"Financial inclusion is not just about where people put their money, it can also drive savings, investment and entrepreneurship. Conversely, lack of inclusiveness can hinder growth and exacerbate poverty. Latin America is making progress, but there is still a long way to go."

Author: Li Xiaotian

Source: Xiaguang Society

"Financial inclusion is not just about where people put their money, it can also drive savings, investment and entrepreneurship. Conversely, lack of inclusiveness can hinder growth and exacerbate poverty. Latin America is making progress, but there is still a long way to go."

In November 2024, Sarah Birke, president of The Economist's Central America bureau, commented in an article on the emerging but arduous fintech wave in Latin America.

To this day, if we go to Mexico, we will find that 80% of local people still choose the country's largest convenience store chain Oxxo as the payment method when shopping online: after clicking Oxxo on the payment page, print the bill, then go to the Oxxo store within the specified time to make the cash payment, complete the online order transaction, and a 1% service fee will be charged for each transaction.

This is very similar to the prepaid card recharge era in China, outdated and inefficient.

The barriers and inconveniences brought by the lack of financial inclusion are reflected in various aspects of daily life in this country: on every payday, long queues form outside Mexican banks; online payment has become a barrier between ride-hailing drivers and passengers; due to the lack of credit channels, Mexican workers often have to advance their wages and live from hand to mouth.

Data shows that about 26% of the Latin American population still do not have a bank account, a proportion lower than sub-Saharan Africa and Southeast Asia, but much higher than the Asia-Pacific region. The gap within Latin America is also very obvious: less than half of Mexicans aged 15 and above have an account; while in the entire Latin American region, this proportion is 73%. Many people do not trust banks, lack financial knowledge, and prefer to keep their savings under the mattress. Even if many people open a bank account, they then let it remain dormant, because having a bank account does not necessarily mean obtaining credit.

Contrary to the lack of financial services, Latin America is showing a thriving development trend: with the intensification of competition between China and the United States, the importance of Latin America in the global political and economic landscape is becoming increasingly prominent, and countries are diversifying their imports and investments, with Mexico and Brazil emerging as new manufacturing hubs; the macro trend of global green transformation has made resource-rich Latin America a commodity superpower in this century; Latin America is also the world's largest net food exporter, and self-sufficiency has become particularly important in the context of rising geopolitical risks.

In fact, not only Latin America, Zhao Penglan observed that global fintech is in a continuous trend of transformation and innovation, and China's past experience has provided a rich mine of experience that can be explored and referenced in this field. "China is the second largest economy in the world, but the first largest 'new economy', and the prosperity of China's new economy is leading Europe and the United States, and far exceeding other emerging markets. The underlying architecture of many overseas payment products can draw on China's experience."

The following is a dialogue between Xiaguang Society and Zhao Penglan:

Zhao Penglan, Partner of BAI Capital

Why does the financial sector produce so many unicorns?

Xiaguang Society: As we understand, BAI previously invested in 3 fintech IPO companies within 5 years in China; afterwards, you set your sights on the overseas Fintech market, investing in Opay in 2019, Stori and Reap in 2020, and Trubit in 2021, all of which have achieved explosive growth after your investment, with two of them already becoming unicorns. How does BAI continue to identify early opportunities in the fintech development?

Zhao Penglan: The core point is that we are one of the few funds in China that have been continuously and deeply engaged in the Fintech field, so we have accumulated a large amount of high-quality feedback data, both positive and negative. So when these companies meet with us in the early stage, we can quickly assess the existence of the opportunity and the probability of success. In addition, since we look at both the domestic and emerging overseas markets at the same time, we can use the experience from China to judge the opportunities overseas, and provide incubation or empowerment on the opportunities we believe have the highest probability of success, using China's product R&D capabilities to help the team supplement the most important talents, forming a comparative advantage in the local market.

Looking at the results, the Fintech field has produced the most unicorns and billion-dollar companies globally, so this track is the right one. This is similar to stock trading in the secondary market, where first you have to choose which market and which sector to focus on, and the specific stock selection only accounts for 30% of the success or failure, while the choice of market accounts for 70%.

