s banking authority), there are only 0.66 ATMs per 10,000 residents in rural areas, compared to 2.7 ATMs per 10,000 residents in urban areas. This is a major barrier for customers, as according to the World Bank Findex, 21% of unbanked individuals say they do not have an account due to poor financial infrastructure. Despite a gradual improvement in banking infrastructure over the last several years, 75% of small rural municipalities lack a bank branch or ATM.
Figure 15: Percentage of rural municipalities (with less than 5,000 residents) with at least 1 bank branch, or ATM
(6) Remittances Are A Fundamental Lifeline for the Most Vulnerable
Remittances are a critical source of funding for some of the most vulnerable populations in developing economies. According to the World Economic Forum, in 2019 low and middle income countries (LMICs) received a record $554 billion, which exceeded the amount of Foreign Direct Investment these same countries received as a whole. These remittances are important to economic development in receiving countries because they (a) are usually directed to the most vulnerable, low-income households and (b) could potentially offer some protection against economic shocks/recessions.
Figure 16: An estimated US$551 billion in remittances were sent to low-and middle-income countries in 2019 (US$ billions)
Remittances are a particularly important source of funding for millions of families in Mexico. Based on World Bank data, $39 billion are sent to 10 million families annually. Over 90% of that remittance volume comes from the United States. This is due to a large migrant worker population of 11M+ in the United States that caused explosive growth in remittances over the last few decades. As a result, Mexico is the third largest remittance recipient, receiving half the amount that India and China receive, despite having 1/10th the total population of those countries.
Figure 17: Top-10 remittance- receiving countries in 2018 (billion U.S.dollars)
There is a mixed view on how remittances can help smooth the economic cycles for receiving countries. Some academic research suggests that remittances can be a countercyclical stabilizer in economic downturns as remittances help diversify the financial structure of these countries. Others believe that as recessionary pressures impact migrant workers in “sending” countries, a reduction in remittances can have a compounding impact on receiving countries. In 2009, for example, worldwide remittances fell by 12%, following the 2008 financial crisis.
In early April, the World Bank put out an alarming prediction on remittances, estimating sharpest decline of remittances in recent history. Globally, remittances were expected to drop by 20% in 2020 as the migrant workers suffered from unemployment and falling wages. In Latin America, remittances were expected to fall by 19% in 2020.
However, the results thus far indicate that remittances to the region have not only held up during the COVID-19 pandemic, but have actually reached historic levels. In the month of March, remittances to Mexico exceeded $4 billion, despite the commencement of government mandated lockdowns and resulting unemployment. Through the month of June, migrant workers sent over $19 billion to Mexico, a 10% YoY increase. The fact that the US dollar strengthened significantly (20%+) relative to the Mexican Peso in that same time period, certainly helped. At any rate, this influx of foreign capital certainly provided a lifeline for millions of Mexican residents at a time when the home economy virtually shut down for a period of time due to COVID 19.
Figure 18: Total Remittances to Mexico from January to June Increased Amid COVID-19 Pandemic
Mexico Lags Much of the Developing World in Digital Financial Services…
The percentage of adults with a formal financial account has improved since the Great Recession, jumping from 50% in 2011 to nearly 70% in 2017. And this improvement likely persisted through 2019. Much of this progress came from the formal financial sector, according to the Global Findex Database. This was the case in both high-income economies and developing economies alike.
However, developing economies also saw a gradual impact from mobile accounts, particularly towards the latter half of the decade. By 2017, nearly 5% of adults with accounts in developing economies had a mobile money account.
Figure 19: Financial institution accounts have fueled the growth in account ownership since 2011, but mobile played an important role in developing economies
Adults with an account (%)
The role of digital payments also intensified over the course of the decade. In 2017, at least 50% of all adults with a financial account used it to make or receive digital payments (including P2P transactions, bill payments or other transactions). The growth of digital payments increased significantly in developing economies. In 2014, 25% of adults with accounts in developing economies had participated in a digital transaction. By 2017, that number was 40%. We believe this growth trend continued into 2019.
Figure 20: Percentage of account holders who made or received a digital payment
Surprisingly, Mexico has lagged in adoption of digital payments and mobile banking. Less than a third of the country has made or received a digital payment, according to the World Bank Findex. This ranks the country behind other major economies in Latin America. Even within the banked population, only about 22% regularly use mobile banking services provided by their financial institution.
