There is never a dull moment in Fintech. Just when the stack feels settled, a fundamental shift arrives to rewrite the rules of commerce. We saw this when payments moved from offline to online, and again when they migrated from web to mobile. In each transition, technology introduced new use cases, business models and experiences, expanding commerce. Today, we are witnessing the next massive platform shift: the leap from human-driven systems to agentic systems.

The Plastic Card Era: We declared war on cash, enabling consumers to pay electronically at the point of sale through credit and debit cards.

The Online Era: We solved trust. Browser-based checkout and early digital wallets made it safe to send money to a stranger on the internet.

The Mobile Era: We made the payment invisible. Tokenization turned phones into payment devices and hid the transaction behind the experience (e.g., Uber, Doordash).

The API Era: We turned payments into code and a developer primitive. Third-party platforms embedded commerce directly into existing workflows.

AI Will Drive The Fifth Era in Payments

We are now entering the fifth era in payments: The Agentic Era.

This era is defined by a new economic actor: the AI Agent. Like human transactors, this agent is capable of researching, negotiating, buying, and selling. An agent is, after all, an extension of its owner.

But it is a far more intelligent and demanding transactor. An AI agent can transact 24/7, is unconstrained by banking hours, currencies or geographies. It can optimize across different form factors (cards, fiat, stablecoins), pricing schemes, settlement schedules and execute complex transactions in real-time.

The Bottleneck: Agents need a purpose-built infrastructure

Yet for all their intelligence, agent automation stops in its tracks at a KYC prompt, a sign-up form or a paywall. The market is currently obsessed with “agent wallets” to fund transactions. But that wallet is useless if the agent cannot get past onboarding.

Just as humans once needed better onboarding to participate in digital commerce, agents need infrastructure that removes their onboarding friction. We need a convergence of identity, onboarding and payments for this new economic actor.

Why We Invested in InFlow

This is why we are thrilled to announce our investment in InFlow, the first payments platform purpose-built for the Agentic Era.

InFlow realized that the problem is not just moving money; it is the entire flow of agentic commerce. They enable AI agents to seamlessly onboard, verify, and transact directly, within the natural context of their workflow.

1. Intelligent Identity & Autonomous Onboarding: InFlow securely stores verified identity and billing credentials, enabling agents to autonomously register for third-party services — whether intelligent subscriptions or cloud infrastructure — without human data entry.

2. Policy-Aware Transactions: Autonomy requires trust. InFlow’s policy engine enforces human-defined guardrails: spending limits, approved vendor lists, and transaction limits. The agent works freely, but within the rules you define.

3. Multi-Rail Global Infrastructure: Supporting all major types of payments, including stablecoins, InFlow allows agents to operate domestically or across borders while optimizing across available payment rails.

InFlow is led by Jim Nguyen and Nas Kavian, who leverage unique experience across online payments (PayPal), frictionless in-game payments (Rubycoins), mobile payments (Obopay), API-based global payments (Braintree) and stablecoin payments infrastructure (Versal). In addition to deep domain expertise, they are maniacally focused on removing friction for agent initiated-payments.

At Leap Global, we invest at the intersection of Money Flows and Data Flows — two forces shaping the new economy. Agentic Commerce represents the ultimate convergence of these themes. With InFlow, agents can now onboard and transact directly within their workflows, without redirects or friction.

This is a meaningful unlock that enables native agentic commerce between agents and businesses, as well as emerging use cases such as agent-to-agent commerce and financial transactions. We look forward to seeing the new business models and AI/agent-native applications that InFlow will usher in.

2020 was a big test for fintech and the ecosystem rose to the challenge. Throughout the back half of the year, we saw an acceleration in fintech adoption across the board, as both businesses and consumers adapted to the COVID-19 health and economic shock. According to a September 2020 Survey conducted by Plaid, nearly 60% of Americans confirmed they were using more fintech apps to manage their money and over 70% were convinced that digital money is part of the “new normal” (see Figure 1).

Figure 1. Fintech is the New Normal

Fintech companies — particularly in high-income economies — have addressed some of the biggest obstacles to financial services innovation — including a fragmented, legacy infrastructure, data connectivity challenges, and regulatory compliance issues. These investments paid off for customers, the ecosystem, and its leading innovators. Paypal and Square had banner years in the public markets; theirs shares soared by 100% and 200%, respectively. Visa announced plans to acquire Plaid for $5.3 billion and Stripe’s valuation is approaching $70bn.

And yet, we believe we are just starting to see how impactful this new wave of fintech innovation will be to the financial lives of consumers and businesses. We expect to see a surge of new fintech applications thanks to a wide range of open-banking APIs. Many of these applications won’t necessarily come from traditional “financial services companies”. Indeed, just about any company can consider launching financial services to become increasingly relevant to their customer’s financial lives, enhance their near-term profitability, and gain a long-term competitive advantage.

The clear winners from the coming wave of fintech applications are the individuals and businesses that consume them. But how can investors make sense of a world where every company is potentially a fintech company? How can up-and-coming fintech startups think about their long-term positioning in such a rapidly evolving landscape?

We believe that data flows and money flows will drive the future fintech winners. In other words, companies will need to think through two key factors in order to form a long-term competitive advantage in the new fintech landscape. First, companies will need access to relevant proprietary data — either directly or indirectly. Second, companies will need to position themselves in their customers’ flow of funds in order to act on that data.

Companies that achieve this will have the ability to offer customized, targeted financial solutions that are relevant to their customer’s current context. By doing so, these companies will remain important to their customer’s ever changing financial needs. Data flows and money flows are at the heart of the new paradigm in fintech innovation: Contextual Financial Services.

(1) Follow the Data Flows

Needless to say, data plays a critical role in financial services. Financial institutions have long leveraged data to underwrite credit, authenticate customers, and flag potential fraudulent transactions. The nature of that data — where it comes from, how it is generated and who provides it — has evolved rapidly, however. Data from web apps, mobile devices, and even social networking platforms are now leveraged in financial services. As a result, most of the recent fintech innovators have leveraged these alternative data sets to launch better credit, insurance, payments, and other financial services to customers.

The accessibility to this data has greatly improved in recent years thanks to API driven solutions from Plaid, Yodlee, and others. These solutions enable companies to directly connect to their customer’s financial accounts, enabling a seamless consumer experience. Similarly, companies such as Marqeta, Galileo and others enable fintech companies to seamlessly issue payment credentials to their customers. These open banking solutions have facilitated the launch of several innovative financial services applications.

(2) Follow the Money Flows

Similarly, we have witnessed how companies can leverage their positioning within the flow of customer funds to gain a long-term competitive edge. This positioning enables companies to greatly enhance the overall consumer experience by offering differentiated, often customized solutions. One example of this is the merchant working capital product. For years, payment processors, point-of-sale vendors and banks with merchant processing arms have successfully deployed working capital solutions for their merchants.

But perhaps none are as differentiated as PayPal and Square. As payment processors, both of these companies leverage historical sales data from their merchants. This enables them to model out the consistency and seasonality of those sales. As a result, these companies can detect when retailers are likely to have relatively weaker sales (i.e. a seasonal pattern) and proactively offer working capital loans that can cover those tougher months.

Access to data is only half the story, however. It is the positioning within their customers’ money flow that enables Paypal and Square to offer a credit product that is superior to many alternatives. Merchants opt to pay a fixed percentage of each sale towards the loan. This percentage is automatically deducted from the sales until the loan is paid off. The percentage approach helps merchants smooth out their cash flow, paying more towards the loan in strong months, and paying less towards the loan in slower months. The entire loan product and — more importantly — the loan repayment schedule is designed to adjust based on the strength of their customers’ sales. That is contextual.

