Digital banking allows for individuals to access a bank’s services remotely, exchange money across vast distances, and engage with economic activity in ways that were not possible before. Digital banking plays a vital role in economic development because digital banking can facilitate greater economic inclusion for those living in poverty or those being un- or underbanked.
While much research has been dedicated to understanding the role of digital banking in economic development amongst communities in the United States, Europe, and Asia, particularly China, fewer resources have been allocated to understand digital banking in the Latin American context. Within Latin America, while digital banking does hold potential for economic inclusion, that potential has not been reached because of a lack of access to internet capable devices by unbanked people. Furthermore, high fees, policies which prioritize wealthy users, and a lack of trust in the banking sector create additional barriers for accessing digital financial services. In order to facilitate greater inclusion in the banking services, governments must invest in digital and electric infrastructure and pass policies banning excessive fees and paperwork which create barriers to banking access.
The Current State of Banking in Latin America
As the role of the internet and technology has grown, the financial sector has increasingly digitized. Fintech companies, short for “financial technology,” create software and technologies meant to improve and automate traditional forms of finance such as brick-and-mortar banks.[1] As in other parts of the world, Latin America has seen a substantial increase in the number of fintech services and platforms offered in the region since 2018.[2] This increase is likely due to the potential for growth in the Latin American financial services industry which makes the market appealing to investors. In much of Latin America, the banking penetration rate and the number of people with a bank account is low compared to the global average.[3] For instance, in Mexico, the second largest populace in Latin America behind Brazil, more than 50% of citizens are believed to be unbanked.[4] Across all of Latin America, only 51% of adults have a bank account.[5] Due to this gap, fintech startups such as Nubank and Kubo Financiero have identified Latin American as a prime growth region and have used digital banking services, as opposed to in-person banking, to disrupt the established and exclusive banking industry.[6]
For this reason, the digital banking sector has grown drastically in Latin America over the last several years. In 2018, 13% of Latin American companies surveyed by Finnovista, a venture development firm focusing on tech startups, had digital banking services. When the same group was surveyed in 2021, 43% offered digital banking.[7] While part of this rise can be attributed to the necessity of digitalization during COVID-19, the industry was steadily growing prior to the COVID-19 pandemic due to corporations identifying the large number of unbanked and underbanked people as a potential new client base. The potential for growth has spurred a boom in the creation of “neobanks,” or banks that use fintech to operate completely digitally.[8] The influx of new fintech companies and neobanks is not only a result of identifying potential growth, the amount of digital services offered is also reflected in the number of digital service users. In 2018, nine million people living in Latin America had an account in a neobank, in 2021 this number grew to 77 million.[9] Notably Brazil, the largest nation in Latin America, saw 42% of its citizens holding an account in a neobank in 2021.[10]
Favorable policies and regulations towards fintech startups have allowed for the growth that the industry is experiencing. Brazil, Mexico, Chile, and Colombia all passed legislation between 2018 and 2021 that created legal frameworks in which fintech companies could operate between the lines of traditional financial institutions and technology companies.[11] These laws allowed for fintech companies operating within the region to expand farther into the mainstream financial industry. Mexico’s Ley Fintech went as far as to require legacy financial institutions to allow new financial companies to access their data with the goal of creating better products for Mexican consumers.[12] By doing so, fintech companies have gained greater legitimacy from governments and the market. Furthermore, the regulatory landscape has created a favorable environment for the formation of new fintech companies and the growth of existing ones. While the current banking sector in Latin America is still highly impacted by traditional and exclusive banking practices, fintech groups offer a new vision for the future of banking in the region.
Financial Exclusion
The landscape of traditional financial institutions in Latin America has left many people unable to access banking. Digital banking could lead to the transformation of Latin America’s financial sector as more people gain access to financial services.
According to the 2021 World Bank’s Global Findex Report, there are numerous reasons why people do not have access to financial services or banking. The central reasons are that banking institutes are too far away from where people live, that financial services are too expensive to access, and that many do not trust financial institutions with their money.[13] These issues, while prevalent for all people, particularly impact low income communities. Globally, close to 36% of unbanked people cite cost as the primary factor for being unable to open a bank account. In Latin America, the percentage is nearly 60%. Furthermore, women in Latin America are seven percentage points less likely to have a bank account than men, demonstrating that the issue of financial exclusion is gendered as well as class based.
