A conversation with with Rafael Carvalho, Head of Credit Analytics for Nu Mexico
The LATAM fintech market is as ripe for innovation as one can get. With a population of 652M and a severe under-penetration of financial products, there is a dire need for new entrants to build products to elevate the financial health of the population. Venture capitalists have been aggressively investing in this opportunity – VC investment in Latin America has doubled every year since 2016, reaching an all-time high of US $4.6 billion in 2019. However, understanding the cultural, regulatory, and other complexities of the region is no easy feat for investors, founders, or startup employees.
Nubank, one of the earliest fintech darlings in the region, recently raised a $750M round led by Berkshire Hathaway at a $30B valuation. In this interview, we chatted with Rafael Carvalho who joined Nubank seven years ago and is currently the Head of Credit Analytics for Nu Mexico. In the interview below, Rafael talks about what makes this ecosystem so unique, the mechanisms of credit building and access, areas ripe for disruption, and tips for launching new products and building companies in the region.
Tell us a bit about your current role at Nu.
I spent the last 7 years at Nubank, first on our team in Brazil. Currently, I am the Head of Credit Analytics of Nu Mexico, one of our newer markets. I oversee all credit, fraud, and pricing decisions when it comes to Mexico. I’m involved in everything from launching a new product to developing a new credit model.
The LATAM financial ecosystem is massive, heterogenous, and difficult to understand from the outside. What are 1-2 unique characteristics of the market that makes it unlike any other market in the world?
The first thing that makes the LATAM market really unique is the high concentration of very few, massive banks. In both Brazil and Mexico, there are magnitudes fewer banks than in the US and other countries. This lack of competition creates very little incentive for banks to innovate – they are too big to fail. They don’t feel pressure to change and they also don’t provide a good customer experience. The concentration also makes it a really profitable business for these banks – there is no reason for them to eliminate hidden fees and high interest rates. There’s a huge opportunity for companies to come in and offer these products with a great customer experience and in a more transparent way.
The second point worth mentioning is the friendly regulatory environment that has emerged for fintechs over the last few years. In Mexico, a recent FinTech law has been approved to increase financial inclusion and formalize the economy. 90% of the payments in the region are cash, and there is a push to digitize more payments so that it is both easier to regulate and easier for more competition to emerge. Regulators have always wanted to figure out a way to introduce more competition, but it is challenging. The same thing happened in Brazil. Brazil has been investing heavily in open banking to create a way for any company to get data and build products on top of it. Brazil also developed the first 24/7 real time payment rails called PIX. This disrupted a previously massive stream of income for big banks – charging fees on top of transfers – but now it flows through the central bank, so it is free for the customer. We expect to see more new products built on top of this real-time payment infrastructure by emerging fintechs. This is all evidence to show that local regulators are really helping fintechs in the region. They want more fintechs to increase competition in the region to drive down prices, encourage innovation, and provide more opportunities for consumers.
Have these open banking tools also made it easier for fintechs to access this data or is it still mostly trapped in the legacy banks and national credit bureaus?
Absolutely, open banking is another very valuable source of data for everyone. Tapping into the credit bureaus’ new information on positive and negative payment history essentially means capturing a consumer’s entire history of transactions. Regulators behind these initiatives want competition to be on a level playing field, so they are actively trying to make this available to everyone. The intention is that the companies that are successful will be successful because they are providing the best customer/product experience or have developed the best credit models.
Are there any other implications of having such a high concentration of banks, besides predatory pricing and bad customer experiences?
The other big issue with having such a high concentration of banks is that knowledge about consumers is also shared among them. If you aren’t able to open an account or get a credit card at one of them, you likely aren’t going to be able to at the others either. They have similar mindsets about how they make decisions. For example, as a foreigner in Mexico I am still not eligible for many credit cards. Without Nu I probably wouldn’t have access to a credit card at all. This negative flywheel is created — if you don’t have credit, they don’t give you credit cards, and to get a credit card you have to jump through other hoops. In many cases, banks require you to directly deposit your payroll with them for many years before you get approved. There aren’t secured credit cards widely available like there are in other regions.
Let’s dig into credit – your area of expertise. Credit building is obviously very different in LATAM than the US, but let’s talk about how it might vary between countries within LATAM. What are some of the biggest differences in credit building between Mexico and Brazil?
