Even in financial services areas, many banks overcharge and underserve customers, while relying on antiquated information technology architecture.
Fintech companies have been quick to seize this opportunity.
The potential for widespread fintech adoption has a strong example in China.
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Just a decade ago, consumers had few options apart from state-owned banks. Pay was usually distributed as stacks of paper bills, and e-commerce companies fulfilled orders via bicycle delivery, which accepted payments in cash.
Chinese technology companies saw an opportunity and developed digital payment systems based on internet technology – giving hundreds of millions of users access to convenient, affordable and secure financial services.
The result has been revolutionary.
Encouraged by the need to seamlessly make online payments, the new financial players jumped over developed banking systems and were able to meet their customers’ financial needs through smartphones.
The total transaction value of online payments in China rose more than 30 times between 2013 and 2020 to CHY 295trn, roughly equivalent to $44trn.
Today, a strong majority of the Chinese Internet population uses digital payments.
Digitization spread from online to offline payments, and then to virtually all financial services – effectively making China, in our view, the world’s first cashless economy.
This is the fastest mass adoption of technology we have seen in our 25 years of global growth investing.
However, Chinese regulators have recently intervened in the local fintech industry, primarily to avoid a concentration of services in just a few firms.
They have been particularly focused on preventing “closed loop” financial systems, where 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.
Large unbanked populations
Several emerging markets – particularly Indonesia, India and Brazil – are at an early stage of fintech development and have large underserved and unbanked populations, as well as SMEs that could benefit significantly from improved access to financial services.
Each country develops its fintech industry according to its needs and within its particular regulatory framework.
In markets such as Brazil and Indonesia, regulators have lowered barriers to entry, encouraging tech companies to acquire banking licenses and offer fintech services.
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Some regulators have allowed fintech firms to offer a range of banking services.
Indonesia, for example, allows channel partnering – where internet platforms are able to provide loans and offload the risk by selling the loan to a bank.
This model can be very profitable, but has a notorious reputation, as off-balance sheet mortgages nearly brought down the global economy in 2008.
Brazil’s regulators, on the other hand, require loans to remain with the originator.
However, the secular trend of replacing cash transactions with digital payments has a long growth trajectory in these markets.
Another area that appears particularly ripe for fintech disruption across emerging markets is credit creation.
Significant parts of the LatAm and ASEAN adult population have no bank account and therefore little access to credit. Moreover, most credit loans are held by large, established banks, which have directed resources to the most profitable group of consumers and businesses.
The resulting financial system is characterized by low credit penetration and a concentration of outstanding credit at traditional financial institutions.
This is an opportunity for fintech companies that can meet this huge need.
Opportunities also bring risks
Investors should be aware that these opportunities also carry risks.
The importance of regulators cannot be overstated.
Sudden, unexpected regulatory changes can undo long-term corporate plans, undermine competitive advantage 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 – where credit markets are highly cyclical.
With war, inflation and economic uncertainty weighing on global investor sentiment, we are watching closely for evidence of credit deterioration.
Where the fintech company is the offshoot of an e-commerce company, we expect the company to leverage the data and credit insights obtained from the e-commerce platform in the form of superior credit quality compared to local banks.
Despite these risks, 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 emerging market middle class.
However, given the complexity of fintech investments and the many levels of systemic and idiosyncratic risk, investors should combine a thorough understanding of the local regulatory and market environment with fundamental, bottom-up analysis of individual fintech companies.
Sara Moreno is portfolio manager for the PGIM Jennison Emerging Markets Equity fund