(3) Investing in Contextual Financial Services

Merchant working capital is just one example of how companies can combine access to relevant data and direct positioning within their customers’ flow of funds to offer contextual financial services. On the consumer side, for example, companies like Affirm and Klarna offer customers ‘buy now, pay later’ options within their shopping experience.

We note that some companies might lack the capabilities to leverage data efficiently. Other companies might have access to data but lack a direct positioning within their customers’ flow of funds. What makes the contextual financial services paradigm so unique, however, is that companies can largely solve these gaps by integrating relevant open banking APIs.

There are a number of ways to invest in this secular trend. As a fintech VC, we are primarily focused on two categories. The first category of investment opportunities is what we refer to as “network platforms”. These companies are equipped to offer contextual financial services directly to their customers. In other words, they have access to the data flows and the money flows. The second category is what we refer to as “contextual fintech enablers”. These API driven platforms provide financial services, software vendors, marketplaces, and other brands with the tools to offer white-label financial services through their platform.

Category 1: Network Platforms

B2B Payment Platforms. As we previously noted, we believe that B2B Payments Automation is finally having its moment. Over the last two decades, much of the enterprise from CRM to ERP to People Ops has moved into the cloud. B2B payments, however, have remained stuck in the pre-digital age. The secular trend away from manual, paper based processes accelerated in 2020. We expect the growth in digital B2B payments to remain elevated, as the ecosystem plays catch up to B2C and C2C payments.

In addition to digitizing accounts receivables and accounts payables, we see B2B payment platforms as well-positioned in the era of contextual financial services. B2B payment platforms have an opportunity to help enterprises manage the full customer sales cycle from the contract to the order/invoice to the actual payment. In addition, by offering customers corporate-based expense cards, these B2B payment processors can track expense patterns over a larger set of transactions.

B2B payment processors will leverage this payment data to offer competitive products to their business customers. These products include accounts receivables financing, corporate credit cards, FX conversion and other commercial banking solutions. We point to similar strategies in the B2C (merchant working capital) and C2C verticals (see Venmo’s debit and credit card offerings).

These contextual financial services could profoundly improve the financial reality for businesses, particularly in emerging markets. As we previously noted, in regions such as Latin America, cash remains dominant and businesses are very early in the process of automating their workflows. As a result, only a small fraction of businesses have access to formal credit products.

Our investments in this category include Paystand (US) and Yaydoo (Latin America).

Payroll Processing Platforms. Payroll processing platforms can emerge as leaders in the age of contextual financial services given their access to unique payroll data and an advantageous position in the flow of funds from employer to employees. In the US, a large percentage of the population cannot cover $400 in unexpected expenses and the Federal Reserve found that 60% of the population do not have liquid assets to cover 3 months of expenses. It is clear that US employees need access to a lifeline when unexpected short-term shocks occur. In other words, US workers need the ability to smooth out their cash flow as their context changes. This would be equivalent to “the merchant working capital case study” we mentioned above.

We believe payroll companies are best equipped to fill this void. Payroll processors can enable employees to access their unearned wages earlier in the payroll cycle or even take out short-term emergency loans. The loan amount can then be deducted from the employee’s future paychecks.In the US, this could serve as an attractive alternative to the predatory practices of payday lending. In emerging markets, where large percentages of the population are unbanked, we believe payroll processors could play a pivotal role in financial inclusion (see our take on how these companies can help tackle financial inclusion in Mexico).

And this is just the beginning. Payroll/HR platforms can see when an employee recently married, had a new child, received an end-of-year bonus, earned a promotion, and more. As a result, we fully expect payroll companies to push into banking/payment products to offer employees contextual financial services.

Our investments in this category include Gusto (US) and Worky (Latin America).

Category 2: Contextual Fintech Enablers

Payment Processing APIs. Large marketplaces, including Amazon, Airbnb, Pinterest and Uber have invested millions in bringing their payment processing needs in-house. The near-term economic rationale for these large platforms is clear. At a certain scale, the cost of outsourcing payment processing to a third-party does not make sense even after tacking on the ongoing maintenance and regulatory compliance cost. But this move also provides powerful data streams that these platforms will leverage to offer their marketplace participants a suite of financial products. A notable example is the Uber wallet, which is offered to uber drivers in order to receive, transfer and spend their earnings.

That said, taking payments processing in-house is not economically or operationally feasible for the majority of small/mid-size companies. In order to compete with their larger peers, these companies need to either outsource their payment processing or integrate a white-label payment infrastructure.

We predict the second option will look increasingly attractive to companies that want to (1) turn payment processing into a revenue generator and (2) offer contextual financial services within their platform. For example, software vendors can add payment processing to the suite of products they offer their customers, potentially enhancing their customers’ LTV. In addition, providers of smart point-of-sale devices can process transactions on behalf of their merchants, paving the way for other solutions, such as the merchant working capital noted above. Moreover, online lenders can offer their businesses payment processing services to enhance revenue and offer a combined loan/payment product. (see Kabbage Payments as an example).

Our investment in this category includes Finix Payments (US).

Insurtech Based APIs. Digital insurance companies will increasingly embed their APIs in third party platforms to scale efficiently, while greatly improving the insurance shopping experience. There are numerous applications where this makes sense. For example, digital auto marketplaces should integrate insurtech APIs to offer their customers the ability to tack on auto insurance at the point of purchasing a car and without having to leave their platform. Online real estate marketplaces (which we speak about more below) can integrate home insurance offerings within their platform as well.

Neobanks, moreover, will look for incremental sources of revenue to increase their LTV. Insurance products should be at the top of their list. While some of the largest neo-banks may opt to build out their own insurance brokerage infrastructure, we believe most will opt to integrate third-party APIs. These insurance integrations are particularly critical for underbanked consumers and for emerging markets where insurance remains largely untapped (read our take on Mexico’s auto insurance opportunity).

Our investments in this category include Guros (Latin America) and Listo Financial (US).

Proptech Based APIs. Prior to COVID-19, residential real estate lagged nearly every major industry in online commerce penetration. According to Properties Online, nearly 100% of customers start their search online, but only 1 in 5 consumers actually transacted or even contacted an agent online. We believe 2020 was an inflection point for online real estate transactions, as COVID-19 forced buyers and sellers to adopt digital tools. The public markets are seemingly pricing this in as well, as illustrated by the 200%+ surge in Redfin and Zillow shares and the recent Opendoor Technologies IPO.

We expect to see a flurry of innovation in the proptech industry. New proptech innovations will facilitate how consumers execute transactions online and, equally importantly, how they finance those transactions. These solutions are necessary in order to narrow the homeownership gap for the most financially vulnerable populations — namely minorities, women, and young individuals.

We see ample space for creative real estate financing solutions — including how consumers purchase a new home, refinance their property, and tap into their equity to smooth out their cash flow. These proptech platforms companies can package their solutions and offer it to real estate marketplaces or neobanks through APIs.

As a result, neobanks that want to “grow” with their customers can offer them innovative, affordable alternatives to traditional mortgages instead of losing them to competitors. These same neobanks, robo-advisors, and budgeting platforms can help customers save for a down payment, before offering them a mortgage-like product. Moreover, payroll processors can offer these innovative mortgage solutions to employees who just got married or recently had a child. The opportunities for contextual financial services in proptech are plentiful.

Our investments in this category include Haus.