These problems have been exacerbated by banking institutions which cater to the wealthy and have not adapted to include lower income people.[14] Most Latin American nations have a few national banks which host the majority of deposits within a given nation. These large banks, such as Brazil’s Itaú and Banco Bradesco, impose high and sometimes excessive fees on individuals in order to open an account. As demonstrated in the Global Findex report, financial services being too expensive to access is a primary reason why people do not have bank accounts. Some major banks even require their account holders to be in the top 20% of the income bracket for a country, excluding people with lower incomes from financial services.[15] Furthermore, it is estimated that nearly 30% of banking profits in Latin America come from fees associated with opening an account.[16] The national bank systems has created an environment in which banks are not incentivized to include lower income people and families in accessing their services. While a shift towards digital banking cannot completely solve the problem of access to financial services, digital banks have already proven promising for greater financial inclusion.
The Potential of Digital Banking for Financial Inclusion
Digital finance grants the opportunity for greater economic inclusion. Groups that have been historically excluded from formal financial services can gain access to banking through digital services which have lower fees, less paperwork, and can be accessed from rural areas. Access to banks has been shown to help those living in poverty increase their incomes and build economic resilience.[17] While digital financial services have potential for economic inclusion in Latin America, such services have already demonstrated positive impacts in communities around the world.
In the case of a Kenyan NGO known as the BOMA Project, a group that works to alleviate poverty among women, the World Bank found that women were able to increase their savings through participation in BOMA’s digital financial services project.[18] This suggests that improved access to financial services has real world implications for the lives of those living in poverty. Furthermore, the impacts of digital finances have been identified by international development organizations as areas for investment and improvement. In 2019, 71% of adults in the Philippines were unbanked.[19] The Asian Development Bank (ADB) has given grants to traditional banks in the region to transition to digital services with the idea that the high mobile phone penetration rate will enable young people to access financial services that they could not previously.[20] In this sense, digital financial services have already shown their impact on economic development and been formally acknowledged through investments by international institutions. In Latin America the high growth of fintech companies and neobanks could be combined by investment from development organizations to improve the lives of those in poverty and with lower access to finances.
As demonstrated in Table 1, the rate in which people receive and send digital payments (of both neobank transactions and payment processing forms such as PayPal and Venmo) has risen steadily throughout Latin America since 2014. While the rate of growth varies by nation, the consistency of this growth illustrates the increasing importance of digital financial services in people’s everyday lives. For this reason, improving access to digital banking is increasingly important as digital finances come to play a stronger role in people’s lives and economic activity.
Table 1: Made or received a digital payment (% age 15+)
Source: The World Bank, Global Findex Database 2021
Gaps in Inclusion and Digital Banking
While the number of people accessing digital banking services has drastically grown over the last five years, it is important to question who is accessing these services. Digital banks have great potential to increase economic inclusion in Latin America, but so far have not fulfilled this potential. Despite the increase in users, only about 20% of those accessing neobank services were previously unbanked.[21] The majority of neobank account holders then, already had access to financial services. Neobanks are able to offer banking services with fewer or no associated fees or forms, one of the primary barriers to accessing banking services. One estimate suggests that neobank’s fees are close to 20% lower than traditional banks.[22] However, as demonstrated by the demographics of those using neobanks, lower costs associated with neobanks have not spurred increased use among those previously unbanked. This indicates that even though digital banks have lower fees than established “in-person” banks, there are still barriers for unbanked people to access their services.
The primary barrier to accessing digital financial services is likely the barrier to access digital technology at all. A 2021 Global System for Mobile Communications Association, GSMA, report found that close to 40% of Latin Americans, or 285 million people, did not have access to the internet despite living in an area in which there were internet connectivity capabilities.[23] The high cost of data plans and internet capable devices, such as phones and computers, are one of the causes of the gap in internet access.[24] With this in mind, those who are unbanked cannot gain access to finances through digital banking without first gaining access to internet connectivity.
