In the 19th century, there were two options to sending money: a coach to physically carry funds or a telegram that transmitted the request through a wire. Today, bank transfers are based on the same technology that was used to send telegrams more than 150 years ago.
The most recent advancement in wire transfers was the establishment in 1973 of Swift, a messaging network that allows banks and other financial institutions worldwide to send and receive encrypted information, mainly for cross-border transfers.
Cross-border payments are more costly, slower and more complex than domestic payments, as well as more difficult to access. This is especially true for low-value payments (up to $10,000), which have been particularly underserved by banks given the proportionally higher costs associated with cross-border transfers.
In Latin America (Latam), these problems are even more relevant, as according to some estimates around 50% of adults do not have a bank account and rely on more costly methods of sending or receiving payments and remittances.
However, recently fintechs have stepped into this gap in the market and started offering better cross-border payment solutions. “Banks are facing huge competition from fintechs, or new payment method companies, that are providing a better client experience and being fast in executing those transactions,” says Germana Cruz, CEO and head of financial institutions, Latam at Standard Chartered.
The market opportunity is there. For example, remittance flows to the Latam region hit a new record in 2021, as the reopening of economies following the Covid-19 pandemic allowed immigrant workers to return to their activities and expand the support they send to their families. In addition, intra-regional trade is on the rise.
Fintech disruption
Remittances is the main source of cross-border transfers into Latam. It is a target market for disruption because it is largely cash-based. Many migrants in the US, who are the main originators of these remittances, are familiar with brick-and-mortar channels but often do not have a bank account in the US.
“Both senders and recipients have to drive, walk or bike to a location and stand in lines so that they can receive or send their money,” says David Goldschmidt, vice-president of cross-border payments for Mastercard Latam and the Caribbean. “It is also very expensive as the transaction could cost $8 with a 6% fee. In addition, because people often commute after receiving their money in cash, this also brings up the issue of security.”
Banks offer slow solutions at high fees, just like the traditional remittance firms
Jairo Riveros, managing director for Americas at UK-based fintech Paysend, agrees. “The solutions offered today to support cross-border payments have been in place for many years. Banks offer slow solutions at high fees, just like the traditional remittance firms like Western Union and MoneyGram,” he says. “Our value proposition is different as we deliver funds digitally and instantly, at a low cost.”
Fintechs can charge much lower fees than banks because they rely on a leaner cost structure. “We operate with 80% lower costs than banks because we have no physical branches, no real estate, and so that provides for a fully digital solution,” says Pierpaolo Barbieri, founder of Ualá, an Argentina-based personal financial management mobile app.
Mastercard’s Mr Goldschmidt adds that the timing is perfect for disruption, with studies suggesting that around 90% of the Latam population now has a mobile phone and 80% have an internet connection.
In November, Paysend announced Paysend Libre, which will allow unbanked users in Guatemala, Honduras and El Salvador to receive remittances from the US. Using this solution, a remitter in the US simply uses a recipient’s phone number to send them funds. As soon as the funds are sent, the recipient receives a notification with a link to log in via Paysend’s website or app. Unbanked recipients and those without a debit card will be issued a free Paysend virtual Mastercard that can be used to make online purchases or withdraw funds from thousands of Cajero 5B-operated ATMs.
Solutions for enterprises
According to Mr Riveros, Paysend was the first to develop the interconnectivity between the three main payment networks, Visa, Mastercard and China UnionPay. This allowed 12 billion cards worldwide to connect cross-border. Paysend can now deliver funds to bank accounts and wallets in 178 countries worldwide.
“We are now offering our payments platform to other fintechs and financial institutions as well,” says Mr Riveros. “Canada is a very good example. The large Canadian banks are looking for an alternative to cross-border payments. So, we know that TD Bank partnered up with Visa Direct, Royal Bank of Canada signed up with Swift Go and we are in conversations with the others to sign up with Paysend Open Payment Network. Banks are looking at these solutions because customers are asking for alternatives to wire transfers, which take too long.”
