There have been three open questions hanging over the Mexican banking system since Nubank entered in 2021 and started offering high interest-bearing deposit accounts in a bid to win new customers as its way to acquire clients.
Will offering high interest rates on deposits work, in terms of adding clients, for challengers? More importantly, will such a strategy work in terms of creating a profitable business? And, lastly, will such a strategy from the new entrants require the traditional banks to react, increasing the cost of funding for these institutions to the point of lowering returns on equity?
A recent report from Citi looks at this issue from the perspective of the last question: to what extent Mexican banks are having to increase interest rates on their deposit base.
As the report’s authors concede, it is still an opaque issue, and more time will be needed before we know the answers to these questions with any certainty, but the early signs for the traditional banks are better than is often assumed. So far, the interest rates being paid by Mexican banks for demand deposits – about half of the total funding of the banking system – haven’t increased.
Relationships
According to central bank data, there has been little change to the interest rates offered by incumbents. One of the main reasons for the surprising stability of interest rates for deposits paid by the incumbents is the multi-product relationships that exist in the system. These banks existing relationships – and mortgages are a large proportion of the retail credit portfolio – lower client portability in the face of single-product pricing advantages. Also, the domination of time deposits (they represent some 50% of total deposits in the Mexican banking system) lowers interest rate sensitivity as they have low correlation with interest rates
If anything, it is the new banks – those digital platforms and fintechs – that are blinking first. Citi says: “High sustainability of high remuneration rates as customer acquisition costs (CAC) could be challenging, with some modifications already visible”.
According to its authors, the cohort of digital entrants covered in the Citi report (Nubank, Uala and Klar) have begun to lower their interest rates or make restrictive changes to the rules that govern which deposits qualify for interest.
Nubank – by far the biggest challenger bank trying to win market share through paying interest rates on deposits – continues to add clients; it has now surpassed seven million customers in the country, but it is still unprofitable (it lost $28 million in Mexico in the last quarter).
And for all Nubank’s claims that the deposit-paying strategy adds quality customers – after all only liquid individuals are attracted to deposit income – their own statistics don’t back this up. The average annual income of Nubank’s clients in Mexico is just $5,200, while its non-performing loans pushed up to 7% from 6.7% in the last quarter, which doesn’t negate the ‘adverse-selection’ challenge that new entrants face: that credit demand comes from individuals who may not have been able to secure credit elsewhere – for good reason.
Advantage incumbents?
It seems that the incumbents still have strong pricing power, but it is too early to say this won’t be eroded in the coming quarters and years.
To get a better sense of the future, Citi’s report looks for parallels in the Brazilian banking system, which has been seeing this type of deposit account-led competition for many years.
In Brazil, digital startups have been growing large client bases since 2015: Nubank is a dominant disruptor in that market with a similar client acquisition strategy. However, much of this growth came from the previously unbanked sector, as the startups still only have a combined market share of deposits of 2%. Indeed, all the large incumbents except for the public banks (Caixa and Banco do Brasil) have seen their market shares of deposits increase of the last few years.
Meanwhile, the funding costs for the large Brazilian banks have followed the Selic rate closely during decade – at an average of 115% of CDI, showing little upward pressure on funding costs and, therefore, no impact on profitability.
It is too early to understand the full competitive impact of the new digital banks that are using interest-bearing deposit accounts to win business. However, as the war for clients intensifies in Mexico – both the short- and longer-term signs are surprisingly positive for the incumbents' ability to maintain market share and profitability.
