The Fintech Opportunity in Emerging MarketsTheFintechOpportunityinEmergingMarkets

Chinese regulators, however, have recently intervened in the local fintech industry, primarily to avoid a concentration of services in just a few firms. They have been especially focused on preventing “closed loop” financial systems in which a single company owns and manages end-to-end financial transactions. This new scrutiny has become an overhang for the Chinese tech industry, making it much more challenging for investors to confidently identify growth opportunities. This example illustrates both the explosive growth potential and some of the inherent risks for the fintech sector in emerging markets.  

This growth potential is based, in part, on the fact that the companies running established e-commerce payment platforms are typically well positioned to expand into new business areas. Because they combine e-commerce with social media, they have compiled relatively sophisticated user profiles. Using technology based on artificial intelligence, these companies can mine customer data to sell additional financial services, including credit scoring, lending, and asset management.

An Expanding Opportunity

We believe several emerging markets—especially Indonesia, India, and Brazil—are at an early stage of fintech development and have large underserved and unbanked populations, as well as SMEs (small- and mid-sized enterprises) that can benefit substantially from improved access to financial services.

Each country is developing its fintech industry according to its needs and within its particular regulatory framework. In some countries, such as India, regulators have allowed incumbent banks to develop and roll out fintech services. India has also introduced a Unified Payments Interface (UPI), which facilitates quick and cheap transfers of funds. These decisions have made the huge growth opportunity in Indian fintech likely to be less profitable for investors and highlight the need for careful bottom-up analysis of the companies in the emerging markets fintech space.

In other markets, such as Brazil and Indonesia, regulators have lowered the barriers to entry, thus encouraging tech companies to acquire bank licenses and offer fintech services. Brazil has also established a government-owned and government-run transaction system, PIX, which replaces a slow and expensive process with instantaneous and virtually free transactions. Some regulators have allowed fintech firms to offer a range of banking services. Indonesia, for example, permits channel partnering—where internet platforms are able to originate loans and offload the risk by selling the loan to a bank. This model can be very profitable but has a notorious reputation—off-balance-sheet mortgages almost brought down the global economy in 2008. Brazil’s regulators, in contrast, require that loans stay with the originator. However, the secular trend to replacing cash transactions with digital payments has a long growth runway in these markets.

Another area that appears especially ripe for fintech disruption across emerging markets is in credit creation. Significant parts of LatAm and ASEAN adult populations have no bank account and therefore little access to credit. Evaluating the financial resources provided by financial corporations to the private sector (as a percent of GDP) is one way to measure a population‘s access to banking. In key Latin American markets, this figure remains below 75% compared to the more than 140% in developed markets such as the United States and the United Kingdom (Exhibit 2).² In the ASEAN region, financial credit to the private sector can also be low. Moreover, most credit loans are held by large, incumbent banks, which have directed resources to their most profitable pool of consumers and businesses. The resulting financial system is characterized by low credit penetration and a concentration of outstanding credit with traditional financial institutions—an opportunity, in our view, for fintech companies who can meet this enormous need.

Risk Awareness

Investors, however, should be aware that these opportunities also carry risks. The importance of regulators cannot be overstated. Sudden, unexpected changes to regulations can negate long-term company plans, undermine competitive advantages, and make it virtually impossible for investors to model earnings and revenue growth.

Another risk is credit quality. Rapid growth in the fintech industry can result in lower-quality loans, which is a risk in emerging market economies as their credit markets are highly cyclical. With war, inflation, and economic uncertainty weighing on global investor sentiment, we are paying close attention to any evidence of credit deterioration. Where the fintech company is the offshoot of an e-commerce company, we would expect the company to leverage the data and credit insights gleaned from the e-commerce platform in the form of superior credit quality compared to local banks that may not have this information.

These risks notwithstanding, we see fintech in emerging markets as a significant investment opportunity, offering exposure to three secular growth themes: technological innovation, financial services for the unbanked, and the strong growth of the middle class within the emerging markets. However, given the complexity of fintech investing and the multiple levels of systemic and idiosyncratic risk, we believe investors should combine a thorough understanding of the local regulatory and market environment with fundamental, bottom-up analysis of individual fintech companies. 

¹One yuan equals approximately 0.16 U.S. dollars and 0.13 euros (as of June 2020). 

²Most recent data available.