Fintech is moving so quickly in Emerging Markets that Developed Markets are being left in the dust. We believe that the financially excluded, the “unbanked,” will be the most visible beneficiaries. You can see it in many places on the ground; this example from an ethnographic visit to Lagos, Nigeria, was typical.
Femi comes from a family of entrepreneurs. His sister started a successful catering business from home selling cupcakes to hotels. But this passionate 28-year-old has bigger dreams. He wants to set up a new minibus transport company and has been frustrated by not being able to get funding for an idea he strongly believes in. When we asked why he didn’t apply for a bank loan, he laughed. “If I went to the bank for a loan,” he said, repeating a local expression “they would ask me to bring my mother [as a guarantor]. If I had a mother, I wouldn’t need a bank loan!”
"If I went to the bank for a loan,they would ask me to bring my mother. If I had a mother, I wouldn’t need a bank loan!”
Femi's story is typical. People in emerging markets on lower incomes are much more likely to be unbanked than in developed markets. In developed markets, fewer than 10% of adults are unbanked. In some emerging markets, it’s above half, and sometimes as high as 85% (Afghanistan)[i].
Conventional banks in Emerging market typically ignore potential business from consumers who are crowded out by lending to governments and big business. Why would you bother creating credit profiles, helping people lift themselves out of poverty, when you can make abnormal profits just lending to friendly governments?
Consumer funding crowded out by governments and big business
That allows new low-cost entrants to enter, with limited resistance from incumbents, who in turn spent little effort on creating regulatory and competitive barriers. In China, the fintech ecosystems of Ant Financial, Alibaba’s affiliate, and Tencent, have blazed a trail, showing the rest of the world the sort of products and efficiencies available. The effect on financial inclusion has been dramatic. Between 2011 and 2017, the proportion of unbanked adults in China almost halved, falling from 36% to 20%[ii]. We believe that MercadoLibre is poised to have a similar impact in Brazil and Argentina, addressing the problem of financial exclusion that has suppressed economic progress and prolonged a vicious cycle of poverty.
In most developed markets, however, barriers are strong, and are only now beginning to be dismantled. The incumbents have a lot to lose if their mass market customers abandon them. They’ve therefore generally supported regulation that excludes new entrants, including access to payment systems, and limiting availability of new licences.
While change has been slow, regulators are now beginning to make way for change. In developed markets, the UK was first out of the block with Open Banking, followed closely by the EU’s Second Payment Services Directive (PSD2). South Korea has recently followed PSD2 with regulation that opens access to payment systems.[iii]
EM Mega Players set to disrupt Hong Kong retail banking market
Hong Kong is setting a new precedent by issuing 6 new digital banking licences[iv] which include EM mega-players, such as Tencent, Ant Financial (and Alibaba associate) and Xiaomi. We expect them to be highly disruptive.
These actions represent the three elements that, in combination, we believe are likely to bring about huge, disruptive changes to retail banking around the world.
New licences are vital if incumbents are to be challenged, as in Hong Kong;
Open Banking, or rather a means to enforce banks to allow customers to share transaction data with third parties. This is underway in, e.g., the UK and more recently in Australia.
Permission for third parties to initiate payments from customer accounts, of course with their consent, as in South Korea, following the PSD2.
We see conventional payments systems today, both interbank systems and card schemes, as acting like communal barriers to competition behind which incumbent banks are protected. Moreover, those barriers enable rent-seeking by the banks, quite literally acting like toll-gates, charging businesses, retailers, and sometimes consumers, every time money is moved.
EMs can leapfrog developed markets not simply because of their lack of legacy technologies, but because the entrenched interests of incumbent banks have not conspired to capture regulators, obstruct competition, hinder innovation, and frustrate financial inclusion.
When regulation breaks down those barriers, mandating access to payments systems by non-bank third parties, the banks’ party is arguably over. A proliferation of competitors should exacerbate this. New entrants can be highly disruptive, for three big reasons:
they have no need for hugely costly branch networks;
they have modern, efficient IT systems, as opposed to the patchwork legacy systems of the old banks; and
they don’t require tens of thousands of staff to support all that inefficiency.
We believe that competition is well and truly on its way. In some markets, where the regulators get it right, this will inflict considerable pain on the retail banks. The old banks will likely have to adapt or die. But what grabs our attention is the fact that this is happening first in emerging markets. They can leapfrog developed markets not simply because of their lack of legacy technologies, but because the entrenched interests of incumbent banks have not conspired to capture regulators, obstruct competition, hinder innovation, and frustrate financial inclusion.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Trinetra Investment Management LLP and are subject to revision over time. Trinetra is authorised and regulated by the Financial Conduct Authority in the United Kingdom.
[i] World Bank, Universal Financial Access database; http://ufa.worldbank.org/country-progress
[ii] World Bank, Universal Financial Access database; http://ufa.worldbank.org/country-progress/china
[iii] Finextra, Feb 27, 2019, Korean banks ordered to open up payment systems to fintech firms; https://www.finextra.com/newsarticle/33444/korean-banks-ordered-to-open-up-payment-systems-to-fintech-firms
[iv] Financial Times, Feb 21, 2019, Hong Kong opens banking market to online competition; https://www.ft.com/content/d5d38eb0-333a-11e9-bd3a-8b2a211d90d5
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