RIO DE JANEIRO, BRAZIL – Since their inception, banks have had a simple business model: to raise money from account holders and lend it with interest. Much more than an activity of “greedy people” – an image consecrated by the character Shylock in Shakespeare’s classic The Merchant of Venice – banks have been instrumental in the greatest achievements of modern man, from great navigations to technological advances, from the conquest of democracy to innovations in medicine.
Without credit, the world as we know it would not exist. According to American economist Robert Shiller, Nobel laureate, the financial system enables the transformation of “creative impulses into vital products and services”. At the dawn of the digital era, all this has been somewhat challenged. The notion that the traditional banking model is becoming outdated is growing among investors, and that in their place there will be room only for the so-called fintechs, app-based financial institutions.
In Brazil, the mistrust has been evidenced by comparing the share performance of the four largest banks in the country – Itaú, Bradesco, Santander and Banco do Brasil – with that of Inter, one of the digital institutions that best symbolizes the new times. Since Inter debuted on the stock market in April 2018, its market value has multiplied eight fold. In addition to Inter, another star in the segment is the XP brokerage house, which has shares traded on the American Nasdaq exchange.
From December last year, when it went public, the stock rise has reached 60 percent in dollars. The four big banks, in turn, saw a drop of nearly 30 percent in their share prices over the same period. The pandemic worsened the scenario: while the shares of big banks have been losing nearly 40 percent between late February and early October, as is the case with the Bank of Brazil, Inter’s shares have climbed about 25 percent.
The phenomenon is not only local. In the United States, four of the country’s most traditional financial institutions figure in the list of the ten largest stock market declines in 2020: JP Morgan, Wells Fargo, Bank of America and Citigroup.
The phenomenon does not represent the end of classic banks. Far from it. When the figures are considered, the disadvantages of newcomers compared to traditional banks start to emerge. While Inter recorded just under R$3 million in profits in the second quarter and has R$12.4 billion in assets, Santander, with 27 million customers, posted profits of R$2.13 billion and R$987 billion in assets.
In June, Itaú’s credit portfolio totaled R$811.3 billion. For Inter, the amount barely reached R$6 billion. “Large banks are money-generating machines,” says Alberto Amparo, an analyst at Suno Research. “Despite the competition with the Fintechs, they still have many advantages.”
Among them are economy of scale, efficiency and the ability to raise money in the market at a lower cost than smaller institutions. Despite all the detached guise of digital banking apps, the banking business is still the same as it was 500 years ago: lending money. “Fintechs need to grow a lot to be able to lend as much as a big bank,” Amparo says.
With their size – and billion-plus profits – banks can simply absorb part of the competition. In marketing, Itaú is fighting with XP in the growing market of individual investors. But in 2017, it bought almost 50 percent of the brokerage house, a share that may increase in coming years. “Fintechs must be partners, and not only competitors,” says Renato Lulia, head of Investor Relations and Market Intelligence at Itaú.
That said, it is undeniable that conventional banks seem to be facing a perfect storm. They suffer from specific issues caused by the pandemic. The main one: the quarantine led to the closing of countless businesses and placed millions of people in the unemployment line. The immediate result is a higher risk of default.
To illustrate, in the first semester last year Itaú allocated R$8 billion to cover potential defaults; in 2020, the amount rose to almost R$18 billion. This significantly impacts results: profits dropped almost R$14 billion since last year. This strategy annoys stock market investors, who see a source of dividends in banks.
What threatens major banks the most, however, is increased competition. A country with historically high interest rates and little competition has always secured fat profits for institutions that have undergone the process of natural selection of Brazil’s economic environment.
Historically, the returns of Brazilian banks are higher than those of foreign banks. Since 2010, Itaú’s ROE (Return on Equity) fell below 20 percentonly in 2012. In the USA, JP Morgan’s return in the past ten years has never exceeded 15 percent. Last year, it reached 13.9 percent.
Recently, Brazil’s Central Bank, following the example of civilized nations, launched a number of regulatory changes that allowed opening the market to fintechs – which drains revenue from large banks. The most recent change is the PIX, an instant payment and bank transfer system that can zero the cost of remittances, making obsolete both TEDs (Available Electronic Transfers) and DOCs (Credit Order Documents), significant sources of income for traditional institutions.
The impact of the Central Bank’s initiatives has resulted in unprecedented competition in the country. There is a wealth of fintechs specialized in insurance sales, credit granting, crowdfunding, investment platforms, and financial management, among other services. According to Radar Fintechlab, there are now 771 such companies in the country, an increase of 27 percent since last year.
Of these, 270 were founded over the past twelve months. There are seventeen digital banks and 114 credit platforms. “These companies have changed the market in a healthy way,” says João Carlos Santos, of the Accenture consulting firm.
The scenario is indeed challenging. “Banks are suffering attacks from all sides,” says Renoir Vieira, manager of Aurora Capital and critic of the country’s financial institutions business model. Vieira became famous by suggesting the sale of Itaú’s shares – a speculative operation in which the operator bets on the depreciation of the price of a given share. According to him, traditional banks are losing the battle to Fintechs.
“They will continue to be good and well-managed companies, but with much lower profits then the current ones. Why would Itaú have a higher profit than JP Morgan? It doesn’t make sense,” says Vieira.
Inter is the best example of the new generation. “We are not a bank, but rather a financial and non-financial services platform,” says João Vitor Menin, Inter’s CEO. The bait to attract clients, typically young people, is the zero cost in opening and maintaining a checking account. To this end, much less infrastructure is required. Not having physical branches is one of the differentials pointed out by Menin. According to him, the client maintenance cost is only 15 percent of what large banks spend on the same activity.
Once inside the platform, anything goes to make a profit. The app is not restricted to traditional banking services, but allows the purchase of products such as clothing, sneakers and airline tickets. In the second quarter, the marketplace grew by 218 percent, with sales of R$123 million. The pace of account opening is as high as 20,000 per day. Currently, there are approximately seven million Fintech account holders. It is this frenzied investment pace, with a pinch of innovation, that is seducing investors on the stock market.
Creating an ecosystem with several brands is Santander’s strategy to compete with Fintechs. Recently, the Spanish bank bought 60 percent of Toro Investments’ online brokerage house. Toro joins Sim, a credit platform for individuals, and emDia, a debt renegotiation platform, among other 22 affiliated brands that operate in segments such as credit, real estate, insurance, technology, entertainment and investments.
“We can create a large ecosystem and be as good as Fintechs specialized in a single product,” says Sérgio Rial, Santander’s CEO. State-owned banks have also increased their digital presence. Caixa Econômica, the Federal Savings Bank, has launched the Caixa Tem app which, among other features, enables the payment of bills without cards in lottery houses, and a few days ago Banco do Brasil created a digital account fully handled through cell phones.
Who will win the battle? Maybe both. Some analysts believe that conventional banks will only shrink in size, but they will continue to be companies as solid as they have always been. In turn, Fintechs need to achieve almost inconceivable gains to outperform giants that have been in the market for over 200 years, such as Banco do Brasil. However, what is known is that, as is usually the case in a market in full competition, the consumer wins.
Source: Veja