WP/21/114Can Fintech Foster Competition in the Banking System in Latin America and the Caribbean?by Suchanan Tambunlertchai, Pablo Bejar, Kotaro Ishi, Takuji Komatsuzaki, Ippei Shibata, and Jasmin Sin IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. © 2021 International Monetary Fund WP/21/114 IMF Working Paper Can Fintech Foster Competition in the Banking System in Latin America and the Caribbean? Prepared by Suchanan Tambunlertchai, Pablo Bejar, Kotaro Ishi, Takuji Komatsuzaki, Ippei Shibata, and Jasmin Sin1 Authorized for distribution by Patricia Alonso-Gamo April 2021 Abstract This paper revisits the competitive environment of the banking system in Latin America and the Caribbean (LAC) and investigates the early impact of f intech development in the region thus far. Against the backdrop of high net interest margins (NIMs) and limited f inancial depth in the region, panel regressions broadly confirm results of existing literature on the association of NIMs with the changes in the f inancial sector structure, including market concentration, administrative costs, and foreign banks, although differences between domestic and foreign banks narrowed after the 2008-09 Global Financial Crisis. Difference-in-difference regressions and case studies on Brazil and Mexico suggest that f intech is associated with a reduction in NIMs and defensive 1 Prepared by Western Hemisp he re Department Fintech working group, led by S. Pelin Berkmen and under the guidance of Patricia Alonso-Gamo. We a re gra teful f or comments by Alejandro Werner, Sole Ma rtinez Peria , Deniz Igan, Andrea Presbitero, Nicola Pierri, Kevin Wiseman, Federico Grinberg and WHD semin ar pa rticipants. The cases studies incorporate interviews with market participants a nd country authorities, including Ba nco de Mexico, Comisión Nacional Ba ncaria y de Va lores (CNBV) of Mexico, the Ministry of Fina nce of Mexico, a nd Banco Central do Brasil. We a re gra t ef ul f o r t h eir t im e a nd d etailed co mment s. All rem a ining errors a re those of authors. IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 3 responses by incumbent banks that benefit consumers. The case studies also shed light on regulatory approaches and prudential considerations in f ostering f inancial innovation and banking sector competition. JEL Classif ication Numbers: D4, G21, L11, N26, O31, O38 Keywords: Banking, Competition, Fintech, Latin America and the Caribbean Author’s E-Mail Address: STambunlertchai@imf.org, PBejarVera@imf.org, KIshi@imf.org, TKomatsuzaki@imf.org, IShibata@imf.org, JSin@imf .org INTRODUCTION The financial sector in Latin America and the Caribbean (LAC) has undergone large structural changes. Financial liberalization in the 1990s was followed by a wave of foreign acquisition of local banks that drove consolidation in the sector (Cardim de Carvalho et. al, 2012). Foreign presence in the region waxed and waned through financial and sovereign debt crises, with more sustained exits of North American and European banks f ollowing the global f inancial crisis in the late 2000s, followed by entries of regional institutions. In more recent years, another structural change has begun to take place within the region. The use of financial technology—or “fintech”—in banking services has emerged and grown at a rapid pace (Berkmen et al., 2019). According to the Inter-American Development Bank, the number of fintech companies in Latin America grew 66 percent (from 703 to 1166) between 2017 and 2018. The trend in Latin America mirrors that taking place across the world where inf ormation technology, the internet, and mobile services are changing the way consumers and businesses access and manage their finances. In particular, fintech companies have been adept at unbundling traditional banking services, offering targeted solutions for existing constraints or inefficiencies including reaching out to unbanked segments of the population. The rise of fintech has disrupted the banking sector, challenging the way banks operate. This has already forced incumbent banks to increase their efficiency and invest more in innovation. Whether fintech can or has threatened the incumbent banks’ market shares and profit margins, thereby affecting competition in the banking sector, is an open question. Dif f erent types of fintech entries imply different effects on banking sector competition. Fresh entries may not threaten incumbent banks if they target a parallel marke