Now that banks in Latin America have fully explored the growth opportunities among the region’s middle- and upper-income segments, most consumers in these groups who want banking services have them. But that still leaves a big opportunity in the region’s lower-income segments, which remain underpenetrated. People in these brackets have a strong need for consumer finance products because without credit they can’t afford most goods, not to mention emergency items such as medicine. In Brazil, the region’s most developed market for consumer finance, current accounts have achieved at least 80 percent penetration in the higher-income segments, compared with only about 30 percent in the lower-income ones (Exhibit 1). In other Latin American countries, the difference is even greater.

Lower-income consumers in Latin America are a demanding market, however. The region’s traditional retail-bank model is not well suited to capturing a sizable share of it, given the relatively high distribution costs—maintaining branches and offering personal attention—and the intimidating environment bank branches can present for lower-income consumers. Retail banks also face adverse economics in serving these segments: acquisition costs can be $100 to $150 per customer, and expected net annual margins only $80 to $120.

Nonetheless, in periods of economic expansion, which are characterized by lower delinquency levels, the best-performing consumer finance companies specializing in lower-income groups in Brazil, Chile, and Mexico have achieved returns on equity of more than 40 percent and their credit portfolios have grown by more than 20 percent a year. Experience in these three countries shows that making credit available to lower-income groups is attractive not only because of the massive market it opens up for financial-services companies but also because it can contribute significantly to a bank’s bottom line and foster economic development.

To serve these segments, banks should develop commercial and distribution models more appropriate to them. Indeed, leading institutions in the market have already developed sophisticated credit and collection skills and built low-cost infrastructures.

A growing but diverse market

Consumer finance in Latin America has advanced steadily. The combined outstanding volume of typical consumer finance products (personal and auto loans, retail financing, and credit cards) increased at an average rate of 20 percent over the five years to 2005 in the region’s seven largest markets: Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela (Exhibit 2). The growth of consumer finance is accelerating even in countries hit by severe economic downturns and financial crises. In Argentina and Venezuela, for example, total credit outstanding nearly doubled from 2003 to 2005. And since the amount of debt a Latin American household carries today is well below the debt level in more developed economies, that growth should continue (Exhibit 3).

The outlook is therefore positive, although low-income consumer finance in different Latin American countries has reached different stages of development. In one cluster, comprising a number of small markets (such as the Dominican Republic, El Salvador, and Paraguay), the “unbanked” low-income population has almost no access to formal credit. These consumers must resort to family and friends and, more commonly, to the usureros or agiotistas—specialized providers of informal loans at astonishingly high interest rates. In these markets, about 70 to 80 percent of the people in lower-income segments are unbanked, and more than half take some form of credit from informal providers. Such resources mostly finance family emergencies and essential household expenses. The loans, which are about one-tenth as large as the average personal loan from a bank, can carry annual rates of more than 3,000 percent!

Countries in the second cluster—Argentina, Colombia, and Peru—have reached an intermediate stage of development, with a basic product offering in place and growing market penetration in the lower-income segments. (Thanks to a boom in consumption brought on by high oil prices, Venezuela is now in the process of entering this group.) The products offered include personal loans, auto loans, and credit cards, marketed either by banks or specialized finance companies. National credit cards, which do not carry the MasterCard or Visa brands, also exist, although they are accepted only at closed networks of stores. Retailers in these countries typically provide installment financing but are only now exploring the possibility of transforming their customer franchises into financial-services enterprises.

More sophisticated forms of consumer finance are available in a third cluster of countries. In Brazil, Chile, and Mexico, the product offering is diverse, including personal loans (both secured and unsecured), auto loans, credit cards, point-of-sale financing in stores, and loans from retailers.

In Brazil banks now dominate the market, having acquired all of the relevant independent finance companies and taken over the financial businesses of major retailers. In Chile, by contrast, retailers have a firm grip on consumer finance and have set up their own banks, which offer mortgages and deposit accounts, though they share the pie with specialized low-end divisions of major retail banks. Mexico is somewhere in between. A few banks, such as Banco Santander Central Hispano (Santander, with its Serfin division) and Banco Bilbao Vizcaya Argentaria (BBVA, with its Finanzia business, serving Wal-Mart Stores), have an important consumer finance presence, but major retailers are advancing quickly.

No matter which industry dominates, the products are becoming increasingly sophisticated and channel strategies more aggressive. Retailers and banks in Chile advertise intensively; retailers claim to have the best mortgage rates, while banks offer direct 18- to 24-month installment financing for purchases of plasma TVs and motorcycles. One noteworthy feature of Brazil’s consumer finance market is the heavy one-on-one marketing typical of the financeiras: specialized financial outlets focused on personal loans, whose promoters (almost literally) grab customers in the middle of the street. The environment of a consumer finance outlet in these countries does not resemble that of a bank branch at all; the look is simple and colorful, and the young staff and the atmosphere are typical of a retail store—features serving to attract segments normally averse to traditional banks.

