If you shop online in Mexico today, chances are that when you go to the checkout there will be a box that says Kueski Pay – a buy-now-pay-later service that is enabling even customers without a bank account to purchase goods over the internet. In doing so, it is expanding e-commerce services to segments of the population that were previously excluded from making digital payments while also giving them access to legitimate sources of credit.
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Kueski is one of hundreds of fintech startups in Latin America that are using technology to provide financial services to previously underserved or entirely unbanked segments of the population. According to venture development firm Finnovista, 36% of fintech startups in the region offer products that are targeted towards people who are totally or partially excluded from the financial system.
The app, Kueski Pay, enables customers to make purchases with more than 2,000 online retailers and 700 stores in Mexico, including brands such as Mobo, Calvin Klein and budget airline Viva Aerobus. Customers can spread the debt over either six fortnightly payments interest free or eight to 12 fortnightly payments with interest. For those without a bank account, repayments can be made in cash at Mexican chain store Oxxo or any business that accepts NetPay.
Roughly 12% of Kueski Pay’s users are likely to be unbanked, based on those who make cash payments, says Krishna Venkatraman, chief data officer at Kueski.
Across Latin America, the number outside the financial system is around 45%, according to the World Bank’s last big study in 2017. Part of the reason for the lack of banking penetration in the region is that it is expensive for banks to serve low-income populations, particularly in rural locations.
“The banking industry has traditionally been based around channels that have a quite heavy cost base – branches and things like that,” says Huw Davies, co-founder and chief commercial officer of UK fintech Ozone, which is working with banks in Brazil to help implement open-banking technology. “For big organizations, it is sometimes quite hard to serve those marginal customers, not just because of the much higher cost base but also because they may not necessarily have the expertise or the risk appetite.”
We’re not hampered by legacy systems, so we have the advantage of a fresh start
It is not only a case of banks being reluctant to serve certain markets. For the 45% of Latin America’s adult population who are unbanked, more than half (52%) cite cost as the chief reason for not having a bank account, followed by a lack of trust (29%), the distance from their nearest branch (27%) and a lack of appropriate documentation (25%), World Bank data shows.
“All of those are higher than we observe in other regions,” says Douglas Randall, financial sector specialist in the World Bank’s finance, competitiveness and innovation global practice. “That is indicating that the traditional model of financial services in Latin America is too expensive, not sufficiently convenient and not engendering trust in the population. So there’s certainly scope for some disruption and innovation and improvement and the need for a more diverse set of customer-centric financial products.”
Fintechs are well placed to do that because they are not weighed down by archaic infrastructure like many traditional banks.
“We’re not hampered by legacy systems, so we have the advantage of a fresh start,” says Venkatraman. “Product innovation is consumer centric, and we have the domain knowledge around credit risks and fraud risks. So that expertise is blended with product and technology, and that is hard for banks to match.”
He also argues that fintechs have an advantage over traditional big-tech firms such as Google or Amazon because, while they excel at technology and have strong customer-centric thinking, they don’t yet have sufficient financial domain expertise.
“What they lack is an understanding of how lending actually works at scale and have that incorporated into their DNA. So because of all of these factors, that is why fintech is probably best positioned to address this huge gap and drive financial inclusion,” Venkatraman says.
Another advantage fintechs have is that they can focus on one particular pain point without the cost overheads of trying to provide universal banking services.
“Fintechs can be quite efficient at targeting a specific market and doing it with lower costs; the barrier of that bottom line of who can get served comes down,” says Davies.
Payments potential
Fintech has the potential to reach previously untapped market segments in Latin America because the population has relatively high adoption rates for technology. In Mexico, for example, more than 50% of the unbanked population has a mobile phone, according to the World Bank.
“Latin America is one of the heaviest users in terms of social media globally – more so than Asian markets like China – and internet penetration is very high,” says Andres Fontao, co-founder and managing partner of Finnovista. "So there’s no question that those segments of the population that do not have access to formal financial services do have access to an internet connection and technologies that will allow them to connect."
