Sergio Furio, a former consultant in New York, was amazed when his Brazilian girlfriend told him about the stratospheric interest rates charged by lenders in her home country. “The Brazilian lending market is extremely inefficient. In certain product categories like credit cards or personal loan overdrafts, lenders take 200% per year,” he says.

He knew an opportunity when he saw one. “Such huge spreads looked like a tremendous opportunity to launch a new business,” says Furio, who has since married and moved to São Paulo, where he heads Creditas, one the hottest fintechs in the fast-growing Brazilian market.

Creditas grants loans to individuals over the internet, using borrowers’ assets, such as their cars or homes, as collateral. The company, in typical fintech fashion, has enjoyed a meteoric rise. Its loan portfolio amounted to 200 million reais ($60.9 million) last year, says Furio, and it is booking 500% growth in 2017. The business, which was born under the name of BankFacil in 2012, now has 285 employees and received a 60 million real investment from the International Finance Corporation (IFC) and Naspers in February 2017. Creditas’ previous fundraising rounds included investments from funds like Redpoint Ventures and QED.

The local banking industry says that the steep interest rates are a consequence of Brazil’s high nominal rates and the elevated risk from high delinquency rates, as well as tight regulations. But Furio claims that technology and the use of collateral help Creditas cut spreads by 90%.

“Disruptive companies in this type of market can leverage multiple advantages to provide cheaper credit,” he says.

Fintechs like Creditas still represent a drop in the ocean in Brazil’s credit market of 1.5 trillion reais, but their importance goes far beyond volume.

“Banks will have to adjust and lower their prices eventually,” Furio says.

The country’s five largest banks currently have an 80% market share in the credit business and act as an oligopoly, according to Ricardo Rocha, a finance professor at Insper, a business school in São Paulo. But fintechs are bound to play an increasingly greater role as the market reaches “a point of no return,” he says.

Rocha estimates that Brazilian fintechs raked in investments of around 200 million reais by the third quarter of last year, an amount that is “still small but very promising.”

He compares consumer acceptance to the early days of e-commerce. “In the beginning, people had some doubts. They were a bit scared. But now, no one buys something in a store before checking prices on the internet. The same thing will happen with fintechs. No one will get a bank loan before checking fintech rates. This will lead to a cut in bank spreads,” Rocha says.

Regulations on the way
Brazil’s central bank is due to enact the first regulations for fintechs in the first quarter this year. Originally, regulators were concerned that the digital startups might be vehicles for money laundering activities, but the view has shifted in recent years. “Now the central bank thinks fintechs are indeed important to the financial system, that they foster competition and that they play a role in developing the financial market,” says Pedro Eroles, a banking and finance associate at the local law firm Machado Meyer.

In practice, fintech-specific legislation means that the digital entrepreneurs, who so far have had to act as banking correspondents, will be able to get a license and act independently from banks. Fintechs will be split in two categories: those that supply direct credit and those that arrange peer-to-peer lending.

“We currently depend on banks for booking loans,” Furio says. “With the new regulations, fintechs will operate independently and report directly to the central bank.”

According to Eroles, fintechs will forge an entirely new role in Brazil’s loans market. “Right now, we don’t have credit market entities that are not associated with a financial institution. When regulations are implemented, new independent fintechs will pop up. The new rules will hopefully foster competition in the credit market,” he says.

But some skeptics remain cautious. “I see willingness for straightforward regulation, but discussions remain necessary,” says SalaryFits CEO Délber Lage, who has taken part in talks with the central bank. Preferring to reserve judgment on the impact of Brazilian legislation until the regulatory climate settles down, he warns that a stricter regulatory framework could erect entry barriers for new players and consolidate the position of incumbents. Compliance costs could also prove too much of a burden for startups and sideline innovation, he says.

SalaryFits has Latin American operations in Brazil and Mexico and provides a platform for so-called payroll loans, which have become popular with Brazilian consumers. Installment payments are deducted directly from borrowers’ monthly salaries or pensions, allowing the lenders to charge lower interest rates than for unsecured loans.

Lage says he would like to view incumbents as partners, rather than competitors, and adds that SalaryFits currently works with more than 50 banks in Brazil. “Specific niche-oriented fintechs will be more cost effective and may target a low-cost market that is not interesting for the big financial institutions,” he says. “Incumbents have a big customer base and for them it is quite expensive to dedicate time and effort to develop new marketing channels.”

Traditional tensions
Fintechs may be important niche operators, Lage says, but their ability to disrupt the market is limited. “Banks are huge. We cannot forget their size, we cannot forget their influence, we can never underestimate their client base and the relationship they have with these individuals. Some banks might suffer. But I don’t see fintechs disrupting the financial environment in a way that will kill the banks in the near future,” he says.

Still, Lage acknowledges that the newcomers could force traditional lenders to change. “They may buy the start-ups or invest in new technologies or change the way they relate with their customers. But I don’t see banks vanishing.”

Brazil’s banks have not stood idle as several have explored their own fintech solutions. For example, Banco do Brasil has launched its own innovation incubator in Silicon Valley. Labb, as it is called, shares space with startups from various countries. The project hosts staff members — there are currently five in residence — who spend three months in a startup environment before returning to Brazil to introduce new digital products, says Vilmar Gruttner, manager of the center.

Gruttner also says he expects more collaboration than confrontation between Brazil’s big financial institutions and entrepreneurs in the future. “Fintechs choose their niches. They do not want to be universal banks, dealing with current accounts for specialized investment funds or loans for sugarcane plants. They do not have the scale for that, so they have to specialize,” Gruttner says.

Some established lenders, however, may choose to take on the startups head to head. “The digital bank is our fintech,” says Marcelo Flora, head of digital banking at BTG Pactual, adding that the bank aims to conquer a 10% market share in three or four years. He also says that high-income customers represent a market of at least 6 million accounts, worth some 750 billion reais in assets.

The smartphone market for digital credit cards was pioneered by David Vélez, A Colombian who took Brazil by storm when he started NuBank a few years ago. “Why would a Colombian who has never worked in Brazil come here and launch a credit card company?” Flora asks. “Why would we not, as an investment bank with 30 years of experience, make our own effort towards opening new niche markets thanks to technology? This is actually our great goal.”

Rapid reaction
Brazil’s banks have reacted fairly quickly to the entry of fintechs in the market, including some that launched their own fintechs to foster digital innovation, says Eroles. For example, Itaú Unibanco, Brazil’s largest private-sector bank, teamed with Redpoint to form Cubo, a São Paulo-based innovation hub focused on early-stage consumer internet startups, while other lenders have relied on technology to promote a better user experience through digital banking. “When innovation pops up, banks always fight back,” Eroles says.

Traditional banks may also rely on “sticky” long-term customer relationships and “well-developed credit underwriting capabilities,” Moody’s said in a report on the competitive landscape in the fintech era. “Traditional banks are launching their own mobile payment applications and, with large existing customer bases, have a competitive advantage over new entrants,” the credit rating agency said.

But whether competition will come from fintechs or digital banking divisions of existing financial institutions, the industry is undergoing a transformation. “Customers are increasingly questioning just about everything. If I don’t get the right products at the right price, I move from one bank to another one, or from one fintech to another one,” Rocha says. “This will encourage a lot of competition in the financial system.” LF