At three o’clock on Wednesday, September 25, the National Banking and Securities Commission closed the window. At that time, the deadline for the platforms operating under the eighth transitory of the Law to Regulate Financial Technology Institutions (Fintech Law) to request its regulation expired. Not all did.
The American company PayPal send a message to its users in Mexico. They reminded them that from that date, they would automatically transfer to their bank accounts all payments received. The measure had already been announced in advance. The message begins with large white letters on a blue background:
The company summarized in three points the changes in its platform:
- All payments will be automatically transferred to the user’s primary bank account.
- Recharge balance will no longer be available.
- The balance remaining in the PayPal account can no longer be used to top up balances.
The company did not mention in the mail nor in the extra information the reasons behind the changes: the law published since March 8, 2018.
Now everyone will follow the rules.
A public company with extensive resources such as PayPal preferred not to request authorization from the CNBV to operate as a wallet. “This tells us that the law is no small matter,” says Gerardo Obregón, CEO and founder of Prestadero, the pioneer platform for crowdlending in Mexico. As of September 20, the Prestadero team submitted their application to be authorized as a Collective Financing Institution (IFC), the legal name for Fintechs in Mexico).
The CNBV received the first applications in February of this year. The crowdfunding platform for real estate development M2Crowd was the early risers. At that time, M2Crowd CEO Simón Dalgleish said that, since they began operations, they turned to the Fintech regulation in the United Kingdom to anticipate the requirements that could be demanded by the Mexican authorities, published on September 2018.
In some sections, the Fintech law is quite severe, in consideration of Gerardo Obregón. Cash restriction is an example. IFCs are imposed on measures for the prevention of money laundering on stricter occasions than other financial institutions. Although for fintech, it is a minor problem, since most of the payments they receive are digital since they are institutions that were born in the digital world. However, it limits the payment options of the users.
Obregón also considers that the restriction on bank accounts is another problem. With the current regulation, users can now only transfer money to accounts in their name. The director of the Prestadero makes an analogy with online purchases, where one can buy a product that will be received by another person to explain the inconvenience. This option should also be available when sending money.
Clear rules make long investments.
In Mexico, the fear of fraud is one of the main reasons that stops people when paying online. This fear is justified if we consider that the country ranks second in digital fraud in Latin America, after Brazil. The figure is surprising, but it is also a logical consequence. Mexico represents the second-largest e-commerce market in the region after the South American nation. When you face with higher transactions, you take higher risks.
Specific regulation for the sector offers guarantees to both entrepreneurs and platform users. Gerardo Obregón is so in agreement with this that Prestadero was one of the companies that promoted the elaboration of law for Fintech. Although “Like any regulation, it is still perfectible,” he said.
In 2012, distrust of digital platforms was more significant than now. The director of Prestadero says that when the startup started operations, not only investors showed suspicion of putting their money. Credit applicants also raised their eyebrows in disbelief.
Why would a stranger on the Internet offer me credit with more favorable rates?
A natural reaction. Financial institutions have been specialists in hiding Leonine conditions among the small letters. The Journalist Michael Lewis told in The Big Short that investor Danny Moses once asked the seller of a transaction that seemed perfect: I just want to know one thing, How are you going to fuck me?” Fintech is also a business with profits and losses. Nothing can be so good to be true.
Banks are specialists in offering loans with high rates for applicants, while investors receive returns at penalties above inflation. In fintech, this is different. At present, the Prestadero’s gains are an average of 14% per year, – after considering the commissions and overdue portfolios -, while applicants with the best score can obtain rates from 8.9% per year. The competing IFCs give similar conditions to applicants and investors. For example, the Yotepresto platform offers higher returns to investors. Although the rates are higher than in Prestadero, they are lower than in the banks.
If you have some experience with financial products, you want to know what the trick is, or in the words of Moses, how are you going to fuck me?