Pandemic push
The use of digital financial products accelerated during the Covid-19 pandemic, not least because government support programmes often needed to be distributed digitally through a bank account. In South America, for instance, somewhere around 100 million bank accounts were created during the pandemic, says Diego Herrera at the Inter-American Development Bank (IDB). A large proportion of those were digital-only.
“Many of those people could not previously access financial accounts, essentially because of physical requirements – a lack of physical access but also lack of identification,” says Herrera. “In some cases, they were excluded simply because they thought they didn’t need a bank.”
In Colombia, microfinance institution Bancamía attempted to solve this problem by going door to door and opening savings accounts for more than 135,000 unbanked Colombians so they could deposit the government’s Ingreso Solidario pandemic subsidy and then spend or withdraw it using the bank’s mobile app, says Gabriela Eguidazu, innovation for inclusive growth director at the BBVA Microfinance Foundation, which has a stake in Bancamía.
Likewise in the Dominican Republic, Banco Adopem helped funnel government aid to more than 3,100 previously unbanked entrepreneurs and independent workers who had to give up trading because of lockdown measures, says Eguidazu.
Against that backdrop, the IDB has been working with governments across the region to help them develop policies that foster either the creation or the growth of the fintech ecosystem. For example, the IDB worked with Chile on its fintech bill, which is currently going through congress, that will underpin open finance in the country.
The bank has also been supporting governments in Central America and the Caribbean with the development of innovation hubs in the Dominican Republic, El Salvador and most recently Costa Rica.
Other countries in the region are also adopting new fintech regulations and other digital financial infrastructure.
In Brazil, the central bank introduced an instant payment system called Pix to enable faster transactions. Mexico has introduced a fintech law, while Ecuador is debating similar legislation, says Douglas Randall, financial sector specialist at the World Bank.
Some market watchers believe the fastest potential route to reducing financial exclusion is by broadening digital payment options outside traditional banking channels.
“Payments is opening the door for every person who needs to be financially included,” says Diego Herrera, financial markets lead specialist at the Inter-American Development Bank (IDB). “Out of the 2,482 fintech platforms that we have in the region, about a quarter are related to payments and remittances.”
Latin American governments are clearly incentivized to drive growth in payments platforms because of the potential to reduce informality and boost the tax base. Almost 60% of workers in Latin America and the Caribbean are active in the informal economy, according to OECD data.
“Informality is a phenomenon that affects a significant proportion of Latin America’s population and of developing countries in general,” says Giovanni di Plácido, analysis and research director at BBVA’s Microfinance Foundation. "Although causality is not always easy to ascertain, the evidence indicates that informality is lower in those countries where financial inclusion is higher."
Yet boosting financial inclusion is not only about reducing informality, it is also about helping to alleviate poverty in the region. Some 32% of Latin Americans live in poverty, according to the Economic Commission for Latin America and the Caribbean; almost 14% are classed as in extreme poverty.
“Some of the best evidence on the impacts of financial inclusion through digital financial services and fintech is the ability to which it helps poorer households to smooth consumption in reaction to income shocks,” says Randall, "whether it be from an economic-income shock, a climate-related income shock or a health-related income shock from the pandemic."
This is because fintech platforms have the ability to make it easier and faster to receive remittances not only from their families or social networks but also social transfers from governments, he says.
Those faster payments rails and broader digital payment innovations are likely to increase competition for the region’s banks, according to Fitch Ratings. It believes that central bank-sponsored payments systems such as Pix in Brazil should increase banking system access to underbanked populations.
Partnerships
Against that backdrop, many traditional banks are starting to increase the pace of their digitalization efforts by partnering with fintechs.
“One of the things we’ve seen in recent years is that big banks are really recognizing that they can move more quickly and innovate more effectively by partnering with fintechs,” says Davies. “If you’re in a really big bank, launching a new product can be a multi-year, multi-million pound initiative, but by partnering with fintechs in a smart way, you can get things out to market and test them and move far more quickly.”
Such partnerships are already growing. About 34% of fintechs are working in alliances or cooperation agreements with traditional banks in the region, according to IDB data.