Three models

Despite small differences across countries, financial institutions generally explore the possibilities of consumer finance for low-income people through three models: partnerships with retailers, setting up financial stores, and offering general-purpose credit cards.

Partnerships with retailers

Banks that develop partnerships with retailers gain access to huge numbers of customers, cut the cost of acquiring them, obtain data about their behavior to help define risk profiles, and expand physical distribution channels. The relationship involves financing in-store purchases through private-label cards or installment loans contracted at the point of sale. The banks also leverage the relationships larger merchants have with customers to cross-sell other financial products and services. Three leading companies pursuing this model in Latin America are Fininvest, Losango, and Taii, all in Brazil.

The model is playing out in two ways, depending on an economy’s volatility (which affects the quality of credit), the sophistication of the players on each side of the table, and the aggressiveness of competitors. In Brazil, for example, financial institutions dominate the relationship, and banks there have developed most of the financial services for retailers. Elsewhere (as in Chile), major retailers have built their own financial services and, in some cases, their own banks. Mexico is an interesting case: two main retail chains—Coppel and Elektra—are dissolving long-standing partnerships with banks to develop their own banking operations. So far, only Elektra, with its Banco Azteca unit, has had enough time to make this model a success.

Partnerships with retailers, though attractive, are difficult to manage because of the conflict of interest between retailers and financial institutions over the ownership of customer relationships. The bank wants to cross-sell financial services to the retailer’s customers, but the retailer may well want to protect them from unsolicited offerings. Yet the prize is sizable for banks that can strike a balance: portfolios with returns on equity of 30 to 35 percent to complement the core business, large point-of-sale networks that can be leveraged, and a big customer base with low product penetration.

Financial stores

Another approach involves creating stores that sell one-off financial products, typically payday advances, unsecured personal loans, and low-ticket insurance products (such as funeral insurance). Fininvest, IBI, and PanAmericano (in Brazil) and Banco Nova de Bci and Santander Banefe (in Chile) have all taken this road.

Networks of financial stores offering emergency personal loans have been the most profitable business in consumer finance, but their attractiveness is fading as competition proliferates. Retail banks in Brazil are targeting low-income segments, and retailers are expanding their product offerings to include personal loans that complement standard private-label cards, as well as other more affordable products. Payroll-linked loans (guaranteed by and directly repaid through monthly salaries) exemplify the kind of product that is eroding the growth and profitability of financial stores.

Credit card players

Credit cards are both high growth and profitable in much of the region. Banks that take this approach offer unbanked consumers general-purpose credit cards, as well as affinity or cobranded products, through call centers, direct mail, and the Internet. (They also use these methods to serve middle- and upper-income groups.) Product specialists such as Credicard, OCA, and Tarjeta Naranja are well-known examples of companies using this approach.

In addition, more retailers are trying to increase their share of total consumer spending by migrating their private-label credit card base to general-purpose cards. (As an issuer, the retailer or credit card company takes a share of the fees that consumers generate when they use their cards in any venue.) One company that undertook such a migration is the department store chain Liverpool (in Mexico), which recently announced that it will offer Visa cards to some of its affluent private-label credit card customers. Another is Brazil’s largest retailer, Casas Bahia, which recently launched a general-purpose credit card in partnership with Banco Bradesco, one of the country’s biggest commercial banks.

The main challenge in marketing credit cards, in Latin America as elsewhere, is a dependency on remote channels such as telephones, mail, and the Internet, which generally have lower rates of conversion to sales than physical branches or stores do (rates of 2 to 10 percent compared with 10 to 20 percent, respectively). Thus, one success factor for credit card players is the ability to manage remote channels to maximize conversion rates. Selling tailored cards to specific segments, an important way to lift those rates, calls for a high level of marketing skill.

Choosing the appropriate model

The best consumer finance model for serving lower-income segments depends mainly on a country’s stage of development, the availability and willingness of large retailers to develop partnerships or sell their credit portfolios to banks, and whether loan rates are capped. Some banks use more than one model, so they can not only capture the economic benefits of the new business but also use it as a customer acquisition channel for retail banks.

The most successful example is Brazil’s Unibanco, which combines all three models very effectively. Unibanco has joint ventures with large retailers such as Magazine Luiza and Ponto Frio, as well as more than 200 financing agreements with small and midsize retailers; upward of 300 low-cost stores, which focus on personal loans, in Brazil’s largest cities; and private-label and general-purpose credit card deals that reach millions of consumers.

What it takes to succeed

The opportunity in Latin America is large and growing, but the bar to profitable competition is high. Players must excel at three skills to serve lower-income segments profitably.

Managing risk

Throughout the world, the broad issues in risk management are how to grant credit effectively, to manage exposures, and to maximize recovery once a line becomes delinquent. In the case of Latin America and other emerging markets, there is an added element: how does a bank accomplish these tasks with limited information, in the population segment that is most exposed to economic downturns, when the credit line must be preapproved or granted at the point of sale?

