Spotlight: Fintech business verticals in LAC

Financial services firms across Latin America and the Caribbean (LAC) have become acutely aware of the importance of fintechs and digital transformation, eager to stay on top of the game or at least keeping watch for major developments.

 "We are witnessing a revolution in the way in which people and business manage their financial matters", explains Gabriela Andrade, a specialist in financial markets at the Inter-American Development Bank (IDB) , in a study by the development bank and fintech research firm Finnovista released in June, titled Fintech: Innovations You Didn't Know Were From Latin America and the Caribbean.

"In addition to lowering costs by adopting digital channels, fintechs use different information sources and new techniques to assess clients, their behavior and risk, which enables companies to reach excluded segments in a more affordable way," reads the report.

The study noted that 703 fintech entrepreneurial projects have been identified in 15 LAC nations, and 90% of these are based in five countries: 230 in Brazil, 180 in Mexico, 84 in Colombia, 72 in Argentina and 65 in Chile.

It also described the LAC fintech ecosystem as filled by relative newcomers, noting that three of five fintech startups now operating in Latin America were established between 2014 and 2016.

An existential crisis for banks

Perhaps the most important development and most difficult to grasp, blockchain technology will play a crucial role in the digital reinvention of businesses and governments across the board. (Read: Blockchain: What it is and how it works)

Blockchain networks have the ability to track staggering amounts of financial transactions with perfect accuracy and transparency, while adding a layer of security to previous transaction blocks with the addition of every new block. The technology brings a new breed of security far safer than the traditional systems protecting most financial databases around the world – one that is perfect for carrying out proprietary person-to-person (P2P) contract implementations.

It also has the effect of decentralizing financial transactions, which poses an existential crisis for banks – why do people need them if they can handle their banking, acquire loans and choose investments safely and securely from anywhere in the world?

There is still time to make inroads. For example, there remains a massive lack of financial inclusion throughout LAC, as many people lack the resources and/or education to access the existing banking system, much less having the skills and gear to interact using the emerging technologies.

It will be key for banks and other financial institutions to bring the unbanked on board via a technology that is compatible with their business model. And ideally, they would have a hand in bringing that tech to market in the first place.

The team-up of IBM and BBVA Bancomer in Mexico announced in June to develop blockchain technology is one such effort to stay in the game.

Then again, if financial institutions do not act quickly, they may find themselves cut off from the many unbanked – particularly in younger, more tech-friendly demos, as the technologies being developed independently and outside of the region soon may open a more efficient, convenient path to inclusion that leaves existing firms on the sidelines.

The following are the key business verticals developing in the LAC fintech industry:

Cryptocurrencies: The development of blockchain technology came along with the birth of cryptocurrencies, being created to support Bitcoin – the most famous of the virtual currencies.

Bitcoins are 'mined' by completing calculations for public blockchains. Thus the currency is underpinned by what is known as the proof-of-work (PoW) concept.

Other cryptocurrencies have since emerged, including importantly the Ethereum network, spawning multiple variations on the PoW concept – usually changing what kind of data will form the blockchains to be mined as a central basis for the currency.

However, Ethereum (with its soon-to-be-launched Casper algorithm) and others are making a critical pivot towards the 'proof-of-stake' (PoS) concept. At the core of PoS is the notion that transactions that break from an agreed-upon set of standards – for example, operations that appear dishonest or could potentially damage or crash a market – are refused by the network through a sophisticated verification system.

The hope, naïve or not, behind PoS and blockchain is that Wall Street gremlins like dishonesty, market manipulation and insider or malicious trading could become things of the past.

Veritseum – built on the Ethereum network – is a rising star in finance circles.

One rising star in the PoS world are Veritas tokens. Their developer, Veritaseum, is a financial and consulting services firm that is working to develop a cryptocurrency catering to the financial services industry.

The firm raised eyebrows in May 2016 by enabling a hedge fund to trade P2P via blockchain, completely circumventing Wall Street banks and brokers and the fees they entail.