“What we are seeing is ‘co-opetition’ – they are cooperating, but they are also competing for financial services demand,” says Herrera. “Banks are also changing the way they see fintechs. At first they saw them as potential competition flying below the regulations, but now, as many countries are creating fintech regulations, that view is changing.”
In five years it won’t all be solved, but the barrier will be lower and the next round of innovation will focus on how to bring the next tranche of unbanked into the financial system
Those alliances mean traditional institutions also now have the scope to compete for segments that were previously out of their reach, such as accounts for very small deposits and credit for micro and small and medium-sized enterprises, says Herrera.
Yet some of the challenges that prevented traditional banks reaching certain market segments are also inhibiting fintechs.
“Trust is the first thing,” says Fontao. “We’re dealing with segments of the population who still today believe that putting $100 under your mattress is probably safer and smarter than taking it to your local bank branch and depositing it so that it becomes some form of currency on your phone. Another big hurdle, more on the SME side than the consumer side, is informality – people who just want to avoid the tax system.”
For that to change, small businesses will need to see that the benefits of becoming formal – the potential for greater growth, for example – outweigh the advantages of remaining under the tax authority’s radar.
“The possibility of obtaining access to formal credit and financial services could induce informal workers and entrepreneurs to formalize if they perceive that formal financial services will make their activities more profitable,” says di Plácido.
While tech adoption in Latin America is relatively high, there is still a large proportion of unbanked populations who are not digitally savvy and lack formal education.
“As a result, products need to be incredibly user friendly and tailored, depending on the consumer,” says Brendan Jones, chief commercial officer at regtech company Konsentus. “The first challenge is providing access to financial services, but the second and arguably more important challenge is making these services usable.”
Some parts of Latin America are also more financially underdeveloped than others, which will make it even harder to reach unbanked market segments.
“There are several central American countries where they need more innovation and more dynamism in their financial sectors,” says Randall. “Often it is the case that these countries have a larger share of poor populations, and the traditional business models of banks and microfinance institutions and the cooperatives are just not able to work.”
That lack of infrastructure and smaller market size means those countries are also unlikely to be attractive to fintechs who are looking to expand outside their home territories, he says.
“They will have to rely more on domestically grown fintech industries, which is a medium-term proposition,” says Randall.
This generation will expect banking to be on their phone and be as easy to use as their TikTok or Twitter or whatever it might be
While fintech is unlikely to be a silver bullet that will reduce financial exclusion overnight, it should start shifting the needle in the right direction.
“It will gradually bring down the barriers of the cost to serve and the barriers around credit,” says Davies. “So in five years from now it won’t all be solved, but the barrier will be lower, and the next round of innovation will focus on how to bring the next tranche of unbanked into the financial system.”
One development that will likely drive faster financial inclusion is the emergence of embedded finance and the ability for any business to offer financial services and products through fintech.
“What we’ve seen in other parts of the world is embedding financial services in services that people are already using is probably the most promising path to wider adoption,” says Randall. “So, it might not be the case that a standalone financial technology company needs to build its brand recognition. If you look at what’s happening in China, financial services are embedded into e-commerce sites and social media sites.”
While Latin America doesn’t yet have anything to rival Alipay or WeChat Pay, e-commerce platforms such as Rappi and Mercado Libre are already embedding financial services in their apps.
“They’re leveraging their large customer base – millions of clients, both on the consumer side but also on the merchant side – to offer them financial products, whether that is credit to merchants, salary advances to their drivers and payments and buy-now-pay-later solutions to their customer base,” says Fontao. “This is really going to help scratch beyond the surface and really make a dent in reducing financial exclusion.”
Demographics are also favourable. There are 106 million young people aged between 15 and 24 in Latin America and the Caribbean, 20% of the total population and the largest share of that age cohort in the region’s history, according to the UN.
“For those under the age of 25, their expectations of financial services are going to be much different than what they were for their parents and their grandparents,” says Fontao. “This generation will expect banking to be on their phone and be as easy to use as their TikTok or Twitter or whatever it might be. So 10 or 20 years in the future, consumers and businesses are going to be native to this – and, while financial exclusion won’t be fully eradicated, we will be in a much better position.”