The correlation between economic development and access to digital infrastructure is not unique to Latin America. A study by scholars at the School of Economics at Guangxi University in China found that digital finance had the potential to greatly boost local economies growth, but concluded that China had to “promote digital infrastructure construction” in order to realize this potential.[25] In Côte d’Ivoire a digital financial services (DSF) initiative by the IFC found that financial inclusion increased with the introduction of a digital financial services pilot program. In particular, a small change shortage was causing significant burdens for local businesses and consumers. The introduction of the DSF program alleviated the financial burden as it allowed businesses to use digital finances to exchange money instead of small change.[26] Thus, Latin American nations must similarly prioritize the growth of their digital infrastructure in tandem with the growth of digital banks in order to promote economic inclusion.
The digitalization of the financial sector has great potential for economic inclusion, but if left to develop without the guidance of inclusive practices and sustainability in mind, might come to strengthen exclusive practices instead.[27] According to the World Bank’s State of Economic Inclusion report, 30% of government led programs globally use digital platforms and technology to deliver social services, due to the gap in access to the internet “economic inclusion beneficiaries are less likely to be connected or familiar with digital interfaces.”[28] Thus, many who need social service support are unable to access that support due to the lack of sufficient digital infrastructure. Similarly to government programs, without prioritizing investment in digital infrastructure, neobanks and other fintech groups cannot meet their potential for economic inclusion.
Drawbacks to Digital Banking
The growth of the digital financial industry and its potential for financial inclusion have made digital banking a key point of investment for economic development groups such as the World Bank and Inter-American Development Bank. However, just as digital banking has not met its full potential, its inherent drawbacks are also important to consider. Digital banks risk data security breaches, violations of consumer privacy rights, and internet fraud. These risks are also present for traditional banks but are higher for digital banks due to their online-only platforms.[29] Furthermore, the primary drawback for digital banking when it comes to economic inclusivity is the difficulty of making cash transfers to digital banks.
Cash is vital to the economic activity of the world, particularly among low-income communities. Despite rapid digitalization, in Latin America cash continues to be the most used payment method, with 38% of point of sale transactions using cash.[30] Unbanked and underbanked people typically rely on cash transactions because of a lack of access to digital payments and debit or credit cards. Additionally, the informal economy is mostly cash operated and with over half of all employment in Latin America being considered informal it is still widely relied upon for payments.[31] As digital banks do not offer brick-and-mortar services it is difficult for those paid in cash or heavily relying on cash in their economic activity to deposit that money into an account. In this sense, digital banking is not a strong option to those who are cash reliant. While the use of digital payments is rising, it is likely that cash will continue to be an important payment method in Latin America.[32]
Implications
Traditional banking has long been an exclusive financial service, particularly in Latin America where fees and paperwork make opening an account inaccessible to many people. The rapidly growing digital banking industry presents a unique opportunity for building a financial sector with greater economic inclusivity. Lower fees make digital banks more accessible and have been demonstrated to allow for account holders to save more money. However, these benefits have not yet been shown to have helped unbanked and underbanked people, who continue to be excluded from banking by factors such as insufficient digital infrastructure. For digital banks to meet their potential for economic inclusivity, greater investment must be made into digital infrastructure. Additionally, digital banks should not be thought of as a one stop solution. Digital banking investments must be made in congruence with greater efforts to increase formal economic employment and increase digital and financial literacy.
Endnotes
[1] “What Is Financial Technology (Fintech)? A Beginner’s Guide for 2023.” Columbia Engineering Boot Camps, 16 Dec. 2022, bootcamp.cvn.columbia.edu/blog/what-is-fintech/.
[2] “Study: Fintech Industry Doubles in Size in Three Years in Latin America and the Caribbean.” IADB, 26 Apr. 2022, www.iadb.org/en/news/study-fintech-industry-doubles-size-three-years-latin-america-and-caribbean.