Neobank APIs. Scaling a neobank is difficult and costly, which will cause neobanks to rethink their distribution strategy. As a result we expect neobanks to increasingly bundle and integrate their solutions into third-party platforms. By doing so, neobanks can enable marketplaces, and software vendors to embed banking products into their suite of offerings. Taking it a step further, neobank APIs can enable payroll companies — or employers themselves — to offer white-label banking solutions directly to employees.

Indeed, neobank APIs could help transform banking into a central component of an employee’s financial wellness. This has the potential to strengthen the relationship between employers and employees, while providing employees with the tools to better manage their cash flows. Over the long-term, neobank APIs could have a transformative impact on financial inclusion. This is the case even in the US, where 25% of the population was underbanked prior to the COVID-19 shock (read our take on how fintech can help bend the curve for the underbanked.).

Our investments in this category include Rev Worldwide and Challenger (Disclaimer: while Challenger is not a LEAP portfolio company, one of our Partners is an angel investor in the company).

The Future of Fintech is Contextual

The combination of open banking APIs and embedded financial services has ushered in a new, exciting era of contextual financial services. In this era, trusted brands will offer timely, relevant and often customized financial services directly to their customers. These solutions could adapt to the customer’s changing financial reality and these trusted brands need not be traditional financial services companies. Consequently, there are undoubtedly several game-changing fintech applications that we have not even considered yet.

The era of contextual financial services is just getting started. It might get increasingly difficult to gauge the “winners” as the ecosystem evolves. But as a starting point, we recommend you follow the data flows and follow the money flows.

Data Flows and Money Flows Will Drive the Future of Fintech was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.

The world made incremental progress in financial inclusion during the last decade. According to the World Bank, 69% of adults globally — 3.8 billion people — had an account at either a bank or mobile money provider as of 2017. This was up quite significantly from just 51% in 2011. An increase in mobile adoption and internet access, coupled with an uninterrupted economic recovery from the 2008/2009 global financial crisis, were among the drivers of this progress.

Despite that progress and significant innovation in financial technology, over 30% of the world’s population remains excluded from the formal financial system. Moreover, gaps between rich and poor, women and men, urban and rural communities, remain strikingly wide. The COVID-19 pandemic is magnifying these gaps across the world as it disproportionately impacts vulnerable populations with a lack of financial reserves and/or limited access to health care.

The World Bank estimates that the pandemic and related economic shutdowns could push between 70 million and 100 million into extreme poverty. This threatens the progress the world has made in financial inclusion as poverty remains the most important leading indicator of a household’s banking status across the world.

Mexico as a Microcosm for the Developing World’s Unbanked

In this report, we focus on financial inclusion in Mexico, which we see as a microcosm of the challenges and opportunities the developing world faces with financial inclusion. A large low-income population, high levels of inequality, a thriving informal sector that is dependent on cash transactions, and a relatively weak formal financial system are all contributors to the global unbanked population. These are all challenges that Mexico struggles with.

In many respects, we are surprised that Mexico has largely flown under the radar for many global fintechs/Venture Capital investors focused on financial services for the underbanked. We believe this will change as successful neobanks/fintechs from India, Brazil and the US look to expand into Mexico. In addition, we expect to see several domestic fintech start-ups successfully scale over the next decade addressing several multi-billion dollar gaps in banking, insurance, home ownership and more.

Below we highlight some of the key factors that make Mexico a representation of the challenges with financial inclusion in the developing world.

(1) Financial Inclusion Remains Elusive for Over 30% of Mexico’s Population

The World Bank estimates that half of the 1.7 billion adults are living without access to a formal financial account and are largely concentrated in seven world economies, including Mexico. Based on the Findex Database, Mexico has the 7th largest underbanked market in the world and the largest in Latin America.

Figure 1: Nearly half of all underbanked adults live in just seven economies
Percentage of the World’s Underbanked by country (2017)

In Mexico, 32% of the adult population (ages 18–70) is unbanked, which is coincidentally in-line with the percentage of the global adult population that is unbanked (31%). While the Mexican population with at least one account at a traditional financial institution increased by two million people from 2015 to 2018, the percentage of underbanked individuals actually remained flat.

Figure 2: Mexico population aged 18 to 70 and its percentage of those who have a financial product, 2015 and 2018

Financial inclusion is an issue across the entire spectrum of core financial service products in Mexico. According to Mexico’s National Survey of Financial Inclusion (ENIF):

• Only 47% of the population has a formal bank account
• Only 40% of the population has a retirement savings account
• Only 31% of the population has a credit card
• Only 25% of the population has an insurance product

Figure 3: Percent of Mexico Adults with Formal Financial Products

(2) Poverty is the Main Indicator of Underbanked Status in Mexico

Poverty is perhaps the single most important driver for the underbanked population across the world. According to the World Bank, the lowest quintiles represent more than twice as many unbanked households as the highest quintiles. This is true even of high-income countries with relatively large numbers of underbanked individuals, such as the US. This gap, however, is much wider in the developing world than in high-income countries.

Figure 4: Poverty-stricken adults are less likely than wealthier ones to have a bank account

Percent of Adults with a bank account (2017)

Not having enough money is the most cited reason for unbanked status across both the developed world and developing world. Legacy bank infrastructure and business practices make formal bank accounts prohibitively expensive for poor households who can’t maintain minimum balances. The lack of access to these formal financial services, moreover, make it difficult for these families to lift themselves out of poverty.

Figure 5: Key reasons for not having a bank account (%,2017)

Poverty is also a key driver for the unbanked population in Mexico, where poor communities over-index in the unbanked population. In Mexico, the poorest quintile is more than 2X more likely to be unbanked than the richest quintile, similar to the global average.

Figure 6: In Mexico, the only group where the majority has a bank account is the richest quintile

In addition, Mexico has wide gaps in account ownership between rural and urban communities. This gap is on average 15 percentage points across all core financial products and 12 points in a traditional bank account (again, in line with the 13% gap we see between rich and poor across the world).

Figure 7: Mexico rural communities are significantly less likely to have core financial services products than the urban population

Percentage of adults that have a core financial services product (rural vs. urban, 2018)

Source; ENIF, 2018

(3) Youth and Women Are Overrepresented in the Underbanked Population

Young individuals are also disproportionately underbanked across the world. Nearly one-third of the world’s underbanked are between the ages of 15 and 24. These individuals are likely to be out of the workforce or early in their careers with lower earnings power. In developing economies, moreover, there is generally less availability for family-based accounts or accounts tailored for young students/professionals.

Figure 8: Three in 10 unbanked adults are between the ages of 15 and 24

Adults without an account by age group (%,2017)

As in most of the developing world, the penetration numbers are much lower for Mexican women and youth. The penetration rate for individuals 15 years and older are nearly 10% points lower across all core financial products (bank account, insurance, credit, retirement account) compared to the adult population. With respect to a formal banking system, Mexico has one of the lowest penetration for youth in Latin America and worldwide. Only 37% of Mexico’s population ages 15 years or older have a formal banking account.

Figure 9: Percentage of people 15 years and over with a banking account

In addition to youth, women are disproportionately unbanked. According to the World Bank Findex, women are 1.3X more likely to be unbanked than men. This gap somewhat narrowed over the last decade in high-income economies. In developing economies, however, this gap has sustained over time. According to the World Bank, 56% of the world’s unbanked are women, 12 percentage points higher than men.

Figure 10: Gender gaps in account ownership have persisted over time.

Adults with an account (%)

Similarly in Mexico, women are more likely to be excluded from the formal financial system. Only 63% of women ages 18 and over have at least one core financial product, compared to 72% of adult men. This nine percentage point spread, moreover, has remained consistent over the last decade. Only México City has achieved parity in account ownership, though most regions still show a gap in account ownership between women and men.

