Why fintech has failed Mexico’s unbanked

Since 2016, when Finnovista conducted its first surveys of the Mexican ecosystem (which was then the largest fintech market in Latin America), fintech has made little progress in formalizing Mexico’s sizable unbanked population. The most recent National Survey of Financial Inclusion conducted by Mexico’s National Institute of Statistics and Geography finds that as of May 2022, only 49.1% of adults ages 18-70 had a bank account. While this is 3.4 million more than in 2018, it represents growth of only 2%.

Five years after Mexico’s famed fintech law took effect, the sector has failed to meet Finnovista’s prediction that it would “broaden the frontiers of the financial market through the financial inclusion of segments of the unbanked and underbanked population.” While many neobanks, credit providers, and payment providers have gained important traction in Mexico, none have managed to bring millions into the formal banking sector as anticipated.

In fact, if the World Bank’s 2021 Global Findex had included Mexico, Mexico would likely have had the largest unbanked population in the region, surpassing Brazil by over 15 million people.

The unseized opportunity is hard to overstate. Not only would greater financial inclusion in Mexico support the economic development of the country by encouraging savings and investment, expanding access to credit and increasing tax collection; it could also prove to be highly lucrative for those who crack the code and gain scale. Moreover, despite Mexico’s 42.6 million unbanked population, e-commerce in Mexico has nearly tripled since 2018, growing 23% y-o-y in 2021, pointing to a strong growth trend that could be leveraged to encourage greater adoption of formal financial tools.

Several factors have contributed to Mexico’s seeming inability to bank the unbanked. In addition to limited incentives for formalization, the majority of the unbanked simply don’t see the need for a bank account which has made customer acquisition hard and expensive for both fintechs and traditional banks.

Among those surveyed by INEGI, the most commonly-cited reason for not opening a bank account was that those surveyed did not believe they had sufficient income. For context, the average salary in Mexico is 17,933 pesos per month, or roughly $975, with monthly expenses of 15,799 pesos, leaving the average Mexican with slightly over $100 (12% of their income) in monthly savings. With so little disposable income, it is hard for people to intuit how having a bank account could help them, although this overlooks many unapparent benefits of banking such as access to formal credit.

By and large, Mexico remains a cash-based society. For payments under 500 pesos (approximately $25), 90.1% of the population uses cash, with only 12.3% of adults using a debit card for purchases over 501 pesos. Compounding the problem, 55.8% of Mexico’s population works in the informal economy where they are paid in cash. Businesses also prefer cash, with only 45.4% of companies accepting credit and debit card payments, even after the pandemic. Note, of those who did not accept credit and debit cards, a third only accepted direct transfers, another third blatantly preferred cash, and 21.8% said the amount charged was too small. Cash is so entrenched that most e-commerce websites offer the option to pay for goods in cash at local convenience stores, and many popular digital services such as Netflix offer gift cards that can be purchased in cash and applied to users’ accounts.

Mexico’s persistent levels of informality are also driven by a desire to avoid paying taxes. About one in five Mexicans is suspected of avoiding income taxes, not to mention about one in five companies. It is so culturally embedded that it is common to receive (and ask for) discounts for paying in cash. Additionally, unlike in other countries, there are few incentives to file a tax return, and there is a generalized belief that filing taxes will lead to greater tax burdens. This contrasts with countries like the United States, in which lower-income families can receive tax credits and thousands of dollars of government financial support by filing a tax return. In Mexico, subsidies tied to tax reports are minimal.

Also contributing to the problem is limited access to physical financial institutions among rural communities. In Mexico’s South and Southwest, 42.3% and 43.2% of the population are banked, respectively, whereas the country’s Northeast and Northwest have significantly higher banked populations of 57.6% and 56.8%, respectively (see graph below). Not surprisingly, in the South, it takes an average of 29 minutes to reach a bank branch, almost double the time it takes to find a bank branch in Mexico City. While there is a huge opportunity for fintechs to change this, they will only succeed if the preference among businesses for cash decreases.

Source: National Survey of Financial Inclusion (ENIF) 2021, INEGI

While digital retail-banking fintechs, such as HeyBanco and Now, are helping to reduce obstacles to opening a bank account by streamlining the process and allowing people to open accounts online, over a third of the unbanked also remain unconvinced of banking’s benefits, and 7% are even distrustful of financial institutions. According to many Mexicans, this distrust stems from the nationalization of the Mexican banking system in the early 1980s, which caused a period of instability in which the commercial banking sector was reduced from 60 financial institutions to 18 entities. While Mexico’s banking sector today is widely considered to be backed by strong financial fundamentals, the negative perception persists 40 years later.