Many small and medium-sized enterprises (SMEs) in Latam buy supplies from China, according to Mr Riveros. But suppliers tend not to send the items until they have received the payment in full, which creates financing constraints. He believes that Paysend’s payments platform can offer a solution. “We will give the SMEs the ability to push the transaction instantly to the Chinese supplier,” he explains.
The same problems exist for inbound payments in Latam. A foreign company looking to expand to the region needs to sell in local currency and accept local payment methods. But without having a local entity, which is costly, it is not easy.
“If you look at the majority of countries in Latam, they don’t have the possibility of buying in foreign currency,” says Nathan Marion, general manager, Latam, at payments firm Volt.io. “Brazilians keen to buy from a foreign website in US dollars — or any other currency — need to have a credit card that is enabled for international business, in a context where a good portion of the population doesn’t have a credit card.”
Moreover, customers might also incur surcharges for buying in foreign currency.
“We are offering merchants our real-time payments gateway, allowing them accept account-to-account payments in Europe using open banking and local instant payments schemes like PIX in the Brazilian market,” Mr Marion says. “If merchants are keen to accept instant account-to-account payments, they don’t need to connect into multiple banks or multiple payment providers, they can just use Volt.”
These payments move money directly from one account to another without the need for additional intermediaries or payment instruments, such as cards. This reduces the transaction cost significantly and allows the funds to arrive at the merchant faster.
Incumbents up their game
Banks have struggled to be competitive in low-value cross-border payments because of their cost structure.
Cross-border payments can be a costly market, especially if the foreign exchange (FX) regulation is very tight. One example is Brazil, where any cross-border payment amounts to an FX transaction and needs to be registered at the central bank level. This puts a legal and oversight burden on banks.
“But more than that, one of the things that we banks have complained about a lot was the amount of oversight from Brazilian authorities that banks have,” explains Rafael Kappaz, head of global trade solutions at Santander Brasil. This has allowed fintechs to grow their share of the market of FX transactions in the country, even if it is still far from what banks currently manage.
The new Brazilian FX laws in 2023 will establish a more level playing field between challengers and incumbents, as they will increase the regulatory oversight for fintechs while allowing the banks less oversight when it comes to small ticket transactions.
“At the beginning, the central bank was keen to create competition in the market and allow fintechs to bring innovation. Now they are managing a sizeable amount of money and starting to become systemically important,” says Ms Cruz.
Mr Kappaz adds: “When we talk about low-value payments, this is where the central bank has, up until now, brought most of the changes in terms of the FX regulations, making them easier and therefore cheaper for the end user. With the new regulation, the level of oversight that the central bank and local authorities will impose on fintechs and banks will become more even.”
Mr Kappaz expects that it will be difficult for fintechs to step up and start offering the same services to SMEs. “The ticket size of transactions handled by SMEs is higher. This will mean that fintechs facilitating such transactions will need to change their infrastructure and comply with more regulation and more oversight to be able to offer this kind of services,” he explains.
Moreover, Santander Brasil has been investing to improve its product offering for this payments segment. “We have a more robust offer for individuals and SMEs, and will continue to expand it,” he adds. “What we can offer that is different from fintechs is trust. We saw many fintechs having issues and people losing money. Most of the fintechs still live out of capital raises, not generating enough cash to sustain their operations.”
To be more competitive with fintechs, Swift itself launched Swift Go specifically for low-value cross-border payments. “With this platform, we can segregate those low-value payments,” says Ms Cruz. “Banks can have bilateral discussions with their corresponding banks in terms of how much they charge, rather than charging the single payment, as happens today for each payment that goes through Swift.”
Tougher conditions
Now that the interest rate environment is changing, banks expect that this will impact the business model of fintechs, as they will need to pay more for the liquidity. Fintechs that are dependent on future inflows of new capital are also likely to be challenged under the current scenario, given reduced investor appetite.
Banks see this as a window of opportunity to recover some of those payments that they lost to the fintechs
“It will be more expensive for the fintechs to execute on their business model and continue charging nothing for those payments, which is basically the difference with a bank,” says Ms Cruz. “Banks see this as a window of opportunity to recover some of those payments that they lost to the fintechs.”