Figure 11: Women continue to trail men in account ownership across most Mexican regions

Percentage of population from 18 to 70 year with a financial product by region and gender

(4) Large Informal Sector Contributes to Cash dependency

Many countries in the developing world have a thriving informal sector, which represents a sizable share of their GDP. This informal sector runs mostly on cash, which makes it very difficult to track flows and payments. This in turn, makes it difficult for banks to access credit risk for both individuals and businesses that engage in cash based transactions.

The informal sector is a particularly stark challenge for Mexico. Over 25% of Mexico’s GDP is derived from the informal sector. In addition, around 57% of the country’s workers are employed under informal arrangements, which can lead to a higher dependence on cash, lower employee benefits and lack of important employee protections. A large informal sector in Mexico’s economy is one of the leading reasons why Mexico’s economy is dependent on cash. As a result, only 35% of businesses in Mexico accept card payments.

Figure 12: Percentage of businesses that accept card payments, by sector

According to the Dallas Federal Reserve Bank, cash made up 93% of Mexico’s transactions, well below the levels in Canada and the US. This is a key reason why traditional financial services fail the majority of the population in Mexico. The use of cash makes it difficult to track payment and income data and create risk assessment scores that drive traditional credit underwriting models. Without a steady record of wages and payments, many individuals and SMBs are unable to build up traditional sources of credit.

Figure 13: Cashless payments in Mexico, the U.S., and Canada

(5) Banking sector has little incentive to cater to low-income segment

Like much of the developing world, the banking system in Mexico has quite a turbulent history, including a period of nationalization in the early 1980s and a currency crisis in 1994 that threatened systematic failure (for more history, read here). Today, Mexico’s banking sector is dominated by large foreign bank giants, which injected the necessary capital in order to dampen the effect of the “peso crisis”. But the combination of a consolidated banking sector and weak contract enforcement have limited the availability of credit in the marketplace to the mid-to-high income segments. The top foreign banks are actively providing consumer and housing loans where the credit is backed by collateral. Business credit is more readily available for the enterprise segment of the market, leaving a large gap in SMB lending.

Figure 14: Portfolio concentration of the 5 banks with the highest balance, compared to the total portfolio of commercial banks

The general lack of competition enables the Mexican banking sector to be very profitable catering to the high-networth individuals and enterprises. The general fees, commission structures and high interest rates, make the formal banking sector prohibitively expensive for low income individuals. In addition, there is very little incentive for the traditional banking sector to create products for the low-income/unbanked segment, particularly in rural communities which lacks a lot of the traditional retail banking infrastructure found in urban areas.

According to the CNBV (Mexico’s banking authority), there are only 0.66 ATMs per 10,000 residents in rural areas, compared to 2.7 ATMs per 10,000 residents in urban areas. This is a major barrier for customers, as according to the World Bank Findex, 21% of unbanked individuals say they do not have an account due to poor financial infrastructure. Despite a gradual improvement in banking infrastructure over the last several years, 75% of small rural municipalities lack a bank branch or ATM.

Figure 15: Percentage of rural municipalities (with less than 5,000 residents) with at least 1 bank branch, or ATM

(6) Remittances Are A Fundamental Lifeline for the Most Vulnerable

Remittances are a critical source of funding for some of the most vulnerable populations in developing economies. According to the World Economic Forum, in 2019 low and middle income countries (LMICs) received a record $554 billion, which exceeded the amount of Foreign Direct Investment these same countries received as a whole. These remittances are important to economic development in receiving countries because they (a) are usually directed to the most vulnerable, low-income households and (b) could potentially offer some protection against economic shocks/recessions.

Figure 16: An estimated US$551 billion in remittances were sent to low-and middle-income countries in 2019 (US$ billions)

Remittances are a particularly important source of funding for millions of families in Mexico. Based on World Bank data, $39 billion are sent to 10 million families annually. Over 90% of that remittance volume comes from the United States. This is due to a large migrant worker population of 11M+ in the United States that caused explosive growth in remittances over the last few decades. As a result, Mexico is the third largest remittance recipient, receiving half the amount that India and China receive, despite having 1/10th the total population of those countries.

Figure 17: Top-10 remittance- receiving countries in 2018 (billion U.S.dollars)

There is a mixed view on how remittances can help smooth the economic cycles for receiving countries. Some academic research suggests that remittances can be a countercyclical stabilizer in economic downturns as remittances help diversify the financial structure of these countries. Others believe that as recessionary pressures impact migrant workers in “sending” countries, a reduction in remittances can have a compounding impact on receiving countries. In 2009, for example, worldwide remittances fell by 12%, following the 2008 financial crisis.

In early April, the World Bank put out an alarming prediction on remittances, estimating sharpest decline of remittances in recent history. Globally, remittances were expected to drop by 20% in 2020 as the migrant workers suffered from unemployment and falling wages. In Latin America, remittances were expected to fall by 19% in 2020.

However, the results thus far indicate that remittances to the region have not only held up during the COVID-19 pandemic, but have actually reached historic levels. In the month of March, remittances to Mexico exceeded $4 billion, despite the commencement of government mandated lockdowns and resulting unemployment. Through the month of June, migrant workers sent over $19 billion to Mexico, a 10% YoY increase. The fact that the US dollar strengthened significantly (20%+) relative to the Mexican Peso in that same time period, certainly helped. At any rate, this influx of foreign capital certainly provided a lifeline for millions of Mexican residents at a time when the home economy virtually shut down for a period of time due to COVID 19.

Figure 18: Total Remittances to Mexico from January to June Increased Amid COVID-19 Pandemic

Mexico Lags Much of the Developing World in Digital Financial Services…

The percentage of adults with a formal financial account has improved since the Great Recession, jumping from 50% in 2011 to nearly 70% in 2017. And this improvement likely persisted through 2019. Much of this progress came from the formal financial sector, according to the Global Findex Database. This was the case in both high-income economies and developing economies alike.

However, developing economies also saw a gradual impact from mobile accounts, particularly towards the latter half of the decade. By 2017, nearly 5% of adults with accounts in developing economies had a mobile money account.

Figure 19: Financial institution accounts have fueled the growth in account ownership since 2011, but mobile played an important role in developing economies

Adults with an account (%)

The role of digital payments also intensified over the course of the decade. In 2017, at least 50% of all adults with a financial account used it to make or receive digital payments (including P2P transactions, bill payments or other transactions). The growth of digital payments increased significantly in developing economies. In 2014, 25% of adults with accounts in developing economies had participated in a digital transaction. By 2017, that number was 40%. We believe this growth trend continued into 2019.

Figure 20: Percentage of account holders who made or received a digital payment

Surprisingly, Mexico has lagged in adoption of digital payments and mobile banking. Less than a third of the country has made or received a digital payment, according to the World Bank Findex. This ranks the country behind other major economies in Latin America. Even within the banked population, only about 22% regularly use mobile banking services provided by their financial institution.

Figure 21: People 15 and older who made or received digital payments

… But Mexico Has the Right Ingredients for Digital Financial Services

What makes Mexico’s lack of progress in mobile money is the fact that the country has the right ingredients for mobile financial services to flourish. Here, we summarize some of these key ingredients:

(1) Widespread Smartphone Adoption. Mexico’s smartphone adoption has ticked up significantly in the last 10 years, reaching near ubiquity across the country. The combination of lower priced smartphones entering the country as well as the high availability of retail credit (a point we discuss further below) has allowed consumers to buy smartphones with installment payments. According to GSMA, 63% of the population has access to a smartphone and that share is expected to increase to 70% by 2025.

