Among emerging economies, Brazil has long been the red-headed stepchild.
Representing the world’s 9th largest economy (topping both Russia and Canada), Brazil dominates Latin America in size and population and accounts for a nominal gross domestic product (GDP) of around $2 trillion.
But Brazil is also plagued by policy instability, excessive income disparity, and prohibitively high interest rates.
All of the above have fueled a notable new phenomenon. Seemingly overnight, Brazil has become a hotbed for financial technology (aka fintech) innovation and adoption.
It’s estimated that the nation is home to more fintech startups than any other country in Latin America — all aiming to provide for an eager and overlooked consumer base. Recent analysis shows that over two thirds of digitally active Brazilians have started to use these newly available financial services — and that wave is surging: Brazilian fintech adoption saw a 60% increase between 2017 and 2019.
What is going on?
Like many emerging economies, finance in Brazil has been largely elitist and centralized among a handful of banks, with just four institutions controlling over 70% of assets and loans. Up to 40% of the adult population is excluded from even the most commonplace financial services (for example, one in every three Brazilians has no access to a bank account or financial services).
Income disparity helps drive this model: Brazil’s wealthiest 5% have the same income as the remaining 95% of the population. And even while Brazil has lifted some 28 million people out of poverty in the last 15 years, banking services have traditionally been geared only toward those with the greatest resources to expend.
The Brazilian consumer credit scoring models were built on data gathered solely from individuals who had expressly requested registration in private databases. As most consumers had no reason to apply for this process, the pool of information was incredibly shallow — and spreads in Brazil were incredibly high. Essentially, Brazilian financial institutions would not offer credit at reasonable rates to most consumers because they could not make accurate credit risk assessments due to the lack of reliable information.
Signs of change
In 2018, the Brazilian Central Bank and National Monetary Council issued several regulations related to the Brazilian payments and financial market, aiming to increase the use of electronic payments, increase competitiveness in the sector, strengthen governance and risk management practices in the industry, encourage the development of new solutions and the differentiation of products to consumers, and promote the increased use of electronic payments. Resolution 4,656/2018, for example, created two different types of financial institutions to be included in Brazilian regulation: Peer-to-Peer Lending Companies ( known as Sociedade de Empréstimo entre Pessoas) and Direct Credit Company (known as Sociedade de Crédito Direto or SCD). These two financial institutions are popularly called “Credit FinTechs.”
On April 8, 2018, Brazilian Congress approved Complementary Law no. 166, which was published to fix the nation’s credit bureau system. It introduced broadly accessible positive credit scoring (akin to FICO or Vantage scores) for better risk assessment in order to reduce spread, increase competition and democratize access to credits and financial services. Consumer registration in the Positive Registration program is now automatic with codified opt-out protections for good payers, so more accurate credit scores for more people are available to lenders.
In addition to such recently enacted regulations, there are regulatory initiatives currently being discussed by the National Monetary Council and the Brazilian Central Bank which may modify the regulatory framework of the Brazilian payments and financial industries. For instance, there are discussions surrounding the framework regulation on instant payment (named PIX), which will become effective from November 16, 2020. PIX will enable consumers to make 24/7 payment transactions by simply reading a QR code on a mobile phone or typing the number of a person’s phone.
Brazilian Central Bank is also discussing the implementation of regulatory sandboxes to encourage innovation and financial inclusion.
The mobile difference
Where private banking behemoths have continuously failed to serve the vast majority of Brazilians, international telecoms and mobile carriers swiftly triumphed in delivering cellphones and internet connectivity to the masses.
Brazil ranks 4th on the list of nations worldwide with the greatest mobile phone usage (trailing only China, India, and the U.S.). The country has an estimated 284 million mobile subscribers and up to 97 percent of Brazilians who access the internet do so through their phones.
Ubiquitous mobile phone connectivity made app-based financial services possible. For a populace already equipped with delivery devices and without the overhead of brick-and-mortar business, fintech startups can offer affordable cash alternatives to a massive constituency in search of modern convenience. As of 2019, according to researchers at the Locomotiva Institute, “unbanked” Brazilians move about $185 billion USD annually.
A surprising ally
A receptive customer base and readily available new technology present the classic recipe for disruption, which obviously attracts entrepreneurs and investors. But the rise of Brazilian fintech is also receiving encouragement from another interesting quarter.
Since the early 2000s, the Central Bank of Brazil (Banco Central do Brasil) has been looking for ways to facilitate startups and increase financial inclusion for consumers. The flourishing of fintech in Brazil today can be directly tied to these efforts.
For example, under progressive Central Bank policies, small payment and simple digital accounts apps are not subject to same regulatory burdens as big banks. They are still regulated, but are not met with prohibitively expensive compliance and operation process mandates during the growth phases of business establishment and product scalation. Startups can easily apply for licenses designed to encourage entrepreneurship and technological innovation up to a certain number of users or a specified revenue ceiling.
Among the most notable recent initiatives of the Central Bank is the move toward establishing open banking. Using a similar process to that employed by the United Kingdom’s Competition and Markets Authority in 2016, no official Brazilian open banking implementation date has yet been set, but the Central Bank has published prospective regulations, with a public consultation, and codification is expected by the end of year.
Through open application programming interfaces (APIs) and the integration of information system infrastructures, Brazil’s open banking initiative aims to speed digital interactions between licensed financial service providers on the flow of permissioned user-data and thus disintermediate service offerings to consumers.
The benefits of open banking to existing banks and fintech challengers alike are clear: democratization of financial services, easier acquisition of new customers, stability and scalability, more and faster transactions, and an ecosystem that everyone can participate in.
You could argue that fintech is ascendant everywhere these days. Even huge multinational tech giants like Google and Amazon have jumped into the fray. In January, Angela Strange of Andreessen Horowitz famously predicted that every company will be a fintech company in the not-too-distant future. But Brazil’s rapid fintech evolution presents a remarkable case. There are currently two banks and over forty new payment institutions awaiting authorization to operate, demonstrating that the Brazilian market remains an interesting business environment for startups in the Latin American region.
Brazil Central Bank is to be applauded for encouraging entrepreneurship in its efforts to make digital business easier, secure and more transparent.
By being very open to new ideas, embracing technology, and enabling increased competition, regulators are driving fintech innovation, helping to modernize the country and balance a very centralized market that hasn’t been working for the vast majority of its people.
Alex is responsible for managing regulatory matters in the US and Brazil for Airfox. Before joining Airfox he led teams who successfully processed payment institution license applications with the Central Bank of Brazil. Alex graduated from São Bernardo do Campo Law School and has since completed three postgraduate programs, most recently studying innovation management and digital law.