Figure 21: People 15 and older who made or received digital payments
… But Mexico Has the Right Ingredients for Digital Financial Services
What makes Mexico’s lack of progress in mobile money is the fact that the country has the right ingredients for mobile financial services to flourish. Here, we summarize some of these key ingredients:
(1) Widespread Smartphone Adoption. Mexico’s smartphone adoption has ticked up significantly in the last 10 years, reaching near ubiquity across the country. The combination of lower priced smartphones entering the country as well as the high availability of retail credit (a point we discuss further below) has allowed consumers to buy smartphones with installment payments. According to GSMA, 63% of the population has access to a smartphone and that share is expected to increase to 70% by 2025.
Figure 22: Smartphone ownership in Mexico steadily increasing (percent of population)
(2) Improving Connectivity Rates. Internet connectivity in Mexico has improved gradually, making it one of the countries with highest fixed internet penetration in Latin America. There is ample room for improvement, particularly outside of the major cities (such as Mexico City, Guadalajara and Monterrey). However, we note that 63% of smartphone owners have access to 3G or 4G connectivity, critical for any digital financial services application to succeed.
Figure 23: Penetration of fixed internet access service per 100 households
(3) Young, Tech Savvy Demographic. The median age in Mexico is 28 and 45% of the population is between the ages of 25 and 54 years old. This population is more prone to adopt digital products and services in their personal lives and — given that 50% of the workforce are millennials — more prone to adopt technology in the workplace as well.
Figure 24: Mexico Demographic Composition
(4) Fintech Investment Reaching A Tipping Point
According to Ernst & Young (EY), Mexico’s unbanked market represents the most attractive opportunity for fintechs and VC investors in Latin America. EY’s research finds that Mexico’s banking system could generate as much as $7.6 billion in annual revenues by developing new products and regulations that promote financial inclusion.
This has piqued the interest of both fintech entrepreneurs. As a result, both fintech entrepreneurs and VC investor interest is piqued. With over 400 fintech start-ups, Mexico is now an epicenter of fintech innovation in Latin America. The number of Mexico-based fintech start-ups has grown at an average rate of 23% since 2016. Digital banking and insurtech focused start-ups, moreover, are far outpacing other areas of fintech.
According to Finnovista, over two-thirds of Mexico fintech companies have raised over $800 million total in equity and debt capital. We note that most of that investment is concentrated in just a handful of companies. There are only 10 Mexico fintech companies that have raised $10M or more in equity capital. That said, most of this funding has occurred in the last 2–3 years and we expect this momentum in funding to continue building post COVID-19.
How Fintech Can Increase Financial Inclusion in Mexico
Mexico’s leading challenger banks have a long way to go before scaling to the size of the three “unicorn” neobanks in the Latin America region (Nubank, Uala and Neon). But we believe that one of the unintended consequences of the COVID-19 pandemic is that it will accelerate the adoption of digital financial services. As we discussed in a previous note, on Digital B2B Payments in Latin America, over 63 million people (50% of the population) are now shopping online and are expected to drive online ecommerce by over 20% YoY in 2020. Many of these consumers are shopping online for everything from groceries to online banking for the first time. We expect the majority of consumers to continue using digital banking post the pandemic, particularly as banks begin to reign in credit in light of the uncertain economic backdrop.
Figure 25: Products and Services Bought Online for First Time During the Pandemic
Well funded, nimble fintechs have a window of opportunity to acquire new customers. But this is also a golden chance to launch solutions for the most vulnerable, including low-income, youth, women and rural communities. Currently, Mexico’s fintechs are mostly concentrated in catering to clients in metropolitan cities — such as Mexico City, Guadalajara and Monterrey. While it makes sense to focus on these cities given the population size, these markets also tend to have a higher proportion of middle-income users and are extremely competitive. According to Finnovista, two-thirds of Mexican fintech start-ups are based in Mexico City.
As we await to see a continued surge in fintech activity in Mexico, we are particularly excited to see how creative fintech companies address the challenges of financial inclusion across core financial products. Given the complex structure of the Mexico market, there are several strategies that fintechs should consider employing in order to bend the curve on the underbanked population in the coming years, including:
(1) Strategic partnerships with current providers of alternative financial services to the underbanked. One interesting approach that fintechs can employ is to partner with some of the large providers of alternative financial services to the underbanked population. In Mexico, for example, providers of store credit are the de facto credit provider for the underbanked that can’t access formal credit cards from banking institutions.
According to Mexico’s National Survey of Financial Inclusion (ENIF), over 60% of adults have used retailer-issued credit. This is nearly twice as much as the population with a bank credit card. These products play an important role for low-income and middle-income households, facilitating their purchases of a variety of big ticket items from furniture to smartphones to vehicles.