[3] Kerr-Southin, Maggie. “Lac’s Rapid Digitization, Credit Risk and How AI Supports FIS: Brighterion AI: A MasterCard Company.” Brighterion, 10 Mar. 2023, https://brighterion.com/lacs-rapid-digitization-credit-risk-and-how-ai-supports-fis/#:~:text=The%20answer%20is%20both%20complex%20and%20simple%3A%20poverty%2C,services%20or%20were%20unable%20to%20pay%20the%20fees
[4] Li Ng , Juan José. “ENIF (National Survey of Financial Inclusion) 2018.” Www.Bbvaresearch.Com, 28 Dec. 2018, www.bbvaresearch.com/wp-content/uploads/2019/01/2018-12-07_ENIF_2018_EN.pdf.
[5] “How Digital Banking Is Transforming Access to Finance in Latin America and the Caribbean.” Oxford Business Group, 16 Mar. 2023, oxfordbusinessgroup.com/articles-interviews/how-digital-banking-is-transforming-access-to-finance-in-latin-america-and-the-caribbean/
[6] Kauflin, Jeff. “How David Vélez Built the World’s Most Valuable Digital Bank and Became a Billionaire.” Forbes, 4 May 2023, www.forbes.com/sites/jeffkauflin/2021/04/07/fintech-billionaire-david-velez-nubank-brazil-digital-bank/?sh=55d2c2646b27.
[7] “Fintech in Latin America and the Caribbean: A Consolidated Ecosystem for Recovery.” Iadb.Org, 2022, publications.iadb.org/publications/english/viewer/Fintech-in-Latin-America-and-the-Caribbean-A-Consolidated-Ecosystem-for-Recovery.pdf
[8] Walden, Stephanie and Mitch Strohm. “What Is A Neobank?” Forbes Advisor. June 24th, 2021. https://www.forbes.com/advisor/banking/what-is-a-neobank/
[9] Switzerland, Fintechnews. “Latin America Sees Booming Digital Banking Sector with Brazil at the Lead.” Fintech Schweiz Digital Finance News – FintechNewsCH, 13 July 2021, fintechnews.ch/latin-america-fintech/latin-america-sees-booming-digital-banking-sector-with-brazil-at-the-lead/47312/
[10] Digital Banks and the Evolution of Banking in Latin America, dock.tech/en/blog/digital-banks-latin-america/. Accessed 23 May 2023.
[11] Switzerland, Fintechnews. “Latin America Sees Booming Digital Banking Sector with Brazil at the Lead.” Fintech Schweiz Digital Finance News, 13 July 2021, fintechnews.ch/latin-america-fintech/latin-america-sees-booming-digital-banking-sector-with-brazil-at-the-lead/47312/.
[12] Strange, Angela, and Matthieu Hafemeister. “Latin America’s Fintech Boom.” Aa16.Com, 2 June 2022, https://a16z.com/2021/04/13/latin-america-fintech/.
[13] Demirgüç-Kunt, Asli, et al. “The Global Findex Database 2021: Financial Inclusion, Digital Payments, and Resilience in the Age of COVID-19.” World Bank, 18 Nov. 2022, www.worldbank.org/en/publication/globalfindex/Report.
[14] Demirgüç-Kunt, Asli, et al. “The Global Findex Database 2021: Financial Inclusion, Digital Payments, and Resilience in the Age of COVID-19.” World Bank, 18 Nov. 2022, www.worldbank.org/en/publication/globalfindex/Report.
[15] Mulard, Aude. “Financial Inclusion and the Fintech Trends in Latin America.” Shaping Horizons, 2 Apr. 2021, www.shapinghorizons.org/post/financial-inclusion-and-the-fintech-trends-in-latin-america#:~:text=In%20Latin%20America%2C%20around%2050%25%20of%20the%20region%E2%80%99s,population%20have%20savings%20in%20a%20formal%20financial%20institution.
[16] Pooler, Michael. “Brazil’s Biggest Banks Battle for Reinvention in Digital Era.” Subscribe to Read | Financial Times, 4 Apr. 2021, www.ft.com/content/40961d14-f493-422c-9eb6-4d9949716301.
[17] “How Countries Can Expand Access to Digital Financial Services.” World Bank, 29 Apr. 2020, www.worldbank.org/en/topic/financialsector/publication/digital-financial-services.