Figure 22: Smartphone ownership in Mexico steadily increasing (percent of population)

(2) Improving Connectivity Rates. Internet connectivity in Mexico has improved gradually, making it one of the countries with highest fixed internet penetration in Latin America. There is ample room for improvement, particularly outside of the major cities (such as Mexico City, Guadalajara and Monterrey). However, we note that 63% of smartphone owners have access to 3G or 4G connectivity, critical for any digital financial services application to succeed.

Figure 23: Penetration of fixed internet access service per 100 households

(3) Young, Tech Savvy Demographic. The median age in Mexico is 28 and 45% of the population is between the ages of 25 and 54 years old. This population is more prone to adopt digital products and services in their personal lives and — given that 50% of the workforce are millennials — more prone to adopt technology in the workplace as well.

Figure 24: Mexico Demographic Composition

(4) Fintech Investment Reaching A Tipping Point

According to Ernst & Young (EY), Mexico’s unbanked market represents the most attractive opportunity for fintechs and VC investors in Latin America. EY’s research finds that Mexico’s banking system could generate as much as $7.6 billion in annual revenues by developing new products and regulations that promote financial inclusion.

This has piqued the interest of both fintech entrepreneurs. As a result, both fintech entrepreneurs and VC investor interest is piqued. With over 400 fintech start-ups, Mexico is now an epicenter of fintech innovation in Latin America. The number of Mexico-based fintech start-ups has grown at an average rate of 23% since 2016. Digital banking and insurtech focused start-ups, moreover, are far outpacing other areas of fintech.

According to Finnovista, over two-thirds of Mexico fintech companies have raised over $800 million total in equity and debt capital. We note that most of that investment is concentrated in just a handful of companies. There are only 10 Mexico fintech companies that have raised $10M or more in equity capital. That said, most of this funding has occurred in the last 2–3 years and we expect this momentum in funding to continue building post COVID-19.

How Fintech Can Increase Financial Inclusion in Mexico

Mexico’s leading challenger banks have a long way to go before scaling to the size of the three “unicorn” neobanks in the Latin America region (Nubank, Uala and Neon). But we believe that one of the unintended consequences of the COVID-19 pandemic is that it will accelerate the adoption of digital financial services. As we discussed in a previous note, on Digital B2B Payments in Latin America, over 63 million people (50% of the population) are now shopping online and are expected to drive online ecommerce by over 20% YoY in 2020. Many of these consumers are shopping online for everything from groceries to online banking for the first time. We expect the majority of consumers to continue using digital banking post the pandemic, particularly as banks begin to reign in credit in light of the uncertain economic backdrop.

Figure 25: Products and Services Bought Online for First Time During the Pandemic

Well funded, nimble fintechs have a window of opportunity to acquire new customers. But this is also a golden chance to launch solutions for the most vulnerable, including low-income, youth, women and rural communities. Currently, Mexico’s fintechs are mostly concentrated in catering to clients in metropolitan cities — such as Mexico City, Guadalajara and Monterrey. While it makes sense to focus on these cities given the population size, these markets also tend to have a higher proportion of middle-income users and are extremely competitive. According to Finnovista, two-thirds of Mexican fintech start-ups are based in Mexico City.

As we await to see a continued surge in fintech activity in Mexico, we are particularly excited to see how creative fintech companies address the challenges of financial inclusion across core financial products. Given the complex structure of the Mexico market, there are several strategies that fintechs should consider employing in order to bend the curve on the underbanked population in the coming years, including:

(1) Strategic partnerships with current providers of alternative financial services to the underbanked. One interesting approach that fintechs can employ is to partner with some of the large providers of alternative financial services to the underbanked population. In Mexico, for example, providers of store credit are the de facto credit provider for the underbanked that can’t access formal credit cards from banking institutions.

According to Mexico’s National Survey of Financial Inclusion (ENIF), over 60% of adults have used retailer-issued credit. This is nearly twice as much as the population with a bank credit card. These products play an important role for low-income and middle-income households, facilitating their purchases of a variety of big ticket items from furniture to smartphones to vehicles.

These providers of financial services companies are continuously looking for ways to increase their importance to the financial lives of their customers. The top providers of retail store credit have branched out into formal banking in order to bridge their customers into formal banking products. Their financial services offerings now include checking accounts, credit cards, insurance and remittances. But they can benefit from the agility, product and user experience know-how of fintechs.

In addition, large insurance carriers and brokers are looking for ways to grow their business by tapping into roughly 70% of the population without an insurance product. As we previously wrote in an article on Mexico’s Auto Insurance Market, insurance companies are increasingly shifting their distribution strategy from a traditional retail agent distribution channel to digital acquisition channels. This has opened the door wide open for a variety of B2B and B2B2C solutions in insurtech as well.

(2) Partnerships with providers of small business loans and productivity tools. In Mexico, small businesses account for over 70% of employees. However, the majority of Mexico’s SMBs are neglected by the formal banking system given the high degree of informality, cash dependence and — as a consequence — lack of a reliable business credit score system. In recent years, several small business lending startups have successfully raised capital and scaled the number of SME clients. However, we believe that there is also a significant untapped opportunity for partnerships in SME Lending. Banks, institutional lenders and fintechs alike are looking for alternative credit risk models to widen their reach in the SMB market. Larger lenders in particular could leverage low-cost funding/deposit base but do not have credit underwriting models relevant for SMBs.

In addition, companies that help SMBs automate their payments, payroll, accounting and other areas are strong partners for both banks and fintech start-ups looking to offer financial services tools to these SMBs. The data these service providers acquire can be leveraged to customize financial service solutions and/or underwrite credit products.

(3) Creative Approaches to Remittances. Given how critical remittances are to the low-income and rural populations in Mexico, we are excited to see how fintech startups leverage these US to Mexico money transfers as a bridge to provide more financial services for the unbanked. In addition, as we noted in our prior article on the US underbanked market, Latinx individuals are overrepresented in the US underbanked population. Over 60% of these Latinx individuals are of Mexican descent and are responsible for the $36 billion in remittances sent to Mexico.

Fintech startups have an opportunity to leverage digital payments and banking to further bridge these populations beyond just remittances. Successful models thus far have enabled digital remittances, which have cut fees, increased speed in delivery of funds and enhanced security. Other models enable cross-border bill payments, where US senders can pay bills for their families in receiving countries directly. But these models generally require the US based sender to have a bank account, which is not the case for a large percentage of this consumer.

Open banking platforms have predominantly powered banking solutions in domestic markets. However, as these enablers of financial services innovation move across borders, we believe it will open the doors for more fintechs to operate in multiple countries. We thus foresee fintechs having banking clients in both the US and Mexico, solving similar gaps in underbanked populations on both sides of the border.

We believe the next wave of innovative remittance companies will leverage digital remittances to address a variety of issues for the unbanked in Mexico, including insurance, real estate and education. In insurance for example, we envision models where US residents can purchase auto, health or life insurance for their family in Mexico. We also envision models where US residents can seamlessly finance property purchases in Mexico, helping their families circumvent the relative lack of home mortgage loans.

There are just some of the many use cases we can come up with that can bridge the underbanked populations in both US and Mexico. And we are excited to partner with founders creating these solutions over the next several years.

Mexico’s Fintech Moment Has Arrived

We expect COVID-19 to push more households into poverty across the developing world as the pandemic results in job loss and/or wage decreases for millions. The World Bank estimates that as many as 70 million to 100 million will be pushed into extreme poverty in the developing world. Given that poverty is the leading indicator of unbanked status globally, this will all but ensure that the number of underbanked individuals rise sharply.