There is something to be said about the maturity of Mexico’s fintech regulatory ecosystem and how it facilitates innovative business models. While many other countries in the region lack regulation, in Mexico multiple legal structures can be used by fintechs to offer a wide variety of products. While some fintechs have decided to pursue traditional banking licenses, there are additional legal structures that offer similar benefits including Sociedades Financieras Populares (SOFIPO) and Sociedades Cooperativas de Ahorro y Préstamos (SOCAP), both of which allow for the collection of public deposits and also the offering of credit. However, it is also worth noting that other fintech-specific entities, such as wallets and crowdfunding platforms, are prohibited from directly collecting funds from the public and directly offering credit, making the original incorporation process all the more important.

Although fintechs, traditional banks, and the Mexican government may be fighting an uphill battle in which there are few perceived benefits, there are still opportunities for fintechs to position themselves as the ideal partner of the unbanked by addressing their other financial needs.

There is an undeniable and increasing demand for credit in Mexico despite high interest rates. According to the country’s Central Bank, in January 2023, consumer credit reached approximately $60.68 billion, a 17.6% y-o-y increase. There is a similar demand for credit among Mexico’s SMEs, which face an estimated financing gap of $164 billion. Fintechs have smartly moved to occupy this space with some focusing only on consumer credit (Stori) and others focusing on business credit (Konfío), with many using innovative models to offer loans even when the applicant has no financial history.

Nu México, the subsidiary of the Brazilian fintech Nubank, has had particular success. After acquiring a SOFIPO, at the end of last year, the company announced that it would offer savings accounts and debit cards, moving into the more traditional financial services space.  Now one of the five largest card issuers in the country, it has blown by traditional banks because it is willing to offer small loans to those who have no credit history. It is also well-positioned to expand its services to the unbanked with 80% of its clients located in the government’s priority rural municipalities, and an extremely favorable perception, with an NPS in Mexico of over 90. That said, the challenge is big enough that no one fintech will solve Mexico’s unbanked crisis alone.

While most fintechs can reach anyone with a smartphone, the strong preference for cash means a transition to digital products among the unbanked population will require a transitional phase that leverages a physical presence. Consequently, fintechs are capitalizing on existing infrastructure through partnerships to expand their reach without having to build their own outposts. Some examples include Mercado Pago’s alliance with the supermarket chain Soriana and Conketa’s alliance with the pharmacy chain Farmacias del Ahorro. Additionally, many large retailers have also launched their own fintechs. For example, Mexico’s largest convenience chain Oxxo has launched its own digital wallet, allowing its users to receive and send electronic transfers, make deposits and withdrawals, and make payments and purchases. Potential users will be able to quickly open an account at any of its 17,400 stores throughout the country - for comparison’s sake, Mexico’s largest bank, Banco Azteca only has 1,974 branches.

According to estimates from Americas Market Intelligence, e-commerce in Mexico is expected to grow by 24% between 2021 and 2025 to reach $114.1 billion annually, making it one of the fastest-growing e-commerce markets in the world. As digital natives, fintechs can position themselves to help consumers and vendors join the internet economy and at the same time convert them into long-term users of their financial products. E-commerce giant Mercado Libre, for example, has done this by requiring its sellers to open an account with its fintech, Mercado Pago. To strengthen adoption, the fintech also offers these users a wide range of additional features such as the ability to pay utility bills through the app, add funds to metro cards, and receive transfers via Western Union and Paypal’s Zoom.

As of 2022, Mexico has grown to become  the second-largest recipient of remittances in the world just behind India, with remittances increasing for 33 consecutive months now. As a result, many fintechs are seeking to enter this space, which is often criticized for its high commissions and inflated exchange rates. In a clear play for the market, in 2022, Ualá, a digital wallet from Argentina turned bank, announced a partnership with MoneyGram to allow its users in Mexico to receive up to 900 dollars in remittances without commissions a month, provided that the recipient has an Ualá account. The move hopes to leverage remittances to acquire new users who hopefully will take advantage of the rest of Ualá’s product offering. Strategies like this could prove to be exceptionally effective with Mexico’s unbanked population.

Because of the singularity of the Mexican market, a nuanced and holistic strategy is needed to facilitate a transition away from cash and informality. However, those considering taking on the challenge could see a considerable payoff when all is said and done.

There are clear trends that benefit those entering the space: Mexico has one of the fastest-growing e-commerce industries in the world, a young digitally-connected population, an unbanked population with clear unmet financial needs, and a robust regulatory framework that supports innovative business models. Additionally, fintechs might benefit from their “newcomer” status, given the historical distrust of formal financial institutions.

While rapid formalization may be dependent on government-led efforts to provide positive incentives to open bank accounts, many fintechs have made important inroads in hard-to-reach and reticent groups, like rural communities and women (only 42.6% of women have a bank account compared to 56.4% of men).

For fintechs, providing financial services to those previously outside of the formal financial system  is not only a major profit opportunity; it also establishes the infrastructure necessary to tap a market that promises rapid growth in the coming years. If anything can be learned from the last 5 years, it is that bringing more people into the formal financial system in Mexico is a marathon, not a sprint.