A slightly obscure-looking initiative by the Brazilian Central Bank may herald the death of credit cards, kickstarting a period of major financial services disruption. This revolution will start with the card schemes and the payments companies that rely on them, before spreading to the banks themselves.
Pix and SPI together to fundamentally disrupt the payments landscape in Brazil, and to be replicated in other parts of the world
The initiative called Pix, a QR-code-based interface, enables consumers to easily initiate payments through another new central bank initiative, Instant Payments or SPI (Sistema de Pagamentos Instantâneos) and to bypass card schemes. We expect Pix and SPI together to fundamentally disrupt the payments landscape in Brazil, and to be replicated in other parts of the world. Their simpler structures and lower costs are set to bring innovation and competition to the fore. We think they’ll act as a lightning rod for change, triggering yet more innovation and competition, accelerating the pace of financial inclusion, and pummelling margins in banking, largely to the benefit of consumers.
change is taking place first in emerging markets
We previously discussed[1] why we see financial services in the West as sclerotic, with innovation and competition suppressed by the entrenched interests of banks. We see payments as the key to unlocking the hold that incumbent banks have over many financial services products, with payments getting cheaper and potentially becoming free. We also argued that this change is taking place first in emerging markets. China evidently led the charge, but India followed, and Brazil is now making its mark. Most developed markets are, we postulated, too hamstrung by powerful entrenched interests to make such rapid progress.
PIX a fight with the payment behemoths
Instant payments are prerequisite for robust competition with the card schemes. The Card schemes were developed when it made sense for a paper-and-plastic solution to the trust issue, i.e., so that customers could leave a store with their goods, and the merchant would be guaranteed to receive funds. In the digital era, the merchant can receive payment instantaneously. And critically, the marginal cost is much closer to zero. The existing card schemes are expensive and anachronistic because they involve numerous snouts at the trough.
According to Banco Central do Brasil, Pix and SPI will bring a “reduction of the number of intermediaries in the payment chain”, allowing for faster payments at a lower cost. There will also be tangible benefits for many smaller merchants who don’t accept cards under the current expensive system and will soon accept Pix.
The existing card schemes are expensive and anachronistic because they involve numerous snouts at the trough.
As importantly, anyone with a smartphone can use Pix, so it should be a catalyst for financial inclusion. It doesn’t need a bank account to operate – any of the 75-80% of Brazilian adults with a smartphone can download an e-wallet and store digital cash, and then spend it using Pix. Roughly 30% of Brazilians have no bank account and so are excluded from the formal financial system, including access to credit, and to opportunity.
We see this as a major competitive threat to the card schemes. We believe that costs to merchants could fall from 2-3% of a transaction’s value to well below 1%. Credit cards force users to go through expensive toll gates to use their payment toll-roads in order to move money between their bank accounts and the merchants’ accounts. But Pix enables easy access to instant payments which will be cheaper, or even free, and will bypass the toll gates.
Banks are next
The proximate impact of Pix will be on payments, which are the means to an end for ambitious fintech players, and this will threaten not only the payment systems, but the banks too.
We’ve seen it before. Ant Group has shown this in China.
We’ve seen it before. Ant Group (an Alibaba spin-off) has shown this in China. Payments enabled it to make adjacent moves into credit, investments and insurance, selling largely third-party providers’ products on its platform, and winning substantial referral fees.
We see a move towards platforms, like Ant Group, enabling far more transparent pricing and comparability, much like price comparison websites. Not only do they compete away the product providers excessive margins, but they also use AI techniques to understand their consumers, making sure that they’re offered the most suitable products for their circumstances.
Payments now represent barely more than a quarter of Ant’s revenue, with most of the rest coming from referrals. We expect something similar to happen in Brazil – Mercado Pago, MercadoLibre’s fintech arm, appears to be pursuing precisely this strategy, and Pix should accelerate its disruptive impact, posing a threat to banks.
“A Blockbuster Moment”
We often see Emerging Markets through developed world eyes, and with our own biases and prejudices. We might assume that consumers there accept the same suboptimal solutions that we do. But over a decade conducting ethnographic studies, the message we hear from EM consumers could not be clearer. They work hard for their money and they value it. Successful retailers understand this, continuously optimising their cost base so that they can offer value-for-money. Smaller merchants are unwilling to implement anachronistic electronic solutions that allow card networks to extract excessive economic rent.
We think that instantaneous payments, fulfilled by consumers and merchants armed with just smartphones, represents a Blockbuster Video moment for card schemes
We think that instantaneous payments, fulfilled by consumers and merchants armed with just smartphones, represents a Blockbuster Video moment for card schemes. Money, like movies, has been dematerialised, and no longer needs complex physical logistics, or a system that replicates that complexity in digital form. And just like digital movies brought about disruption in the media content and distribution value chain, not to mention viewing habits, we see profound impacts in financial services, starting with payments. From there, we see banks being forced to reshape their value propositions. While developed market banks may maintain their barriers for longer, emerging markets are showing them their futures.
[1] Trinetra White Paper: “Developed world legacy systems are no match for China's innovative Fintech.”, November 2017
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Trinetra Investment Management LLP and are subject to revision over time. Trinetra is authorised and regulated by the Financial Conduct Authority in the United Kingdom.
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