Juan José Cervantes
Managing Partner
Trebol Capital
/
Expert Contributor

Fintech: An Industry on the Rise

By Juan José Cervantes Mena | Mon, 02/28/2022 - 15:00

For some years now, fintech startups have been increasing their presence within the financial industry. Proof of this is the participation they have in industries that were previously dominated by the big players of yesteryear, such as debit cards, consumer credit, exchanges of different types of assets and business credit.

But what exactly is the fintech industry? The fintech industry involves the use of technology in the financial industry for the development of the ongoing activities of businesses. But the industry is very broad since, as we have mentioned, it involves the different solutions or advances within the financial industry. In view of this, the Fintech Association of Mexico has made a classification that serves as a parameter to locate the different branches of the fintech industry, which designates the following branches:

• Means of payment and transfers

• Infrastructure for financial services

• Digital credit origination

• Financial solutions for companies

• Personal finance and financial advice

• Financial markets and investments

• Crowdfunding

• Insurtech

• Cryptocurrencies and blockchain

• Disruptive financial entities

In large part, the emergence of the strength of the fintech industry in recent years compared to other new industries in the use of information technology has been divided into two important points:

First, the flexibility that fintech companies have against the different players in the industry to be able to perform different functions much faster and with a much more personalized approach.

Secondly, they propose solutions to problems that the traditional financial industry cannot solve, either due to regulation or operation, in order to generate greater efficiency in the use of resources.

This has brought not only a series of interesting solutions but also the emergence of many companies that pose as fintech companies and that with little regulation from the authorities have been able to carry out operations and even raise capital from the general public. This has generated an urgency at the industry level to determine sufficient regulation to be able to deal with these companies and to help proper fintech companies achieve their development under the correct supervision of the authority.

Mexico has been a reference in fintech regulation, including the well-known Fintech Law, formed during the previous administration, which among other issues puts companies in this branch under regulation in order to have control over them with respect to their functions, especially before the general public. This has caused a purge in the industry in Mexico where many companies have gotten out of the game.

Additionally, it has pushed fintech companies in the country to have more resources, largely due to the solidity of the remaining participants, in addition to forcing the large banks to turn to the industry in search of solutions for their daily operations.

It has also led to interest from foreign companies. Proof of this is the arrival of firms like NuBank, a fintech that offers credit cards. In Brazil, the country from which it originates, NuBank has more than 20 million cards placed in addition to a valuation of US$20 billion, which places it as one of the most important startups in the fintech industry and one of the best-valued unicorns in Latin America.

Mexican startups like Clip, a point-of-sale terminal for businesses, Konfio, which offers business credit, and Bitso, a cryptocurrency exchange, have become unicorns. That is, they have a valuation of more than $1 billion dollars. Of the Mexican unicorns at the time of this publication, almost half are fintech companies, demonstrating their great drive. This strength will be cemented due to the flow of important players wanting to be part of this nascent industry.

There is a great deal of talk that they come to offer services and products that traditional banks are not offering, but at what cost?

Let us remember that venture capital funds that invest in these companies seek growth above all, so the value of the company is based on the acquisition of users at the highest possible speed where the quality of the user or the quality of the product, including profitability, pass to a second term.

And what dangers does this bring in some fintech models? Here are two: to continue their accelerated growth, the fintech will have to reduce its filters when granting credit and ask for fewer guarantees in order to have this rapid acquisition of users that the funds are waiting for; and second, these fintech companies are receiving money from debt funds but with rates of up to 18 or 22 percent because these funds perceive the risk model of the fintech, and if the startup wants to grow rapidly it has to lend at rates above 40% to get from under the contracted personnel expenses, marketing efforts and technology, and thus be able to sustain this growth model in some way.

The challenge for these companies is to be able to achieve something that the traditional financial industry appreciates in an important way, which is the quality of the portfolio, given that a large part of these valuations is linked to the growth of the loan portfolio. This puts the quality of the portfolio at great risk: when there is little stress in the economic model of the companies, amounts of money begin to be lost because they are uncollectible.

High growth requires a substantial amount of cash to be able to keep pace in models that may never become profitable, given the characteristics of the companies as well as those that are accredited. In the face of this, voices have arisen denoting the great danger in this type of model given that there is a point where the potential clients of a fintech meet and begin to open other segments that are far from the core business of these companies, in addition to taking extremely high risks to achieve compliance with these metrics.

Photo by:   Juan José Cervantes