Banking

Disruptive technologies change the face of the Brazilian financial market

Over the past few years the Brazilian financial market has blossomed, with an unprecedentedly open attitude towards technology and modernisation. For a country that has been historically conservative when it comes to monetary policy and burdensome bureaucracy, Brazil is now embracing innovation, and allowing new ideas to form and shake up the traditional standards and practices of its banking industry.

According to CB Insights, Brazil is Latin America’s leading tech hub. It accounts for most of the US$1 billion in venture capital invested in the region last year, and registered over 450 technology-oriented start-ups in 2018. Since 2014, there has been a sharp growth in new projects favouring business models built on technology, striving for sectors typically overlooked by larger players.

A Brazilian unicorn, Nubank, was recently valued at US$4 billion through its Series-E US$180 million investment from the Chinese giant Tencent. Another native start-up, 99, was acquired in January 2018 by Didi Chuxing, after a multimillion-dollar investment by SoftBank.

In 2017, approximately US$31 billion was invested in fintechs globally, an increasing share of which has been channelled to Brazilian fintechs. E-payments, cryptocurrencies, investment crowdfunding, blockchain, open banking and other globally trending innovations are now the talk of the town and familiar to local regulators. Culturally this can be explained by the fact that Brazilians are particularly eager to use technology, especially when it opens the door to financial services that were not previously accessible to them.

Naturally the Brazilian Central Bank (BCB) has embraced a strategic role in the promotion of competition and efficiency. With a notable ethos of change, the monetary authority is laying the foundations of a new regulatory environment, welcoming disruptive technologies to lead the Brazilian financial market en route to a more dynamic ecosystem. By listening both to main players and newcomers, as well as accompanying international discussions, the regulator is playing a crucial part in driving the country towards the forefront of global financial trends.

An example of the BCB’s commitment to modernisation is the BC+ Agenda, inaugurated in 2016 with the aim to review structural issues of the national financial system. It has four main goals:

  • to promote financial education and inclusion;
  • to update and simplify regulation;
  • to facilitate access to credit and payments; and
  • to develop a more competitive and efficient system.

Financial inclusion and financial education are key to the regulator, especially in view of the historical high costs of credit and the concentrated market in the country. According to data collected by the BCB, today there are over 15 million adults in the country that do not maintain any kind of relationship with a financial institution (ie, they do not hold accounts, have never had access to credit and never made investments of any sort).

Cognisant of the fact that payments and credit markets are still highly concentrated (at present, the country’s five largest banks hold 78.51 per cent of all loans extended by financial institutions in Brazil), and of the fact that the unbanked population offers both challenges and opportunities, the BCB has been actively nurturing of a more fintech-friendly setting to foster the access to credit and the reduction of banking spread rates; and, consequently, to design a more efficient, healthy and competitive industry, beneficial to both players and consumers.

In its intention to use technology as a tool to achieve this goal, the BCB has had multiple initiatives in different segments, such as payments, credit fintechs, peer-to-peer funds transfers and open banking, always keeping an eye on how to align disruptive technology with mindful regulatory policies.

 Payments Industry

In 2002, the BCB adopted an institutional project for the modernisation of the local retail payments market. After a decade of research and analysis, and with a little push from the government, the BCB has started to regulate the Brazilian payment industry.

Law 12,865 of 2013, known as the Brazilian Payments Law, introduced the concept of payment arrangements and payment institutions – which are participants of the payment arrangements in the capacity as issuers of prepaid instruments (such as cards and e-money), issuers of post-paid instruments (such as credit cards) or as acquirers – and delegated powers for the National Monetary Council and the BCB to create the general regulatory framework for payments in Brazil.

One of the main innovations prompted by this legal regime was the creation of payment accounts (registry accounts held by final users that are used for payment transactions) and rules for issuance of electronic money in Brazil. As far as the treatment of funds existing in payment accounts goes, the Payments Law obliges payment institutions to segregate those funds from those encompassing the assets of payment institutions.

The BCB also created a compulsory deposit regime to ensure this feature, whereby payment institutions that issue e-currency must keep the amounts received by their clients either at the BCB or use them to purchase government bonds. In case of bankruptcy of a payment institution, such funds would be excluded from the bankrupt estate.

As a result, the Payments Law and the BCB regulations that followed not only forced traditional payment networks to allow the entrance of new issuers (a niche until then mostly dominated by banks) but also allowed the unbanked population to have their first credit card or their first account.

 Credit Fintechs

In Brazil, lending activities are restricted to financial institutions, which can only operate after obtaining a BCB licence – which requires observation of fairly heavy capital requirements, complex risk-management and compliance policies, and of unlimited liability of shareholders and managers in case of insolvency.

Because this framework used to discourage smaller players to engage in financing activities, the BCB – also sensitive to the necessity of reducing credit costs and making space for new players – created a special set of rules for “light financial institutions”, paving the way for newcomers to join this market.

A regime for credit fintechs was introduced on 26 April 2018, allowing companies to operate under two new financial institution models: direct credit entities (SCDs) and peer-to-peer lending entities (SEPs). Both are only allowed to operate through online platforms.

In general terms, SCDs can carry out credit transactions, financing transactions and acquisition of credit rights using funds originating solely from their own capital. This means that SCDs are forbidden from raising funds from the public, or collecting deposits, and from participating in the corporate capital of financial institutions.

