Bloomberg Línea — The growth of unsecured credit lines, especially credit cards, has put pressure on traditional financial institutions, neobanks, and card companies in Brazil, and has affected credit quality and company profitability, which is an additional challenge at a time when the Brazilian government is seeking alternatives to reduce interest rates on credit card operations, amid a high default rate and a high Selic benchmark interest rate.
On Monday, Brazil’s Finance Minister Fernando Haddad met with the presidents of Itaú Unibanco, Bradesco, Santander Brasil, Nubank and the Brazilian Banking Federation (Febraban) to discuss the matter.
According to Isaac Sidney, president of Febraban, the government should create a working group to evaluate the causes of high interest rates in the country in credit card operations - a topic discussed for more than a decade in governments of different parties.
The working group is expected to include representatives from companies, the government, and the central bank.
Central bank data shows that on average, the interest rate charged on credit cards was 417.35% per year in February, the latest available data, and which was the highest since August 2017.
Meanwhile, household debt in Brazil is equivalent to 48.8% of accumulated income in 12 months through February, while defaults accounted for 4.1% of individual credit operations in February, the highest level since October 2016.
This scenario challenges fintechs in particular.
A recent Fitch Ratings report noted that lower-income customers accounted for almost half (48.8%) of credit card debt in non-bank financial institutions at the end of 2022, compared to 23.9% for large banks.
The greater risk appetite of fintechs and neobanks compared to incumbent banks, coupled with a relatively low entry barrier, facilitated the growth of credit cards in Brazil, and while the market share of fintechs in the credit card segment was 16.1% at the end of 2022, it was just 9.9% at the end of 2019, according to the Fitch report.
The market share of mid-sized digital banks also increased to 14.9% at the end of 2022, compared to 13.5% in 2019, while the market share of banks considered systematically important lost ground, falling to 67.3% of the total credit cards issued to end-2022, compared to 75.6% at the end of 2019. Fitch emphasized that in the last three years, credit card origination volumes increased 71.6%, according to central bank data, while outstanding balances grew 77.7%, representing 15.5% of total consumer loans in Brazil (13.9% at the end of 2019).
According to Fitch, the credit quality pressure will be more evident in smaller or less diversified companies.
The rating agency expects neobanks and fintechs to reduce their appetite for credit issuance in the coming months, focusing on clients with better credit quality, a segment where competition from large banks is greater, and, at the same time, implementing collection strategies to recover their stressed portfolios.
Provisions and their impact on margins
In addition to the economic challenges of inflation and interest rates, the increase in credit card defaults in Brazil is related to high unemployment rates and decreased government stimulus measures. Ceres Lisboa, director of Moody’s bank analysis in Latin America, explained that credit is more expensive. In addition, inflation is consuming a significant portion of families’ income. “There has been a compression of the available portion of income to pay off debt,” she said.
This brings more defaults. Credit card payment delays of up to 90 days have been growing since mid-2021, reaching 8.2% at the end of January 2023, the highest level in over a decade, compared to 7.8% at the end of 2022 and 6% in 2019.
Lisboa believes that the default rate may be pushed up in the coming quarters. “But the banks haven’t just stood still waiting for this. They have already done their homework a long time ago, increasing provisions, the cushions that will absorb these losses. And, at the same time, they have decreased their credit offering, especially in recent quarters,” she said.
Although rating agencies are paying attention to bank risk ratings during this period, it does not mean they will stop lending, as it is an adjustment given to the default cycle, according to Lisboa.
“Banks also have a high funding cost,” she said.
However, for fintechs, high financing costs also represent a competitive disadvantage for the sector, and the significant reduction in market appetite for risk financing adds more pressure in terms of results and capitalization for these companies, according to Fitch.
“In 2023, fintech margins should be pressured due to higher provisioning requirements and financing costs,” the agency said in its report, which also states that digital banks and fintechs have higher growth among lower-income clients, with the proportion of clients with income below two minimum wages (including clients without proven income) growing 95.4% and reaching 27.8% of the outstanding balance of all credit card debts at the end of 2022, compared to 25.2% at the end of 2019.
For fintechs, growth in riskier clients has been significantly higher compared to banks, 235.8% for fintechs versus 66.9% for banks, which indicates that these startups will remain more vuln
erable to any recession in 2023, according to Fitch.
According to the agency, the credit quality of digital banks, fintechs, and credit card companies in Brazil may be further pressured due to the relatively short history, smaller scale, and operation in higher-risk customer segments.
Latin American fintechs have adopted different strategies for credit origination in a higher-risk scenario in Brazil with high interest rates combined with increased household debt. There are also pressures caused by the bankruptcy process of Americanas and fiscal instability with the measures of the new government.
Nubank said in a conference with investors about the results of the last quarter that it plans to accelerate the origination of personal loans this year, while Mercado Livre said it will still wait to observe how the macroeconomic scenario will behave. Both companies slowed down origination in 2022.
PagSeguro said it is reinforcing and developing the risk and fraud prevention structure so that it can, “at an opportune time this year,” return to originating unsecured credit lines, as CEO Alexandre Magnani said in an interview with Bloomberg Línea.
Stone, which faced problems with defaults of small and medium-sized companies in 2021 and decided to suspend its credit operations at that time, said that in 2022 it worked to rebuild the product and systems, rethinking risk policies.
The company intends to relaunch the credit product in the second half of this year, but the speed of origination will depend on the economic environment and the fintech’s risk appetite.
“In the last quarter of 2022, we started testing these systems we built with a few customers. We will increase the size of this test in the first half and our focus is to be in a position to relaunch [the working capital and credit card product for small and medium-sized entrepreneurs] in the second half,” said Lia Matos, director of strategy at Stone.