Based on our experience, any economy with a certain scale has the soil to grow fintech unicorns, the key is the team's execution. In an economy that may seem to have a limited TAM for e-commerce, consumer goods, or B2B, it may still be possible to create fintech unicorns, because finance has a leveraging effect and is the industry with the highest monetization efficiency.

Xiaguang Society: Why is BAI so confident and determined about the development opportunities and potential of Latin American Fintech?

Zhao Penglan: We have a global layout in the Global Fintech field, not just limited to Latin America. Of course, we are very optimistic about Latin America, where the Fintech opportunities are very abundant. First of all, financial services must be rooted in the real economy, rooted in consumption and production, otherwise it will inevitably be a doomed bubble. When the economic fundamentals of a country are improving, a lot of financial services will emerge, and Fintech is to digitize these financial services.

But there is often a misconception that the opportunities generated by financial technology are simply correlated with GDP growth rate, which is a counter-consensus. We have found that the probability of producing Fintech unicorns is not positively correlated with the GDP growth rate of the market it is in, but is positively correlated with the economic stock and the willingness of residents to consume. A more accurate indicator is that it is positively correlated with the "laziness" of traditional banks in the local area. Currently, the two largest digital banks in the world, Nubank in Brazil and Revolut in Europe, do not rely on the Beta of GDP growth, but precisely reflect the positive correlation of the above indicators.

Mexico, the second largest economy in Latin America, has been a beneficiary of the near-shore outsourcing trend for a long time, and with the background of the global supply chain restructuring, a large number of manufacturing enterprises have moved in, bringing stable employment to Mexico. In March 2024, Mexico's unemployment rate reached a historical low of 2.3%. Stable employment has led to the emergence of a new middle class, and the rise in wages has brought about a continuous increase in consumer power, thus forming a new middle-class consumer market and creating a demand for financial services.

Landscape of the industrial city of Monterrey in northern Mexico, where Chinese companies have built factories

Looking at Chile, the fifth largest economy in Latin America. In 2023, Chile's per capita GDP exceeded $17,000, placing it among the high-income countries. And under the macro trend of global energy transformation, Chile, as the country with the largest lithium reserves and the second largest exporter in the world, is ushering in a period of rapid economic development. With lithium resources comparable to gold, this country is standing on top of rich mineral resources, so the stock is large enough.

Brazil, the largest economy in Latin America, is similar. Brazil is one of the world's largest agricultural product exporters. When manufacturing companies flock to Latin America, they will bring strong demand for upstream commodities, and the vast and resource-rich Brazil can undertake and supply these demands. In addition, almost all Latin American countries are net energy exporters, and they can achieve self-sufficiency at the energy level, which is crucial for an economic entity in the current international situation of frequent geopolitical conflicts.

The development of residents' income has brought a strong demand for financial services, but the supply of financial services in Latin America is extremely lacking. The top five foreign banks in Mexico account for 80% of the market share, and Brazil and Argentina are also similar, with insufficient innovation momentum. The main source of bank profits is the difference between loan interest income and deposit interest expense, and due to the imbalance between supply and demand, the difference for commercial banks in Latin America is the highest in the world. To what extent? The return on net assets of Mexican banks can reach twice that of China, and the spread between loans and deposits is the largest. This is what I call the "laziness" of traditional banks. Using a more data-oriented indicator, we call it the size of the financial inclusion market.

Fintech is doing financial inclusion, by extending supply and improving supply efficiency, to systematically solve the unmet demand for financial services. The size of the financial inclusion market can be calculated using a formula: per capita GDP x underbanked population. Using this formula, the global financial inclusion market leader is China, the second is the United States, and the third is not India or Indonesia, but Mexico.

Of course, if we apply this formula to other economies, we will also find that not only Latin America, but also many other parts of the world have continuous opportunities for the penetration of financial inclusion services.

Six out of the top nine startup unicorns in Mexico are fintech companies

Three Trillion-Dollar Opportunities

Xiaguang Society: Not only in emerging markets like Latin America, how do you see the global development trend of Fintech?

