Mexico’s fintech boom

FINANCIAL INCLUSION

If I had a dollar for every time I heard someone in Mexico use the phrase “financial inclusion” in recent days, my digital wallet would crash.

The nation is belatedly awaking to the urgent need for a deeper and broader banking system, and everyone from the “fintechs” vying to win the race to provide financial services to the government seeking to boost fiscal revenue want to capitalize on the so-called unbanked. The idea of financial inclusion seemed like the only topic that officials and financiers wanted to discuss at the country’s annual banking convention near Puerto Vallarta last week, a positive step given Mexico’s evident shortcomings in this part of the banking sector. More than 85% of purchases below 500 pesos (about $25) are made in cash and only 3.4% of the population have a savings account with investment options.

Surely, it’s just a matter of educating Mexicans about the superiority of digital transactions and the convenience of using banks to make their financial lives easier, right? Wrong.

Such views underestimate how entrenched the use of cash is in a country where more than half the labor force remains part of the informal economy, and many companies and households operate in the financial shadows to avoid taxes or regulations. The sad reality is that making Mexico a financially inclusive economy on par with neighbors such as Chile and Brazil may take decades. To speed up the process, the government — which until now has relied on the privates to lead digitalization efforts — should make of expanding banking services a priority as a way to achieve a more dynamic business environment. That means adopting bold ideas such as granting a digital wallet to every Mexican while curtailing the use of cash in transactions and giving tax incentives in exchange for using electronic payments.

Mexico is one of the world’s largest manufacturing hubs, capable of building plane parts and state-of-the-art vehicles. It’s the US’s top trading partner. To continue developing, it’s crucial that Mexico upgrades its banking system to better compete in the global economy.

Lured by forecasts of exponential growth, the number of financial products being offered has boomed in recent years. By some estimates, more than 1,100 domestic and international financial technology companies operate in Mexico, competing with established banks and nonbank retailers such as Walmart Inc. and Femsa in providing digital payment, lending and remittance services. Some even focus on extending credit to small companies.

Yet for the most part these operators focus more on gaining market share from rivals instead of converting Mexicans who had never considered an electronic wallet. It hasn’t been easy. Even with sweeping marketing campaigns, the percentage of the population that frequently uses cash shrank by just five percentage points between 2021 and 2024. By comparison, those in Brazil saying cash was their most used option fell to 22% from more than 60% between 2018 and last year after the disruptive emergence of the instant payments platform known as Pix.

There is social and economic value in having as many households as possible operate within a formal financial system and that should trump any fiscal considerations. As laudable as the goal of increasing tax compliance is, the government won’t convince many Mexicans to switch to the formal economy if that means paying more in taxes

Another problem is that fintech companies are plagued by relatively high ratios of bad loans due to aggressive strategies, which means consolidation among the many players in a crowded field seems inevitable. The industry has already seen a fair share of failures. Most recently, Grupo Financiero Banorte overhauled its digital bank Bineo after losing more than $50 million in just over a year of operations. More will surely follow. “There will be a consolidation of the financial system because technology will eventually equalize, and at some point, we'll have everything digital,” Andrés Rodríguez Ledermann, general manager in Mexico for Ualá, a Latin American fintech, told me. “The digitalization process is capital-intensive because expanding credit increases default rates.”

Despite the growing pains, Mexican authorities, including the central bank, need to find ways to force the unbanked into the financial system. There is social and economic value in having as many households as possible operate within a formal financial system and that should trump any fiscal considerations. As laudable as the goal of increasing tax compliance is, the government won’t convince many Mexicans to switch to the formal economy if that means paying more in taxes. Again, Brazil works as example: The moment the government suggested a closer oversight of Pix earlier this year, Brazilians panicked.

The problem isn’t, as suggested by Bank of Mexico Governor Victoria Rodríguez last week, just the perception that digital services are expensive or that they don’t meet the needs of users. To a big extent, the issue is that the incentives to use cash and to remain off the financial grid are still very powerful for a significant number of Mexicans. And that’s in addition to connectivity and logistical issues in the more remote parts of the country.

There is still much that authorities can do to make cash less sticky, starting with using the Banco de Bienestar — the state-owned entity that distribute billions of dollars in social assistance — to promote digital savings and investment plans in partnership with other banks. Making electronic transfers mandatory for more transactions, promoting interconnectivity between platforms and cutting the use of higher-denomination bills, together with other measures already in discussion, are also policies that can be easily adopted.

At the same time, the establishment of trustable judicial courts will be the best tool to promote the expansion of credit by reducing the legal uncertainty that loom over banking activities. Forcing institutions to lower interest rates won’t automatically lead to more loans to small companies, some of which don’t want to become indebted anyway.

Former President Andrés Manuel López Obrador famously boasted that he never used a credit card. As with millions of Mexicans, he was cash only. So it’s no surprise that his government did little to formalize the economy. His successor Claudia Sheinbaum appears to have different ideas, including a better dialogue with business and plans to drastically cut red tape for companies. The moment to push on that is now.

Originally published as: ‘Mexico’s Fintech Boom Needs Help from the Government’.

Courtesy: Bloomberg.com