These providers of financial services companies are continuously looking for ways to increase their importance to the financial lives of their customers. The top providers of retail store credit have branched out into formal banking in order to bridge their customers into formal banking products. Their financial services offerings now include checking accounts, credit cards, insurance and remittances. But they can benefit from the agility, product and user experience know-how of fintechs.
In addition, large insurance carriers and brokers are looking for ways to grow their business by tapping into roughly 70% of the population without an insurance product. As we previously wrote in an article on Mexico’s Auto Insurance Market, insurance companies are increasingly shifting their distribution strategy from a traditional retail agent distribution channel to digital acquisition channels. This has opened the door wide open for a variety of B2B and B2B2C solutions in insurtech as well.
(2) Partnerships with providers of small business loans and productivity tools. In Mexico, small businesses account for over 70% of employees. However, the majority of Mexico’s SMBs are neglected by the formal banking system given the high degree of informality, cash dependence and — as a consequence — lack of a reliable business credit score system. In recent years, several small business lending startups have successfully raised capital and scaled the number of SME clients. However, we believe that there is also a significant untapped opportunity for partnerships in SME Lending. Banks, institutional lenders and fintechs alike are looking for alternative credit risk models to widen their reach in the SMB market. Larger lenders in particular could leverage low-cost funding/deposit base but do not have credit underwriting models relevant for SMBs.
In addition, companies that help SMBs automate their payments, payroll, accounting and other areas are strong partners for both banks and fintech start-ups looking to offer financial services tools to these SMBs. The data these service providers acquire can be leveraged to customize financial service solutions and/or underwrite credit products.
(3) Creative Approaches to Remittances. Given how critical remittances are to the low-income and rural populations in Mexico, we are excited to see how fintech startups leverage these US to Mexico money transfers as a bridge to provide more financial services for the unbanked. In addition, as we noted in our prior article on the US underbanked market, Latinx individuals are overrepresented in the US underbanked population. Over 60% of these Latinx individuals are of Mexican descent and are responsible for the $36 billion in remittances sent to Mexico.
Fintech startups have an opportunity to leverage digital payments and banking to further bridge these populations beyond just remittances. Successful models thus far have enabled digital remittances, which have cut fees, increased speed in delivery of funds and enhanced security. Other models enable cross-border bill payments, where US senders can pay bills for their families in receiving countries directly. But these models generally require the US based sender to have a bank account, which is not the case for a large percentage of this consumer.
Open banking platforms have predominantly powered banking solutions in domestic markets. However, as these enablers of financial services innovation move across borders, we believe it will open the doors for more fintechs to operate in multiple countries. We thus foresee fintechs having banking clients in both the US and Mexico, solving similar gaps in underbanked populations on both sides of the border.
We believe the next wave of innovative remittance companies will leverage digital remittances to address a variety of issues for the unbanked in Mexico, including insurance, real estate and education. In insurance for example, we envision models where US residents can purchase auto, health or life insurance for their family in Mexico. We also envision models where US residents can seamlessly finance property purchases in Mexico, helping their families circumvent the relative lack of home mortgage loans.
There are just some of the many use cases we can come up with that can bridge the underbanked populations in both US and Mexico. And we are excited to partner with founders creating these solutions over the next several years.
Mexico’s Fintech Moment Has Arrived
We expect COVID-19 to push more households into poverty across the developing world as the pandemic results in job loss and/or wage decreases for millions. The World Bank estimates that as many as 70 million to 100 million will be pushed into extreme poverty in the developing world. Given that poverty is the leading indicator of unbanked status globally, this will all but ensure that the number of underbanked individuals rise sharply.
On the other hand, the pandemic is also notably accelerating the digitization of payments, commerce and financial services. Across the world, millions of individuals are flocking to digital payments and commerce, many for the first time, as businesses were shut down. This shift in consumer behavior has opened a window of opportunity for mobile money providers that can potentially gain share of wallet as more consumers are pushed out of the formal banking system.
This represents an interesting inflection point for fintech in Mexico, which has struggled to reduce its underbanked population. Mexico’s banking system has failed to address the challenge of financial inclusion for years. But over time the country has amassed interesting demographic and market factors that bode well for adoption of digital financial services. The COVID-19 pandemic has already forcedforce a large part of the population to adopt more products and services digitally, perhaps sparking a trend that can finally make a dent on a thriving cash economy. This is a big moment for fintechs in Mexico and for VCs that support them.