Zhao Penglan: We believe that Global Fintech currently has three major trends.

The first trend is the continuous penetration of financial inclusion, that is, the users who were not served or not well served by banks before are now getting better services due to the emergence of Fintech. This is happening in mature markets like Europe and the United States, and is happening more vigorously and rapidly in emerging markets like Southeast Asia, India, and Latin America.

I just talked about emerging markets like Latin America and Southeast Asia, but it's the same in developed markets like Europe and the United States. Although an American citizen may have a credit card, he may not have obtained a sufficient credit limit from the bank, but a fintech company can allow him to get the credit limit he deserves. The reason behind this is that the transaction structure and cost structure of Fintech are different from traditional banks, so it can serve a group of people who are more underserved or difficult for banks to serve.

For example, there is a product in the US that is very popular, called the HELOC Credit Card (HELOC stands for Home Equity Line of Credit). Many Americans who have a house, this house is most likely already mortgaged, but before and after the pandemic, the house prices in some parts of the US have risen, for example, the original house worth $1 million is now worth $1.2 million, in theory the owner can re-mortgage this increased amount to get some funds. But this business is not something banks are willing to do, because mortgage products are cumbersome to operate and the amount is not large enough, so it is handed over to Fintech platforms, and the HELOC Credit Card appears, that is, the platform issues a credit card based on the owner's property appreciation, and the owner enjoys further credit services, and Fintech's big data dynamic pricing can help the platform flexibly adjust the credit card limit to control risks, which is also a case of continued penetration of financial inclusion, and just doing this one product, there are already two unicorn companies in the US.

From the perspective of the global increase in new bank users, the market share of digital banks has already surpassed traditional banks, and these digital banks currently only penetrate retail banking business, and in the future they will definitely pose a challenge to traditional banks' corporate business and wealth management business. Our judgment is that there will be 5-10 digital banks with a market value of over $100 billion in the future. We believe that the current digital banking leaders Nubank and Revolut will have a market value of over $100 billion in the next 3 years.

The second trend is the popularization of embedded finance. What is embedded finance? Embedded Finance refers to the integration of financial services directly into the products or services of non-financial companies, so that users can access payment, credit, insurance and other services without going through traditional financial institutions. In plain language, it means using finance as a way to monetize any scenario, and you will find that this is the most efficient way to monetize.

Everyone is familiar with scenarios like Klarna and Affirm embedded in e-commerce, "buy now, pay later". But it's far more than that, we find that more and more companies are using financial services as the most important monetization means. For example, Shopify, you say it's an e-commerce company or a SaaS company, but over 60% of its revenue comes from payments and finance. Another example is Deel, a global employment and EOR company, for a long time the media touted it as the world's fastest-growing SaaS company to reach $100 million in annualized revenue, but this is a misunderstanding, Deel's rapid monetization is actually relying on global payroll and cash in advance, these two financial businesses. This is what I mean by the high efficiency of embedded finance monetization in the scenario.

We estimate that by 2030, the revenue of the embedded finance market will reach $320 billion, of which $200 billion will be in the B2B field and $120 billion will be in the B2C field.

The third trend is the outbreak of decentralized financial services. This is an increasingly prominent disruptive opportunity, which is to use the real-time settlement capability of blockchain technology, use stablecoins as a new digital foreign exchange and its global circulation capability, to replace SWIFT in cross-border remittances and payments. Everyone must have used SWIFT, it is the most important infrastructure of the global financial system, the world's largest cross-border payment clearing communication system, with a history of nearly 60 years. In a vivid way, SWIFT used to be "Move money at Bank speed", and now with the support of blockchain and stablecoins, it can be "Move money at Internet speed". What used to take several working days for a transfer can now be done in just a few seconds, and the cost has also dropped significantly. This is a huge space, with $200 trillion in transactions running on SWIFT per year, and a 1% penetration rate is a $20 trillion opportunity, but we believe the penetration rate will be far more than 1%.