[18] Colin, et al. The State of Economic Inclusion Report 2021: The Potential to Scale. World Bank Group. 2021.https://openknowledge.worldbank.org/server/api/core/bitstreams/33e62d47-7ba8-5d38-ae09-48f1daf3607d/content
[19] Adrian, Marc. “71% of Filipinos Are Still Unbanked in 2019.” iMoney.Ph, 20 July 2020, www.imoney.ph/articles/71-percent-filipinos-unbanked-2019.
[20] “Testing Fintech Bank Solutions in the Philippines.” Asian Development Bank, 4 Nov. 2019, www.adb.org/results/testing-fintech-bank-solutions-philippines.
[21] Lehr, Lindsay. “Latin America Payments 2021: The Good, the Bad and the Ugly.” Americas Market Intelligence, 5 Aug. 2021, https://americasmi.com/insights/latin-america-payments-2021-the-good-the-bad-and-the-ugly/
[22] Castano, Ivan. “Latin America: Neobanks Boom, but with a Bubble?” Retail Banker International, 3 Nov. 2020, www.retailbankerinternational.com/research/latin-america-neobanks-boom-but-with-a-bubble/#:~:text=Overall%2C%20Diniz%20says%20neobanks%E2%80%99%20fees%20are%20roughly%2020%25,lower%20than%20those%20of%20the%20high%20street%20banks.
[23] “La Oportunidad Para Una América Latina Digital Y Conectada.” Www.Gsma.Com, 2021, www.gsma.com/latinamerica/wp-content/uploads/2021/04/La-oportunidad-para-una-America-Latina-digital-y-conectada.pdf.
[24] Drees-Gross, Franz, and Pepe Zhang. “Less than 50% of Latin America Has Fixed Broadband. Here Are 3 Ways to Boost the Region’s Digital Access.” World Economic Forum, 21 July 2021, www.weforum.org/agenda/2021/07/latin-america-caribbean-digital-access/.
[25] He, Chengying, et al. “Research on the Influence of Digital Finance on Local Economic Development.” Elsevier, 10 May 2022, www.sciencedirect.com/science/article/pii/S1877050922005877.
[26] “Digital Access: The Future of Financial Inclusion in Africa.” Ifc.Org, 10 Jan. 2018, www.ifc.org/wps/wcm/connect/96a4f610-62b1-4830-8516-f11642cfeafd/201805_Digital-Access_The-Future-of-Financial-Inclusion-in-Africa_v1.pdf?MOD=AJPERES&CVID=mdz-QF0.
[27] “Latin American Economic Outlook 2020 : Digital Transformation for Building Back Better.” OECD iLibrary, 2020, www.oecd-ilibrary.org/sites/e6e864fb-en/index.html?itemId=%2Fcontent%2Fpublication%2Fe6e864fb-en.
[28] Andrews, Colin. “The State of Economic Inclusion Report – 2021.” Worldbank.Org, 2021, https://openknowledge.worldbank.org/server/api/core/bitstreams/75ea67f9-4bcb-5766-ada6-6963a992d64c/content
[29] Barefoot, Jo Ann. Digital Technology Risks for Finance: Dangers Embedded in Fintech and Regtech. Harvard Kennedy School, Mossavar-Rahmani Center for Business and Government. No. 151, June 2020. https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/files/AWP_151_final.pdf
[30] “Cash Is Used for 20.5% of Global Point of Sale Transactions (FIS, 2021).” Cash Is Used for 20.5% of Global Point of Sale Transactions, 21 Aug. 2021, www.cashmatters.org/blog/cash-used-205-global-point-sale-transactions-fis-2021.
[31] Gómez Ramírez, Enrique and Cecilia Handeland. The Informal Economy and Coronavirus in Latin America. European Parliamentary Research Service. PE 690.587. May 2021. https://www.europarl.europa.eu/RegData/etudes/BRIE/2021/690587/EPRS_BRI(2021)690587_EN.pdf#:~:text=Although%20the%20scale%20of%20the%20informal%20economy%20has,employment%20in%20the%20region%20%28around%20140%20million%20workers%29.
[32] The 2020 Mckinsey Global Payments Report, Oct. 2020, www.mckinsey.com/~/media/mckinsey/industries/financial%20services/our%20insights/accelerating%20winds%20of%20change%20in%20global%20payments/2020-mckinsey-global-payments-report-vf.pdf.