On the other hand, the pandemic is also notably accelerating the digitization of payments, commerce and financial services. Across the world, millions of individuals are flocking to digital payments and commerce, many for the first time, as businesses were shut down. This shift in consumer behavior has opened a window of opportunity for mobile money providers that can potentially gain share of wallet as more consumers are pushed out of the formal banking system.

This represents an interesting inflection point for fintech in Mexico, which has struggled to reduce its underbanked population. Mexico’s banking system has failed to address the challenge of financial inclusion for years. But over time the country has amassed interesting demographic and market factors that bode well for adoption of digital financial services. The COVID-19 pandemic has already forcedforce a large part of the population to adopt more products and services digitally, perhaps sparking a trend that can finally make a dent on a thriving cash economy. This is a big moment for fintechs in Mexico and for VCs that support them.

Mexico’s Fintech Moment Has Arrived was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.

Below I offer my thoughts on the lack of diversity in VC and some suggestions on how to address this issue, drawn from my personal experience and recent learnings.

The Diversity Gap In VC Represents A Massive Opportunity Cost for Investment Returns and the US Economy

The diversity gap in VC is daunting. To summarize:

• Only 1% of all venture capital is invested in Black founders. Less than 2% is directed to Latinx founders. Let this sink in for a bit: less than 3% of all venture-stage funding goes to Black or Latinx founders, combined. This is the “funding gap” for founders of color in VC.
• It is even worse for women of color. Black and Latinx women founders receive less than 1% of all venture investments, combined.
• This funding gap for diverse founders is mirrored by the lack of diversity within VC investment professionals. Unsurprisingly, less than 3% of investment professionals at venture firms are Black or Latinx, combined. This is the “hiring gap” for investment professionals of color in VC.

The fact that the diversity gap in VC remains so stubbornly wide is particularly problematic. In December 2018, Morgan Stanley outlined how VCs are missing out on as much as $4 trillion in value by underinvesting in minority and women founders. Separately, a 2020 research report by the Stanford Latino Entrepreneur Initiative noted that if Latinx-owned businesses were to grow to match the size of non-Latinx owned businesses, it would add $1.5 trillion to the US economy.

The lack of diversity presents a conundrum in VC. As venture capitalists, we are economically incentivized to generate the best possible returns for our investors. We attempt to achieve those returns by identifying and investing in founders, ideas, and companies that will transform entire markets, often by challenging the status quo. And yet, the lack of investment in founders and GPs of color seems to be at direct odds with the fundamental role of venture capital given (1) the data suggesting that increased diversity amplifies returns and (2) the opportunity to drive transformational change through investing in diverse communities.

Figure 1: VCs Can Tap Into A Trillion Opportunity By Prioritizing Diversity

Capital Is Necessary but Insufficient

Let’s be clear, in order to improve the funding gap, founders and GPs of color need more investment. If you are a GP at a VC fund and want to move diversity beyond the 3%, invest in founders of color. If you are a Limited Partner in funds and you want to help move the needle beyond the 3%, allocate capital to GPs of color.

But, we cannot systematically improve the “funding gap” without improving the “hiring gap” simultaneously. In addition, diverse participants in the VC industry are not just starved for capital, they find themselves isolated from “standard industry practices” that make raising subsequent financing rounds, collaboration and getting hired significantly difficult. Capital is necessary but insufficient.

How can GPs of all backgrounds help?

If you are a GP, here are some key items to consider beyond investing in founders of color:

Hire diverse investors to build a diverse pipeline of founders and co-investors.

As VCs, we tap into our existing networks to build our pipeline and share insights/opportunities with our trusted peers/industry connections to help us quickly and efficiently assess these opportunities. And — whether we care to admit it or not — we are more likely to invest in people we can relate to and products/solutions that are addressing issues we can directly relate with. Moreover, we avoid what we don’t understand, and risk aversion is a well documented behavioral bias that leads to status quo reinforcement (see the “status quo bias” identified by Nobel Laureate Richard Thaler). This is particularly the case when you assess the very early stages of a startup.

Diverse investors leverage their existing networks as well. If you are having trouble building a pipeline of diverse founders, hire diverse investment professionals, who might see the world from a different vantage point. If you bring on these diverse investors, the chances are really high that your pipeline will begin to look more diverse, the insights you have on these opportunities will be different, and the deals you eventually execute will be unique, all of which can yield a competitive edge among peers.

Create the right environment for diverse founders.

One of the most counterproductive things you can do as a VC, however, is to hire Black and Latinx investors and not create an environment that encourages these diverse investors to leverage their unique networks. I personally know several diverse investors who are reluctant to source diverse founders in their firms out of concern that they will be seen as biased or labeled as the “diversity person” and get left out of high-quality deals without a diverse founder. This was exactly the situation that one anonymous VC investor spoke to in a Dot.LA article on diversity.

This is problematic as it could both hurt the career trajectory of the diverse investor and not generate the desired increase pipeline of diverse founders for the VC firm. In order to avoid this, VCs should clearly state their commitment to diversity, hold all levels of the firm accountable to that commitment and encourage diverse founders to leverage their networks to help the VC firm execute on that commitment.

Rethink some industry practices on how we source opportunities.

This is also a good time for VCs to reexamine some of the standard industry practices that may inadvertently present barriers to founders of color. These are just two examples — both of which Freada Kapor addressed during a call on diversity:

• Warm Intros: In efforts to either (a) manage hectic schedules and (b) help filter potential leads, VCs typically prefer warm intros to founders. These warm intros come from a VC investor’s existing network, including founders from an existing portfolio company, a limited partner, a co-investor or trusted industry connections. But the industry’s reliance on warm intros can close the door on founders of color. On the one hand, these founders of color are less likely to have an existing network that can make those critical warm intros. On the other hand, if a VC’s existing network does not include a lot of diverse people, then changes are they won’t receive a lot of warm intros to diverse founders.

In VC, your network is part of your competitive edge. So the point here is not to stop leveraging that network. It is more about expanding that network to uncover potential blind spots. One idea is to actively bring more diversity into your network of trusted peers — actively engage with VCs focused on founders of color, organizations that have a wide reach into diverse founders or thought leaders in a particular industry who happen to be diverse.

Another idea is to simply allow founders of color that fit your investment themes/strategy to contact you directly for a defined window. For example, Jason Lemkin from SaaSTR and Nihal Mehta from Eniac Ventures recently put out a call for black founders to reach out without an intro.

• Skill-based Assessments: Develop a “skills-based assessment” of talent when making hiring and investment decisions. As Freada Kapor pointed out in a recent discussion, “investing in Stanford graduates with an experience in Google” is not a skill-based assessment and it is a very narrow criteria for hiring or investing. This criteria, moreover, is likely not explicitly stated anywhere on a VCs pitch deck or shared through internal memos. It is something that VCs need to be conscious of nonetheless, and take actions to ensure that everyone is doing their part to create a “skills based assessment” because as Freada and Mitch Kapor rightfully assert: “Genius Is Equally Distributed by Zip Code, Opportunity is Not”.

How Can Limited Partners of all backgrounds help?

If you are a Limited Partner in VC, here are some key items to consider beyond investing in GPs of color:

Co-invest alongside a GP of color to build the relationship.

One effective way for institutional investors to foster new relationships with diverse GPs is by co-investing alongside them. By doing so, Limited Partners can have a direct look at the diverse GP’s pipeline, investment process and ability to add value following an investment.

