The Future of B2B Banking in Latam

Banking in Latin America is broken. Not by accident, mind you; it was designed to be broken. Limited transparency, heavy bureaucracy and red tape, internet 1.0 technology, and hidden fees have generated a deep-seated mistrust of banks, both at a personal level and at a business level. In countries like Mexico, the unbanked population sits at 63% (and remains high across Latam at 47%). 37% of Mexicans state lack of trust as the primary reason they don’t open an account.

I’ve seen this first-hand — my wife Cecy owned a bakery in Mexico City and asked her employees to open bank accounts for payroll disbursements. The result? Her employees would cash out their accounts completely, same day, and store the cash at home. When her employees complained about the fact that the banks “robbed” users, Cecy offered to let them switch back to biweekly cash payments as opposed to direct deposits. 100% of her employees switched back and closed their bank accounts same-day. These same employees were then *literally* robbed on more than one occasion between work and home because thieves know pay-day in Mexico means cash-on-hand. The cognitive dissonance here really drives home the fact that this issue is deep-seated and cultural. Education clearly plays a part, as financial product uptake follows formal labor force participation:

But the fact remains: 70% of adults in the formal labor force don’t even have a debit card; they rely on cash and keep an open bank account solely out of necessity. The implication is obvious: deep-seated distrust, coupled with a cultural tendency to “hide” money from the government, have historically limited the adoption of digital banking services in Mexico and Latam.

The resistance is bottom-up, so the adoption of new technologies must be bottom-up as well. Startups must convince the average Latam user that digital solutions can be trusted, that they will simplify his life, and that they will not replace his job. At the same time, these technologies cannot change user behavior outright, but rather augment existing behaviors and make associated tasks 10x better, to the point where going back to the way things were would be unthinkable.

Clip and Konfio are great examples of this, and provide early indications that bottoms-up adoption is a winning strategy in the region. In the case of Clip, users’ original behavior is unchanged — microbusinesses sell a product or service and the client pays for that service. The only difference is that the vehicle by which the client can pay has now expanded from cash only to cash/card. The tool is simple enough for anyone to use, the process is seamless, the business owner expands his customer base and his competitive advantage, and the client receives a superior PoS experience.

With Konfio, the song remains the same. SMBs have always, and will always, need financing. The existing financing process in Latam is incredibly cumbersome, time-consuming, inaccessible to a large portion of the population, bureaucratic, and (to be perfectly frank) often infuriating. Konfio does not change the product or behavior, but simply the process by which loans are applied for, assessed, and disbursed, thereby providing clients access to credit without the pain of dealing with local banks.

Moving a bit further downstream to larger, more formal SMBs, the approach must be similar. A startup must begin with a simple product/service that does not change current consumer behavior and is 10x better than existing processes. This initial product acts as the “tip of the spear” onto which additional services can be embedded as the user becomes comfortable with the platform. Rappi (while not a fintech) did a fantastic job of this, beginning as a delivery platform before expanding into adjacent services. The solution now looks more like a WeChat for Latam than an UberEats competitor.

Given the state of banking in Latam, the specific problems fintechs can address appear limitless. However, finding problems to solve is not the issue; finding solutions that generate bottoms-up adoption and product-market fit is the issue. Below are a few problems being attacked by up-and-coming startups that represent the future of finance in Latam.

Payroll: Pre-nomina, nomina, post-nomina, aguinaldo, prima vacacional, pensiones, afores…payroll management in Latin America implies keeping close tabs on a breadth of ancillary services. These processes are all relatively straightforward and represent low-hanging fruit from an automation standpoint. By attacking specific pieces of the HR puzzle with solutions that are seamless, automatic, and transparent, and integrated with existing SMB systems and workflows, payroll solutions are a no-brainer for teams to adopt. Furthermore, by getting access to employee payroll data, these solutions can quickly expand into new financial revenue streams (e.g. insurance, loans) and develop into an embedded finance solution. The resistance these solutions will need to overcome are the payroll outsourcing models often seen in Mexico, where 3rd-party providers handle payments and benefits for SMBs (often as a strategy for tax avoidance). They’re heavily entrenched in Mexico and any software looking to replace those incumbents faces an uphill battle.

Runa and Worky are interesting SaaS platforms in this space (though both identify as HR solutions rather than fintechs). In terms of market potential for these two players, there are 1.3M SMBs in Latam, representing 5% of the total MSMB market. In order to build a billion-dollar business, it will be necessary to either: 1) completely dominate the SMB market; 2) create a product that can appeal to formal SMBs as well as more the informal long-tail of micro businesses (a la Clip); or 3) launch with an SMB solution, and, as the platform matures, move downstream to enterprise.