Sophisticated underwriting is difficult because of scant information, but managers have learned how to use local credit bureaus in addition to sources such as retailers, which have closer ties to customers. The keys to distinguishing between the creditworthy and the less creditworthy have been, first, developing models segmented according to income, region, and product, and, second, gaining a deep knowledge of local markets and customer behavior (see sidebar, “Capturing the value of remittances in Latin America”). All major consumer finance operations have developed these skills.

In addition, credit approval rates must be adjusted frequently to keep delinquencies under control. During 2006, for example, the approval rates of individual consumer finance companies in Brazil varied from 10 to 60 percent; in developed countries, by contrast, these rates remained fairly constant. The rates oscillate widely in Latin America because its economies are so volatile (Brazil is one of the more extreme cases) and because customers are still getting used to a broader set of products and to larger credit lines. The combination of these two factors makes the business more complex because frequent adjustments mean that consumer finance companies must constantly monitor and closely manage their approval rates, or delinquencies will explode during bad credit cycles.

Collections are a fundamental part of consumer finance, especially when companies deal with the low-income segment. The most aggressive companies expect about 40 percent of an incoming group of customers to become delinquent within 6 to 12 months. Cutting-edge collection operations segment their customers (for example, by the willingness and ability to pay) and use a number of channels (automated call centers, personal calls, letters, text messaging). The best collection operations achieve net losses that are more than 20 percent lower than those of average ones. Finally, collections may be a retention tool: a large part of the customer base is or has been in collections, so if the effort is successful a customer may be eligible for new loans. The best Latin American players—such as Contax, a specialized collection and telemarketing company in Brazil—are quite advanced.

Managing partnerships

The challenges in a partnership involve managing the conflicts of interest between the retailer and the financial institution, aligning their objectives, and developing a strong value proposition (such as high credit approval rates and low credit losses) that will satisfy both. Players must also learn how to leverage the partner’s operating capabilities to enhance the venture and cut the cost of serving customers, as the joint ventures of Unibanco with Ponto Frio and Magazine Luiza have done by using Unibanco’s product-structuring and risk-management skills and the retailers’ strengths in distribution and marketing.

A variety of bank-retailer partnerships are available, but the 50-50 joint venture with profit sharing seems to work best. This model offers the partners a favorable alignment of interests—no decisions are made unless both parties agree, and there are fewer hidden agendas. Partnerships with other ownership structures (for example, 60-40) or with financial institutions that acquire the full credit operation sometimes dissolve in conflicts over loan rates (banks, for instance, want to maximize rates and retailers want to minimize them), credit approval rates, and the right to use the customer base in specific ways. Several Brazilian consumer finance companies that entered into these types of partnerships with retailers in the late 1990s and early 2000s failed to establish long-lasting businesses. In some instances, the retailers that ended up managing the credit models raised approval rates, thereby increasing their own sales volumes but also raising delinquencies for the banks.

Successful partnerships can help banks build a powerful customer acquisition engine because they provide low-cost access to a big customer base. In Brazil acquiring a new customer through a partnership costs less than $20, compared with $20 to $30 in a financial store and more than $100 in a full bank branch.

Keeping the low-cost focus

When serving low-income customers, it is necessary to make the operating areas that support the business (for example, call centers and the back office) more efficient and effective to provide a homogeneous and adequate standard of service at a price compatible with the customer economics. Given the lower margins, the costs of serving low-income customers must be controlled; anything from posh branches to personal attention to tailored service adds expenses that will be hard to recover. Successful players instead use mass mailings and call centers, point-of-sale marketing (such as store signage and street promoters who hand out leaflets), and inexpensive branches whose colorful furniture is more in sync with the target market.

Credit approval and collections—the most important processes—are managed in industrial fashion from centralized facilities that capture substantial economies of scale and scope. To reduce costs further and gain significant scale advantages, banks merge the loan-servicing departments of their commercial and consumer finance arms, so that only one credit function analyzes and develops models for private, retail, and low-income customers alike. Gains in operational efficiency are crucial to compensate for the lower revenues per customer and the relatively high delinquency rates typical of the low-end market.

Until recently, competition in Latin American consumer finance was limited. But the saturation of markets in countries such as Brazil and Chile, combined with the increasingly comprehensive regional strategies and cross-border expansion of major retailers, has generated a multicountry battle initiated by international banks such as BBVA and Santander, by the largest Chilean retailers including Falabella and Ripley, and, more recently, by Brazil’s Banco Itaú. Many other players, taking advantage of their local knowledge and experience, are assessing this expansion opportunity.

That expansion will occur is certain, but the consumer finance endgame in Latin America is far from clear. Although commercial banks—both international and strong locals—have better skills and are the natural developers of financial services for low-income people, big retailers have the best relationships and the most contact with these consumers. The way the market evolves will depend not only on the influence of such players but also on the social and economic development of the many countries in the region. Regulation will be an important factor as well.