In addition, diverse GPs will likely bring a different set of opportunities that at the least will further diversify the underlying assets in your portfolio and potentially amplify your returns due to the ability to co-invest in some of the most attractive deals that perhaps other VCs will overlook. Institutional LPs can manage these co-investments directly or require that it is implemented as part of existing Emerging Manager programs.

Invest in GPs of Color, through a Fund of Fund allocation.

One of the most efficient ways to get more capital into founders of color is through a carefully designed Fund of Funds (FoF) strategy.

If you create a Fund of Funds that invests in ~20 VCs focused on diverse founders, and each of those VCs invests in ~20 companies, you could indirectly fund up to 400 diverse founding teams. If instead of creating a FoF yourself, you invest in 10 FoFs with an underlying focus on diversity, you could indirectly fund 4,000 diverse founding teams. And this can be done in a period of 3 -5 years.

Hold VCs accountable for lack of diversity.

Limited partners can hold VCs accountable for lack of diversity in their firms and in their underlying portfolio. Diversity amplifies returns and thus it is both an institutional LP’s and VC’s fiduciary duty to take diversity seriously. This goes beyond just the largest pension systems. Endowments, foundations and family offices can exert significant influence — particularly on small and mid-sized VC funds.

Leverage existing networks to build a pipeline of diverse GPs.

Limited partners should establish meaningful relationships with organizations such as Blck VC, Latinx VC, New America Alliance, Kauffman Fellows and others to expand their pipeline of talented emerging managers. In addition, larger institutional investors that outsource some of their Emerging Manager initiatives could ensure these FoF manager programs are leveraging these same networks to build out their pipeline of Black and Latinx GPs.

Let’s Follow our Female Colleagues’ Lead to Finally Move the Needle on Diversity

I understand and share the frustration that many of my diverse VC colleagues have voiced in recent weeks on the diversity funding gap. But I am also hopeful that as a VC community we can learn from the leadership that women have shown despite facing significant underrepresentation. In a January 1, 2020 article, Forbes reported that while the 2010s saw some incremental progress in funding for female founders, the 2020s will likely see accelerated improvement in the gender funding gap.

Between 2008 and 2020, the percentage of VC capital invested in a team with at least one female founder nearly doubled from 6.5% to 12.6%. Similarly, according to All Raise — an organization focused on increasing female representation in VC and tech — the percentage of female decision-makers in VC reached 13% in 2019. Coincidence? I think not. These numbers move in parallel. Similarly, we cannot improve the funding gap without narrowing the hiring gap for founders of color.

These results are not cause for a victory lap, as 65% of US VC firms still do not have a single female partner. But a win is a win. And if we can move the percentage of VC Funding in Black and Latinx founders to 13%, I think we can all agree this is a step in the right direction.

The window of opportunity is as open as it has ever been. The time to move diversity in VC beyond the 3% is now.

Diversity: The Trillion Dollar Opportunity Hiding In Plain Sight was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.

It is expensive to be poor. This is true for the nearly 2 billion unbanked individuals in the world. But in the U.S. this masks a deeper truth. Black and Hispanic communities are overrepresented in the underbanked and financially vulnerable populations, which spend ~$200 billion in interest and fees to access financial services.

In America, it is expensive to be Black and Brown.

We expect the underbanked and financially vulnerable populations to rise as the COVID-19 driven economic shock disproportionately hurts minorities and young individuals. These are unfortunately the same populations that were already overrepresented in the underbanked population and among those most vulnerable to an economic shock. As in the decade following the 2007–2008 Financial Crisis, we believe FinTech startups could help bend the curve for the underbanked post the pandemic.

Sizing the Underbanked In the US

The Financial Crisis of 2007–2008 ushered in a big decade for FinTech companies serving the underbanked. Companies such as Green Dot (NYSE: GDOT), NetSpend (a Total Systems company), Lending Club (NYSE: LC), and XOOM (a PayPal company) all went public with a vision to provide financial services to a vastly underserved segment of the market. The services they offered varied from debit accounts to credit to remittances. Some of these models have proven to be more successful than others and all of them have shifted parts of their business model/strategy post IPO.

But their legacy in FinTech is cemented. These companies proved that you could leverage technology to offer better services to underbanked consumers. And you could make money doing it. FinTech founders saw that they could do well by doing good. VCs saw the potential for “billion-dollar IPOs” (NetSpend and Xoom were slightly below $1 billion at IPO but would eventually get acquired at/or above the $1 Billion mark).

These IPOs ushered in a wave of socially-focused entrepreneurs wanting to offer sound financial services to the underbanked population. Some of these efforts — along with the longest US economic expansion in history — seemed to pay off over the last decade. According to the 2019 FDIC National Survey of Unbanked and Underbanked Households:

• The unbanked population — households that do not have any formal bank account — shrank from 7.7% in 2013 to 6.5% in 2017.
• The underbanked population — households that have at least one bank account but use alternative financial services outside of the formal banking system — decreased from 28% in 2013 to 25% in 2013–2017.

As of 2017, 25.2% of US households were not fully incorporated into the formal financial services system. That represents 32.5 million households, a net decrease from 34.3M underbanked households in 2013. But despite the progress of the last decade, the size of this group remains alarmingly high. And the fees they pay to access alternative financial services has actually increased over the last few years.

Figure 1: Banking Status of US Households, 2013–2017

Who Are the US Underbanked: Black, Brown, and Young

In the US, there were key demographics more prone to be underbanked: minorities and young individuals.

(1) Black and Hispanics: There was also some incremental progress in the underbanked and unbanked status for Black and Brown populations, but they continued to be overrepresented.

• The unbanked rate for Black and Hispanics decreased by approximately 4 percentage points each. However, the gap between these groups and white households improved only gradually. In 2017, the gap between Black and White households was 14% points and the gap between Hispanic and White Households was 11% points. That gap only decreased by 3% for each group since 2013.

Figure 2: Unbanked Rates by Households Race and Ethnicity

• The underbanked rate for Black and Hispanics was approximately 30% in 2017. This was a gap of 16% points compared to Whites (which had an underbanked rate of 14%). Black and Brown communities were 2X more likely to be underbanked than White households.

Figure 3: Underbanked Rates by Households Race and Ethnicity

(2) Young households.

• Young individuals are more likely to be unbanked than older generations. However, that gap improved significantly over the last decade. For example, when comparing the two youngest cohorts (15–24 and 25–34) to the two oldest cohorts (55–64 and 65 and older), the gap in unbanked rate for young individuals improved from 19 percentage points in 2013 to 8.7 percentage points in 2017.
• The underbanked rate for these young individuals in 2017 was 52.4% for younger households. This was a 13% point gap to the underbanked rate for older generations (29.4%). The gap in the underbanked rate for younger individuals in 2015 was 22%. This was almost a 10% improvement in just two years.

Figure 4: Unbanked Rates by Household Age and Year

US Underbanked Revenue Opportunity: $200BN

While the global underbanked opportunity represents a $1 Trillion revenue opportunity, we believe the US market alone offers a sizable market for FinTechs. According to the Financial Health Network, underbanked consumers spent $189 billion in fees and interest on financial products in 2018. That number was projected to grow to $196B in 2019.