Open banking platforms: the average SMB in Latin America has 3–5 accounts open across multiple banks, each of which offers one specific service. These SMBs and their respective admin teams have no way of consolidating information across these accounts or achieving cohesive visibility. Regional banks, as mentioned before, also seem designed to make life difficult for the user with time-consuming, offline, and bureaucratic processes. Accounts must be opened in-person, users are charged high monthly fees, and any question or issue implies either hours of waiting on the phone or going to the specific branch where you originally opened your account to address the issue. Closing an account often implies weeks of jumping through bureaucratic hoops. The lack of visibility also makes compliance a nightmare. In Mexico, for example, the “nominas” mentioned above must be matched with the company’s bank accounts and internal + external accounting records.

Companies such as Belvo, Plunzo and Quanto are tackling these problems leveraging the bottoms-up, tip-of-the-spear strategy outlined above. Instead of replacing existing accounts or processes, these companies leverage APIs to offer improved visibility across all accounts and therefore easier administration, charging a SaaS fee + a fixed fee per API call. Belvo is more focused on providing the rails, while Plunzo and Quanto are more focused on simplifying the administration process by integrating accounts into existing productivity software (e.g. GSuite, Slack, Telegram). Again, the key here is that they augment existing processes rather than replace them outright. Furthermore, driving my point home about bottoms-up adoption, Plunzo approached customer acquisition by first targeting individual consumers (pulling together 3,000+ in a few weeks) before rolling out to SMBs. Post-adoption, the moats and additional revenue opportunities these companies have will be significant given the amount of financial data they will be processing on behalf of their clients. The companies are setting themselves up to be attractive strategic partners for financial institutions as well.

Pay-on-demand software: Latin America has some of the lowest savings rates in the world, with a significant number of individuals living paycheck to paycheck (the table below illustrates the savings problem facing Latam):

COVID-19 has only exacerbated this, with governments enacting provisions allowing businesses to cut wages to the minimum throughout the crisis. Pay-on-demand has emerged as an employee benefit and retention solution in other geographies globally (e.g. Wagestream). These pay-on-demand benefits are often adopted due to demand at the employee level. Blue-collar and low-wage employees are disproportionately living paycheck-to-paycheck and financial liquidity helps alleviate financial insecurity in the short-term. Minu has emerged as an attractive player in the region, offering a mobile-first, pay-on-demand solution that charges users a fixed fee per cash-out. Minu covers the float and takes on the financial risk between paydays and charges the employer for all loans extended during the pay period. SMBs win by offering employees a solution that helps reduce churn and recruit new employees (a process that can cost up to $400 per employee).

Banking as a Service (for incumbents): As regional banks work to boost their digital capabilities and compete with fintechs, they must make the decision of whether they should build in-house or outsource the development of digital channels. While historically, these banks have opted to build in-house, they are quickly coming to the realization that this solution is untenable from a speed, cost, or quality perspective. As such, BaaS companies such as Novopayment and Technisys have emerged to help incumbent banks ramp up their digital capabilities, while open banking players such as Arcus and Belvo are helping provide the infrastructure and rails for executing transactions online.

Branchless SMB banks: The last play I’ll touch on in this analysis is that of the branchless bank. Consumer-facing challenger banks have grabbed all the headlines in recent years, with companies like N26, Revolut, and Nubank dominating the headlines. The consumer space has become increasingly crowded, but interesting solutions targeting SMBs have begun to emerge in Latam. Oyster offers an interesting solution that hopes to corner the creator economy, with a simple end-to-end financial administration and banking solution for micro-businesses. Delt.ai goes after the creator/freelancer space as well, but focuses on replacing specific services such as corporate credit cards and financial reporting. Both solutions are an order of magnitude better than existing banking solutions in the region and have several levers to pull in terms of revenue generation, but limiting themselves to digitally-native microbusinesses could really limit the market size.

Exit and Fundraising Landscape: The Latam market is admittedly much smaller than the US market. However, solutions that address regional, rather than local problems have significant room to run and limited competition. As such, rapid execution can lead to a large, and relatively uncontested market share capture. Exits in the region have been limited to-date, but winners such as Nubank, Clip, Konfio, Rappi, and Kavak(among others) are beginning to emerge as potential IPO candidates down the road. US-based investors have begun recognizing the opportunity: recent international investors in the region include Tiger, Sequoia, a16z, Founders Fund, Softbank, Redpoint, DST, General Atlantic, QED, Y-Combinator, aCrew, Altos, Quona, Clocktower Ventures, and others. With this increased investment has come a wave of startups (particularly in the fintech space), and regional hubs have begun sprouting up in Mexico City, Buenos Aires, and Sao Paulo. Below is an overview of the fintech market in Mexico alone:

Exits will continue to be complicated in the short-term. Local banks lack the size (and vision) to execute an outsized acquisition and IPOs are significantly more cumbersome than in the US. That said, a VC’s first concern should be to invest in good companies with attractive economics and the exits should follow in due course. Innovation is global, and the continued growth of technology-enabled companies and investments in Latam will eventually drive improved liquidity. While investing in Latin America will always imply greater geopolitical, regulatory, and macroeconomic risk, it also offers geographic diversification, reasonable valuations, decreased competition, and the opportunity to make a significant social impact on developing economies.