Also, SCDs can only carry out the sale or assignment of credit rights to:

  • financial institutions;
  • investment funds whose quotas are exclusively offered to qualified investors (ie, those whose investments exceed approximately US$300,000); and
  • securitisation companies that distribute securitised assets solely to qualified investors.

Another important feature of SCDs is that they can offer payment accounts, which enables them to become almost a one-stop shop for financial services: credit, deposit-like accounts and payments.

Unlike SCDs, SEPs are not allowed to carry out financing using proprietary funds, but rather can mediate credit transactions by connecting investors with borrowers in a peer-to-peer lending arrangement.

Permitted creditors of transactions originated by SEPs are restricted to:

  • individuals (up to approximately US$4,000 per transaction, per SEP);
  • financial institutions;
  • investment funds whose quotas are exclusively offered to qualified investors;
  • securitisation companies that distribute securitised assets solely to qualified investors; and
  • non-financial corporations.

SEPs cannot retain risk, directly or indirectly, from their transactions and are expressly forbidden from:

  • providing collateral to their transactions;
  • paying creditors or debtors in advance;
  • maintaining creditors’ and debtors’ funds in an account held by a SEP (except if it offers payment accounts).

As one can note, this simplified regulatory framework provides fintechs with a great opportunity to explore new business and offer financial services to an unattended share of the Brazilian population.

Fintechs are now rushing to get the BCB’s approval and start operating under these new financial institution categories. Since larger financial institutions are not particularly keen on providing services to low-income consumers, or to very small companies, there has been a relevant market space, which remains untouched.

Credit fintechs’ arrival in the Brazilian financial market should help cut costs for retail consumers and companies through technology and by increasing competition, ultimately achieving BCB’s goal towards stronger competition and reduced credit interest rates.

Some fintechs already in operation in Brazil (those that began before the new regulation was enacted) managed to grant loans through joint ventures with smaller banks and financial institutions using mobile technology to interface with the customer. This shows that the fintechs were able access clients wanting a loan across all geographical areas of Brazil, with the same or even better coverage than larger banks using their branches. The difference lies in the fact that the “acquisition cost” for fintech clients is substantially cheaper than that of banks that use branch networks and bear related personnel and manual processing costs.

Instant Payments

In May 2018, the BCB created a working group to study the regulatory foundations of real-time transfers, and called upon more than 90 entities (including fintechs, marketplaces, payment institutions, banks and associations) to help build an instant payments scheme for Brazil.

While Brazil already has a very efficient system for fund transfers between banks and bank accounts, this system only operates during business hours and is only accessible to those with a bank account. Also, banks typically charge high fees for each transfer, which can make these transactions very expensive (especially when microtransfers are taken into account).

The idea now is to provide the regulation and infrastructure for instant payment services, which will enable users to carry out payment transactions in real time – 24 hours a day, 365 days a year – with or without a bank account and at very low costs. Initially, the working group is conceiving a model that allows a wide range of payment transactions – person to business; business to person, business to business, business to government  and government to person – among other combinations that the new regulation will contemplate.

This initiative is inspired by other similar enterprises thriving abroad, such as the EU’s Single Euro Payments Area, the Australian New Payments Platform and the American Faster Payments Task Force. The BCB has also studied the Chinese model, which is structured by two different vertical systems, provided by WeChat and Alipay.

Brazilian directives come closer to the European and Indian models, relying on a single open system in which real-time settlement transactions are facilitated by a central body.

Discussions are moving fast, and several operational and regulatory aspects have already been properly laid out. Though many issues are yet to be addressed, the outlook is promising and may create opportunities for fintechs to provide services for consumers on equal terms to traditional big players. This also means that traditional banking products such as cheques, cash and debit cards may suffer with the emergence of cheaper and faster products, and eventually be reshaped or discontinued.

Open Banking

Conversations about the future of open banking in Brazil are taking place. This system entails the sharing of data relating to financial institutions’ customers for processing and use by payment service providers and other financial institutions. Brazilian authorities have recently approved new rules regarding data protection, following global trends (eg, Law 13,709, amended in August 2018, treads much the same ground as the EU’s GDPR). Local banks are already developing application programming interfaces with commercial partners, pushing the BCB to the reality of open banking.

The Brazilian open banking model focuses on the creation of a safe system that provides the interaction of various financial institutions networks through single platforms, so that users/account holders may access financial and payment services from different institutions at the same time. These platforms are built by third-party developers, using open
source technology.

Market players and the BCB have already agreed upon general principles, including:

  • the user is the owner of its data;
  • the user must consent to, and expressly allow, any kind of data sharing; and
  • the user experience has to be simple, easy, entanglement-free and 100 per cent digital.

Also, within the context of the BC+ Agenda, it is expected that the BCB will publish general foundation rules for open banking, but always involving open discussions with the main players so as to allow the market to develop self-regulation on more operational aspects.

 ***

Expectations are high in view of the avid regulatory opening-up of the market, as demonstrated by the BCB’s latest developments that focus on technology and competition. Amid the severe recession faced since 2014, the BCB has been able to remain sensitive to the needs of a changing financial system, actively promoting reforms and boosting entrepreneurship and innovation.

The opening-up of the Brazilian payment and financial markets to technology companies is (not so) silently revolutionising the way banking is done in Brazil and also forcing traditional players to reinvent themselves under the penalty of losing their leading role in the field.

In this new banking scene, going digital not only means creating a cool app that users are going to enjoy. It also means providing easy payment solutions; making access to credit more democratic; and, most important of all, prioritising the client and adapting banking products to their needs – not the other way around, as used to be the case.

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