In Mexico, we have had a FICO like score, which tries to capture the history of payments that a customer has made, for many years. On the other hand, Brazil’s credit bureau historically only captured negative information about consumer payments until new regulation was passed about 2 years ago. This meant that if you are paying all your credit cards on time but pay an electric bill late, the only thing bureaus will factor into your creditworthiness is your missed electric bill and eventual inquiries by financial institutions. However, recent regulation was approved to create a means to integrate positive payment data, and a richer payment history overall. Brazil is expected to catch up to where Mexico is in the next few years.
Looking forward, I think we will see banks get even more creative with how they underwrite credit. In most parts of LATAM, banks want to see a constant inflow of cash (ie. direct deposit of payroll configured) before they extend any form of credit to a consumer. With a lack of positive payment history, this is the most reliable way to see that a consumer is willing and able to pay back credit. This is good for young adults and foreigners, but for many locals who prefer to mostly hold and transact with cash this can make it difficult to build credit.
What are some of the most common challenges fintechs face when launching in the region? What advice would you give them before launching?
The first thing founders need to make sure they understand are the differences in regulation. As we talked about, each country within LATAM has its quirks. Some have strict regulations about deposits, some will have dynamics that drive up CAC, and there are complex cultural norms that could affect your business strategy. If you are from another country (founders or employees) you really need to understand the mechanics of society and how money moves. In Mexico, everything is cash based and paycheck to paycheck. Every 15th and 1st day of the month there are big lines at banks to cash out because they don’t want to keep it in their checking account.
Talent attraction and talent retention is also a big challenge. Engineers in LATAM are targeted by companies all over the globe, not just locally. This can create a tough and competitive scenario to hire for data scientists and engineers. Having an equity program is not enough – locals aren’t as knowledgeable about the value of equity, because the number of large exits in LATAM is still limited. Overtime, as companies like Nubank continue to pave the way and prove that large companies can be built locally, the value of equity will hopefully be more widely accepted.
Lastly, there can be a high bar to get locals to put money into a new fintech product. Figuring out a strategy to make sure that consumers trust you is essential.
When talking about unique mechanics of the way money moves, is there one thing that you think is most difficult for outsiders to understand about this ecosystem?
Every country is different, but it is important to understand what some of these differences are. One example is that in both Brazil and Mexico you have an option to pay for many goods with rotating installment payments free of interest. Consumers can pay with their credit card online, or can go in store and make a purchase using these installment payments, uniquely free of interest. This is a very common product in both Brazil and Mexico. These payment options really emerged to serve the big need for consumers who couldn’t access formal credit to be able to finance purchases in other ways. There’s a bunch of players now trying to bring buy now pay later (“BNPL”) to Latin America, which could potentially be the next hot market, but this “credit card equivalent” feature that is widely available within Mexico and Brazil already is very similar to BNPL from the customers perspective.
How are local founders in the region thinking about fundraising from US vs. LATAM funds?
There is a huge benefit to having US investors, because it can give you exposure and visibility for later stage rounds. The LATAM fundraising market has developed a lot at the seed and series A stages, but we still are not as developed as other regions at the later stages. Having global funds on your cap table can also help with raising future rounds more generally, and with hiring. However, it doesn’t have to be the US specifically. The validation by other investors goes a long way in emerging markets.
Looking ahead, what do you think are some of the ripest opportunities for innovation in the region?
The biggest opportunity from my point of view is investments. If you look at the maturity of LATAM versus the US, how far we lag behind is astonishing. Less than 2% of the population in Brazil is investing in the stock market, compared to ~55% in the US. Most investment activity in LATAM is saving accounts and other low yield strategies. It is partly due to lack of knowledge, and also because most deposits are held at big banks that aren’t innovating and offering alternatives. Only the most wealthy and educated are accessing these tools today. There is a large opportunity to make it easy for the mass market to invest.
Insurance is also an area ripe for innovation. There is a huge opportunity to create health insurance, car insurance, and other personal insurance products that often aren’t offered by employers here. Not having to go through an intense credit process could drastically improve accessibility. But, first we really need to continue making credit more accessible and understanding building risk models for these categories.
The last area is BNPL. It has taken off in Europe and the US, and there are some unexplored opportunities for this in LATAM. The dynamics will just be different given the existing installment options for local merchants.
If you are building something in this area, please reach out to kyra@twosigmaventures.com. We would love to hear from you!