In recent months, the Jamaican stock exchange has begun working with Veritaseum to develop a special exchange platform for the tokens.

Nevertheless, there remain broad inconsistencies across the region in terms of regulations on cryptocurrencies, with most recent action involving warnings against transactions carried out via virtual currencies as unprotected by central banks, as recently occurred in the Dominican Republic. Bolivia has even gone so far as to declare such transactions illegal.

But banking authorities are clearly watching and looking to experiment, as was acknowledged by Mexico's central bank governor Agustín Carstens in April.

Robo-advisors & Personal Finance: These are applications meant to carry out tasks such as asset/fund management and consultancy, usually utilizing some form of finance-oriented artificial intelligence.

Beyond the obvious advantage of having a sophisticated AI with near-instant access to vast, rapidly changing financial data streaming from markets around the world every second of the day, robo-advisors may well be backed by PoS-driven blockchain technology offering reassurances to investors looking to cut down on commissions as well as avoid dishonest investment managers.

Perhaps the strongest example in LAC, Brazil's Magnetis charges a 0.40% consulting fee on invested funds, calculated annually.

According to the Finnovista study, the firm has only accrued between US$2-6mn after an initial US$3mn investment in 2015, and it looks to earn US$3mn in the next three years. The low financial profile of the firm exemplifies the relative ease of bringing such technologies online, and if proven to be successful, robo-advisors could give high-paid financial consultants a run for their money.

Regtech: Short for regulatory technology, this business vertical focuses on using technology to facilitate or improve regulatory monitoring, reporting and compliance.

"Addressing regulatory requirements is, in terms of cost and resources, one of the greatest burdens that financial institutions are bearing today, and it is becoming increasingly complex," said BBVA Research analysts Vanesa Casadas and Javier Sebastián In the report RegTech the new magic word in FinTech.

The complex nature of Latin America's hodge-podge of regulatory frameworks, many of which woefully need constitutional and structural reforms to be brought up to date, make regulatory technology particularly challenging in the region, and therefore potentially lucrative.

A technology that could help businesses open and modify their operations at the local, state, federal and even cross-border levels, could be a tremendous boon for business development in the region.

According to BBVA, "RegTech is an emerging trend, and there is neither a closed definition nor a track record for its potential benefits."

RegTech's promise is "to leverage existing systems and data to produce regulatory data and reporting in a cost-effective, flexible and timely manner without the risk of replacing/updating legacy systems," reads the BBVA report. "However, this is only a first step towards a more ambitious vision on data-led dynamic regulation."

Digital Banks: Attempting to adapt successful models such as Simple in the US or Number 26 in Europe to the LAC market, 100% digital banks with no brick-and-mortar branches have been opening across the region.

These include Afluenta in Argentina, Clip and Bankaool in Mexico, Kushki in Ecuador and Nubank in Brazil.

Opening a digital bank carries many of the problems any bank has wishing to enter a market, including regulatory approval that requires established liquidity requirements among a myriad of rules aimed at ensuring stability and consumer protection.

A dearth of physical locations to withdraw cash also requires developing relationships with traditional banks and ATM networks, creating additional costs for consumers. However, digital banks intrinsically require lower overheads, creating space for the firm to bring the savings to clients.

Their strictly digital nature also contends with the reality of millions of existing and potential customers that prefer to conduct business at brick-and-mortar locations or lack the technological resources to make the benefits of a digital bank worthwhile.

So far the experiments in Latin America have produced mixed financial results that have largely driven further adaptations to the marketplace, where success has mainly stemmed from (largely millennial) consumer interest in branch-free banking.

One of the largest, Nubank, reported a 122mn-real (US$39mn) loss in 2016, nearly four times the loss posted in 2015. Nevertheless, it still recorded US$77mn operating net income, seven times that earned in 2015.

As of April, it had more than a million cards in circulation and has received requests for roughly 9mn more.