There has been a lot of new capital deployed in the region to create the solutions. But passing higher funding costs onto customers may be challenging, given fintechs’ largely price-driven strategies and their higher marketing spend to support client acquisition goals. “Obviously, with the current market conditions, I don’t think everybody will survive,” adds Mr Barbieri. “I think that there will be consolidation and there will be fewer alternatives.”
Mr Riveros adds: “We will continue to expect some consolidation in the market because not everyone will be successful. Partnerships are very important — that’s why we have a strong partnership with the card networks. I see the banks behind this evolution. But I wouldn’t be surprised if they start reaching out for partnerships and collaboration, as just having an app doesn’t make you a fintech.”
On the positive side, Latam is a place where there is extensive opportunity. The economies are relatively wealthy on a per capita basis and some countries, particularly the commodity-exporting ones, are doing quite well in the current macroeconomic situation.
“Some economies are performing really strongly – [for example] Mexico is growing really well,” says Mr Barbieri. “Colombia has done very well in the past few years and Brazil seems to be coming out of its economic crisis. Credit is more expensive, and therefore, there’s going to be less money; but at the same time, the opportunity in Latam is very large. It is clear that digital payments are going to grow a lot.”
In Brazil, fintechs brought international cash accounts, payments, debit and credit cards to the market, which the big banks in Brazil did not offer at that time. Some banks still do not offer international cash accounts for individuals as they do for corporates, as in Brazil it was not possible to hold foreign currency accounts locally.
While some of them started by offering a free digital account, fintechs are evolving and expanding their product offering to increase their competitiveness. They are now offer lending and buy now, pay later services, as well as investment services, such as the possibility to buy equities or cryptocurrencies from the same account.
“When you start offering investments, you’re putting in front of your client a more value-added solution,” says Mr Kappaz. In Brazil, this possibility attracted attention from the small investors, especially during the Covid-19 pandemic. In a low interest rate scenario, Brazilian investors were pushed to look into alternative types of investments, such as investing abroad in foreign currency. The offering from fintechs therefore became more compelling.
Eventually for most services, neobanks need to acquire a banking licence. “We have been focused on getting bank licences to be able to do the whole stack of payments from remittances to serving large companies, [as well as] delivering returns on chequing accounts. You’re going to need a bank if you want to really achieve scale and we need scale to be able to charge less than the incumbents,” explains Mr Barbieri.
Each country in Latam has a different regulatory regime, which makes it more difficult to expand cross-border. For instance, Ualá created a bank in Colombia to serve Colombian customers, but then had to partner with a bank in Mexico to serve Mexican customers.
Innovation
The EU, for example, is easier to operate in than Latam because it only takes one licence to operate across the region. “That’s a big difference,” adds Mr Barbieri. “The regulators in Europe are also a lot friendlier to technology [innovation] than in emerging markets like Latam. If regulators want to achieve financial inclusion, they need to make sure to welcome technology because it allows us to cut costs radically.”
If regulators want to achieve financial inclusion, they need to make sure to welcome technology
Instant payments, digital accounts and open banking are fundamental to allowing frictionless and cheap cross-border payments.
“I think that the best thing is something that Brazil did, which is open banking and the instant payment infrastructure PIX,” says Mr Barbieri. “I hope that the rest of the countries in Latam emulate Brazil. In Argentina for instance, banks still delay instant payments to Ualá because they don’t want to [facilitate] clients moving deposits from the bank to us.
“Your credit history is yours, rather than the bank’s,” he continues. “If banks don’t share the data and allow portability of data, then credit becomes more expensive — just in the same way as when you couldn’t move your cell phone number to a different company, mobile prices were expensive.”
This is important in banking because a person’s credit history is attached to their account. “I could give you a loan at a cheaper rate if I had access to that data. And so, I find it ridiculous that [many of] the same institutions that do open banking in Europe, because the EU regulated it, don’t do it in Latam,” adds Mr Barbieri.