This transformative trend not only facilitates the flow of funds, but also has great practical significance. Many emerging market countries in Asia, Africa and Latin America have highly unstable exchange rates and poor liquidity in exchange rate conversion. Using stablecoins as a supplement to bank transfers can largely free many cross-border trade companies from exchange rate fluctuation risks and greatly improve convenience. Why is Huawei the largest beef trader in Argentina? Because Huawei has generated local currency income in Argentina, but it is difficult to convert it into fiat currency, either because the conversion of fiat currency is difficult or because of the risk of rapid depreciation of the local currency; therefore, they will use the Argentine currency to buy beef, Argentine beef is popular, and then sell the beef, in this case, beef is essentially a stablecoin, and blockchain technology provides a systematic solution. So I think this will have a very far-reaching impact, it will allow a lot of trade and capital flows to shift from the original necessity of going through Swift, paying high bank fees, and taking a long time, to entering into a new trading medium, and this new trading medium will also spawn many new applications.

We saw the opportunity for this matter in 2020, made early arrangements, and over the past two years, we have invested in two licensed and compliant companies, both of which have grown to be industry leaders. One is Trubit, the largest in Latin America, which has fully integrated into the Stripe system; the other is Reap, located in Asia, which handles 3% of global stablecoin trading volume on its financial infrastructure and is also about to grow into a new unicorn company.

TruBit has become the platform with the most cryptocurrency licenses and fiat currency deposit and withdrawal services in Latin America

Xiaguang Society: How will AI bring changes to fintech?

Zhao Penglan: AI will make finance provide services that understand you. We judge that the above trends will have an impact on fintech that is independent of the development of AI. To be realistic, we do not want to exaggerate the role of AI in fintech at this stage. The application of generative AI in financial services is currently mainly focused on cost reduction and efficiency improvement, such as more efficient customer service and R&D capabilities, but we have not yet seen a real increase in productivity.

However, with the improvement of large model reasoning capabilities, I believe the concept of "contextual money" can be realized. "Contextual money" refers to financial services that understand the context, such as in payment scenarios, AI can recommend appropriate payment methods based on factors such as the user's location, purchase history, and time. For example, when a user shops at a store they frequent, AI can automatically recommend using a combination of store points and credit cards to get the maximum discount. In financial planning, AI will analyze the user's life stage (such as newlyweds, raising children, near retirement, etc.), economic environment and other contextual factors. For newlyweds, AI can combine their income, spending patterns, and future plans (such as buying a house, having a child) to customize a reasonable savings and investment strategy, dynamically adjust asset allocation, and better achieve financial goals. In credit services, AI considers the industry development trends and employment market conditions of the borrower to determine the credit limit and interest rate. For borrowers in emerging, promising industries, and combined with the stable operating conditions of their companies, AI may offer more favorable credit terms.

Xiaguang Society: In the field of fintech, what is the relationship between emerging startups and traditional financial institutions, and how does BAI Capital view this competitive and cooperative relationship?

Zhao Penglan: From the overseas market, we find that the two sides are becoming more and more integrated.

Slow and steady wins the race

On the one hand, fintech companies are applying for licenses and being brought under regulation; on the other hand, traditional financial institutions such as banks are also embracing fintech, launching open banking strategies, the most typical of which is the European Union. The EU's open banking regulations, which came into effect in 2018, broke the banks' monopoly on customer data, allowing other fintech companies to access this data with the customer's permission to train their risk control models, thereby democratizing financial information and promoting innovation in the financial sector.

The most common form of cash payment in Mexico is Oxxo, a chain of convenience stores with 150,000 stores across the country

Xiaguang Society: Based on BAI's many years of investment experience in fintech, what advice would you give to entrepreneurs who want to enter this field?

Zhao Penglan: The most critical thing is to respect the local market rules and never think you have a god's-eye view.