Fintechs arise outside the boxes
Fintechs have two characteristics that have allowed them to break into a field where banks maintained an unquestionable hegemony: technological innovation and peripheral vision. With technological innovation, IFCs reduce operating costs and have greater possibilities for expansion. The peripheral vision allows them to think about new financial products.
Sometimes, good ideas come from outsiders. The Brazilian unicorn Nubank emerged when Colombian David Velez noticed that in Brazil, banks treated customers as if they were doing them a favor. They did that because there were few competitors. The brasiñelos told him that he could never win against them. Sergio Furio received similar comments when he founded Creditas, a startup that has recently acquired investment from Japanese corporate Softbank. This company was born in response to the high interests of Brazilian banks.
Gerardo Obregón is also an outsider, a foreigner in a nation of bankers. Many venture investors would have refused to issue a check, not because of the business model, but because they lacked market experience. He studied chemical engineering and before Prestadero, he worked in areas that had nothing to do with financial institutions. For him, that was a fortune.
In one of his first works, he was soaked with knowledge about technology. Then he undertook with a meat distributor. One day, when Obregón noticed a worried employee, the man told him that he had trouble paying a loan he had requested for ten thousand pesos. After paying one thousand pesos promptly in six months, I still owed more than eight thousand.
Gerardo was impressed with how such a modest credit could damage a person’s economy. For that reason, he thought of financing alternatives.
Gerardo investigated business models. During this period, he discovered that these alternatives already existed in countries such as the United States and the United Kingdom in a model known as P2P Lending. In 2005, Zopa began operations in the United Kingdom. They’re one of the pioneers in this area. In 2006, Prosper started operations in the United States.
These companies had to learn in a hard way and in one of the worst times for finance. Larry Ludwig, the founder of Investor Junkie, mentions that Prosper’s risk management model was horrible. He said that “the platform allowed anyone with a pulse to get a loan.” The overdue portfolio was alarming, a situation that worsened with the economic crisis.
Although there were references abroad, P2P Lending, now known more as crowdlending, was a diaper model. Around him, Gerardo heard that that could not work in Mexico because “the Mexican does not pay.” Despite this, Gerardo jumped into an industry he was beginning to know, with an unproven business model in the country.
“An entrepreneur must know everything,” said Gerardo, explaining how he leaped chemical engineering to financial innovation. He investigated the requirements demanded by Mexican law, prepared a business proposal, and hired a lawyer to check that everything was in order. He also worked closely in the development of the platform. “I am aware of the Front-End and the Back-End.” About software development, he only knows how to make queries in databases, but he understands enough to specify what changes it wants in the platform. Gerard uses to make suggestions to its team about how it can be improved.
Does regulation kill innovation?
Gerardo Obregón admits that, with the current regulation, he would not have been able to start with Prestadero.
Rigid legislation is a concern not only in Mexico but also in countries such as Chile and Brazil where the desirability of a specific regulatory framework is recently discussed. This situation will have repercussions on the ecosystem. Estimates indicate that only 40% of the institutions required by law to request authorization did so. However, the CNBV has not yet given official figures.
The legislation also offers a legal sandbox to test new models. This part of the law gives space to innovation. The Prestadero’s team asked the CNBV if his PrestaPal product would enter into this scheme, an alternative so that people without credit history or with a bad history can request family and friends credits with rates of 0% to 35% per year.
In Mexico, most loans are informal. In other words, between family and friends. This fact means that their credit behavior is never reported to the credit rating entities. Therefore, they can never apply for a loan with more favorable conditions or of a higher amount. At the same time, the main problem of collective financing platforms is finding applicants who meet the profile to be subject to credit. The same mechanisms that protect investors from losses constrain their opportunities for expansion. A space for innovation is necessary to create new opportunities.
At this time of regulation, the CNBV will analyze each of the authorization requests for companies operating under the 8th transitional. Within three to six months, the agency will offer a response and, if necessary, other institutions such as Banxico or SHCP will provide feedback. If they are rejected, they must stop operating.