Payments & Remittances

Integrated, efficient payment solutions account for most of the digital technology introduced and supported by traditional banking systems, giving clients the ability to access funds or credit online for e-commerce, make purchases at an ever-widening range of locations, as well as transfer funds between friends and family both locally and across borders in the form of remittances.

However, a growing number of startups are developing payment solution technology outside of the banks' internal incubators.

While apps to facilitated shared payment and EFTs largely focus on helping clients, technology is also facilitating business-to-business (B2B), business-to-client (B2C), client-to-client (C2C) and peer-to-peer (P2P) financial transactions, which has had a transformative impact for small businesses in a variety of ways, including reaching a wider range of clients, scaling business operations and enabling business to be carried out across significant distances, often at any time of the day, any day of the week.

One emerging LAC leader in the field is PayU. The firm, with headquarters in Colombia, Poland and India, operates in 133 countries, many in LAC. The company has found success in facilitating e-payments with a focus on MSMEs looking to expand their client base with a minimal overhead.

Alternative Finance: According to the study Harnessing the Fintech Revolution conducted by business consultancy Oliver Wyman and the Inter-American Investment Corporation (IIC), a member of the IDB group, substantial barriers to financing have created "a gap in finance for MSMEs in LAC that stands approximately at US$250bn."

"This gap is due to severe information asymmetries, the prevalence of informal business practices, high costs of underwriting relative to available margins, heterogeneity of the market, impediments to MSME growth and productivity, and regulatory constraints," notes the report.

This business vertical involves generating alternative financing via marketplace lending platforms (B2B, B2C, C2C, etc.) or even crowdfunding platforms, mechanisms that could help to close the MSME finance gap.

"The more that is known about alternative finance mechanisms and their effects, the greater our capacity to strengthen the supporting ecosystem in a way that allows the best possible financing options to emerge for MSMEs," the study says.

For LAC, marketplace/P2P business lending remained the largest alternative finance market segment with US$188.5mn registered in 2016, an increase of 239% over 2015, according to the Cambridge Centre for Alternative Finance's 2017 Americas alternative finance industry report.

The Cambridge study showed that in Canada, donation-based crowdfunding remained the top alternative finance model with US$105.9mn, but balance sheet business lending rose at a rate of 282% to US$103.3mn in 2016. It added an estimated 218,188 businesses raised funds across the Americas from online alternative finance channels in 2016, led by the US (143,344), but with business users increasingly common in LAC (67,499).

"Rapid organic growth led LAC alternative finance markets to grow by 209% to US$342.1 mn in 2016," it said. "LAC, collectively as a regional market, surpassed Canada's national market in 2016, led by high volume markets in Mexico, Chile and Brazil."

Insuretechs: Tech startups are also working to bring digital transformation to the insurance industry via what has come to be known as insuretechs (or insurtechs, the spelling varies).

To date most insuretechs are working with firms to ease or improve access to products offered by insurers, modifying the sales interface and/or client communications, according to the Finnovista study. Potential services include choosing coverage, buying it, paying premiums, reporting claims, checking the status of claims and other customer services.

"To a lesser degree – even though it is here that the greatest possibilities for the segment exist – some startups in this grouping are offering solutions by which they can monitor consumer behavior to personalize [the kinds of insurance products to offer]," it added.

The study noted that this branch could be fed by the development of the so-called internet of things (IoT), which for now largely involves internet-connected consumer devices that go beyond laptops, tablets and smartphones.

IoT also has the potential for tracking consumer behavior, something already advanced through telematics systems that track commercial drivers, to determine potential openings to offer additional coverage or customize existing policies.

The largest obstacle for insurers in LAC remains weak penetration, and these strategies could help in this regard as well, bringing a wider net of users closer to information about available coverage and facilitating the maintenance of policies thereafter.

The Finnovista study identified 28 young insuretechs in the region, representing 4.0% of all fintechs in the region.