First, you must pay attention to licenses and compliance, which is a very important point. Many founders who come overseas may initially have expectations of a frontal assault, and do not respect the local regulations. Because the regulation of fintech in China was once lagging, none of the domestic lending companies have obtained a full banking license, but this was a very China-specific phenomenon at the time, without right or wrong, but a result of the "mass entrepreneurship and innovation" era, where everyone was rushing to get things done quickly, believing that speed was the top priority. But this was a very special situation, which has now been corrected, and other markets are not the same.

So when entrepreneurs come to overseas markets, from day one, you must apply for a license and comply with local regulatory rules. Many internet founders with a fundamentalist mindset may feel that speed is everything, but in the field of fintech, it is precisely the opposite - those who run fast may not live as long as those who live long.

The second point is that just because your product has been validated in China does not mean it will be equally effective overseas. Many people say that per capita GDP and consumption capacity similar to second- and third-tier cities in China can directly replicate the Chinese experience in overseas markets, but that is not the case either. Even the smallest details of product form need to be adjusted to local conditions. For example, domestic products are used to having tabs at the bottom of the vertical screen, while in many emerging markets, they are more accustomed to horizontal swiping; Chinese people are used to the super app nine-grid format, but Europeans and Americans prefer a minimalist interface; many countries have users who are not good at math, unlike the Chinese, so the numerical display in the product needs to be extremely simple. There are many such differences in the way mobile internet products are used by Chinese, Southeast Asians, Latin Americans, Japanese, Europeans, and Americans, and in-depth user research is a must.

The third point is the business model, which also needs to be adjusted according to the market. For example, in China, your product may make money at the front end of the value chain, but in Latin America, you may need to make money at the tail end. If you simply apply the domestic business monetization model to other markets, you may find that the business model doesn't work, and you may have encroached on someone else's interests, so you have to go around and make money from another end. Strong local adaptation is required for the model to work.

For all the projects we invest in, the localization rate of the personnel organization is over 80%, and the local people's perception is that it is a thoroughly local company, which is very important.

Xiaguang Society: In your opinion, what are the comparative advantages of Chinese entrepreneurial teams in the field of fintech?

Zhao Penglan: As for the three major trends in the global development of fintech that I just mentioned, Chinese founders or Chinese teams are more adept at the first two trends, because these two things can be said to be global leaders in China, have been verified and mature, and have also withstood the most severe tests.

Take embedded finance as an example, the ultimate state is Double 11, which is the biggest pressure test for fintech in the world, something that will not happen in any other market. So many users using Huabei or Jiebei to place orders at the same moment on November 11th, a moment unparalleled in the world. The transaction volume of "Black Friday" in the US is 1/5 of China's Double 11, and Europe is even less. In this extreme state, our Chinese engineers and product managers can handle it, which is an obvious comparative advantage.

The Philippines has a national-level e-wallet called GCash, which had over 76 million registered users as of 2023, accounting for 67% of the Philippine population, and is currently the first unicorn company in the Philippines valued at over $5 billion. But if you have the chance to go to the Philippines and use it, you will find that it often has bugs. So the stability of Chinese payment products is not a given, it is the result of the hard work and wisdom of Chinese product managers, engineers, architects, and operations personnel, which allows us to do this well.

In fact, what China is leading the world in is not hard technology, but soft technology. How is soft technology not technology? In soft technology, China's leading global mobile payment is its greatest contribution to the world. The underlying architecture of many overseas payment products, including some national-level payment infrastructure such as India's UPI and Brazil's PIX, have learned from the design of China's mobile payment at that time. The United States is the world's largest economy, and China is the world's largest "new" economy, which is all thanks to the rapid development of mobile payment and the thriving application ecosystem.

We find that the new business model of 1Fintech going overseas should be to utilize China's R&D team to complete the system architecture and design of the product, but the core management team and partners should also have a local overseas team. How to combine the R&D team with the local team in a very good way is very difficult, and as investors, we can help the invested companies to build such a team; after the team is formed, we can then coordinate and communicate an efficient management approach. Some business models have core capabilities in the front-end, some have core capabilities in the back-end, and some have core capabilities in the underlying architecture. Investors need to use a large number of case studies to help entrepreneurs find their core position, and then find a balance with the local team.