Figure 5: Underserved Market Revenue, 2015–2019

There are several key drivers of revenue and growth in the underserved market. We highlight a few of the key drivers of this revenue, including:

• Subprime Credit Cards. Credit cards represented the lion’s share of fees paid by the underbanked for financial services. Subprime credit cards generated $36.3BN or 19% of fees paid by underserved consumers. This grew by a modest 2.8% YoY in 2018 and is expected to remain in the low single digits for 2019.
• Subprime Auto Loans. Underbanked consumers paid $29.8BN in fees to access subprime auto loans. This accounted for 15% of the total fees paid by underbanked consumers. This product continued to capture a larger share of underbanked total spend grew at 9.7% in 2018.
• Installment Loans. These installment loans continued to grow at a rapid clip of $9.8BN in 2018. This represented 5% of the total revenue generated by underbanked consumers. From 2015–2018, installment loans posted a CAGR of 13% and are expected to continue posting double-digit growth.
• Private Student Loans. Underbanked consumers paid $9.5BN in fees for private student loans. This made up 5% of the total fees paid by underbanked for financial services.
• Payment and Deposit Accounts. Finally, while payment and deposit accounts generate a relatively smaller percentage of total fees for the industry ($16.7BN or 9% of total) compared to credit products, it is worth mentioning some of the key drivers in this bucket as they remain important products in the underbanked market. These include (1) Checking and Deposit Accounts, which generated $4.2BN, (2) Remittances, which generated $3.7BN, and (3) GPR Prepaid Card, which generated $2.8BN worth of fees.

Credit remains the largest driver of fees in the underbanked market, but payment/deposit accounts continue to drive more engagement. We see this as a key factor in the “rebundling” trend we are seeing in fintech today. FinTech Startups/NeoBanks that started with deposit or payment solutions are seeking to add a credit product to drive additional monetization. Companies who had existing credit customers are adding payment and deposit account products to enhance everyday use and stickiness.

Figure 6: Share of Underserved Market Revenue

COVID-19 Will Lead to An Uptick in the Underbanked Population

In an April 23, 2020 blog post — The Federal Reserve of St. Louis simulated how COVID-19 will disproportionately impact families in Financial Distress (defined as a family that is delinquent on credit/debt). Their model split households by “quintiles of financial distress”, where Q1 are households who live in the 20% of zip codes that exhibit the lowest levels of financial distress and Q5 are those in the 20% of zip codes with the highest levels of financial distress.

According to the Federal Reserve simulation, a demand plunge of 75% in the accommodation sector, food services sector and related sectors (such as leisure and hospitality) would reduce the income of the most financially distressed households by over 9%. This impact is 1.5X higher than the estimated impact on families in the least financially distressed households.

Figure 7: Simulated Impact of COVID-19 on Household Income

Such a shock to income for the most financially vulnerable could have a significant impact on their ability to access mainstream financial services for two key reasons:

(1) Income is still the main reason cited for Unbanked Status.
According to a 2017 FDIC Survey, 52% of US unbanked households cited not having enough money to keep in an account as a reason for not having a bank account. This was the main reason cited for 34% of the unbanked households. This had a 20% point lead over the second most cited reason for not having a bank account, which was a distrust of banks (a topic we address below).

Figure 8: Reasons for Not Having a Bank Account

(2) Financially Vulnerable Households Can Be Pushed Further into Underbanked Status.
According to a Financial Health Network report, 71% of the US Population struggled with at least one aspect of their financial lives. In total, this represented almost 180m people that were either classified as “financially coping” (defined as individuals struggling with some aspects of their financial lives) or “financially vulnerable” (individuals struggling with all or nearly all aspects of their financial lives).

Figure 9: Financial Health in America

US households cannot weather an economic shock of more than 5 months.
The Financial Health Network found that household balance sheets in general recovered from the Great Recession of 2007–2008. But despite the fact that more people felt comfortable with paying their bills and managing their debt, most of the population were financially susceptible to an unexpected shock as of 2019. In fact, 65% of the population had 5 months or less of liquid savings in 2019. Nearly 50% of the population had 2 months or less.

Figure 10: Months of Savings for US Households

Who are the Most Financially Vulnerable? Black, Brown, and Poor
In addition to being overrepresented in the underbanked population, Black and Hispanic communities were significantly more financially vulnerable than their White or Asian peers. The Financial Health Network measures financial health through a proprietary FinHealth score, which measures 8 indicators on a household’s ability to manage to spend, save, borrow, and plan for the future. Black and Hispanic households scored 56 points on this measure, a full 10 percentage points lower than their White peers (and about 15 percentage points lower than Asian households).

Figure 11: Black, Brown and Poor Communities Had the Lowest FinHealth Score

COVID-19 Is Disproportionately Hurting Financially Vulnerable Populations

According to a study conducted by Gusto — a leading provider of HR, payroll and benefits solutions for US small and medium-sized businesses — these most vulnerable populations were far more likely to be impacted by COVID-19 related shutdowns.

Below is a summary of their findings, which includes data from over 100,000 US SMBs:

• Lower-income employees were more likely to be laid off. For example, Gusto data showed that workers earning less than $20 per hour had a 115% higher rate of layoffs compared to workers making $30 or more.
• Younger workers were also disproportionately impacted by COVID-19 related layoffs. Workers aged 25 or younger experienced a 93% higher rate than workers aged 35 or older.
• Finally, employees who worked in low-Income areas were most at-risk. Employees who worked in lower-income areas were 25% more likely to have been laid off compared with employees who work in higher-income areas.

In Hindsight: FinTech’s impact on the Underbanked since the Great Recession.

It is perhaps a little difficult to gauge the positive impact that FinTech has had on the lives of the underbanked over the last decade. After all, the number of underserved households is still in the millions and they are paying ~$200 million dollars in fees per year. However, we offer up the following data points as an indication of positive impact:

1. Payday Lending has been on a secular decline since the Great Recession.

Payday Lending is perhaps the most notorious alternative financial services product in the market. High fees (with APRs that can be well over 400%), high rollover rates, and overall subpar customer experience are general hallmarks of payday lending.

Payday lending has decreased to $4.3Bn in fees, with storefront payday lending shrinking -16% for storefront payday lending since 2015 and online payday lending revenue decreasing by 10% over the same time period.

Figure 12: Payday Lending Is On a Secular Decline

2. Prepaid cards continue their steady, but uninterrupted growth.

The general-purpose reloadable prepaid cards made popular by the likes of Green Dot and NetSpend represented a simple, yet creative solution to one of the greatest challenges faced by the unbanked population: how to participate in digital banking/commerce. By enabling unbanked and underbanked individuals to digitize cash (through either direct deposits or cash-based deposits in retail stores), prepaid debit cards enabled millions of unbanked individuals to shop online, pay their bills digitally or send electronic transfers to other people in the network.

Currently, millions of users are loading over $300 billion annually on general-purpose reloadable prepaid cards. GRP debit card providers are generating $2.8Bn in fees in 2018, according to the Financial Health Network.

Figure 13: Annual Load Volume in US GPR Prepaid Cards

3. P2P Models Led to A Wave of Digital Lenders.

Peer-to-peer models presented an innovative and disruptive approach to lending. By connecting individual borrowers to lenders (individual and/or institutional lenders), the platforms were able to cut out traditional banks from the lending process. By handling the entire lending process digitally, these online credit marketplaces did not have the high fixed costs associated with branches, agent, and back-office costs; and had relatively lower regulatory requirements than deposit-taking institutions.

These US P2P lending platforms have had varying degrees of success, but as a group generated $1BN in revenues and have grown at a CAGR of 19% from 2015 -2018.

Figure 14: Personal Marketplace Loans Continue to Post Solid Growth

But perhaps the most significant contribution from models like Prosper Marketplace and LendingClub is that they paved the way for the digital lending platform to challenge traditional lending models across several markets, including SME lending, student loans, and more recently, mortgage lending. Additionally, these models encouraged other founders to defy traditional underwriting models with more robust credit decisioning algorithms, leading to models such as Upstart and Sofi in the student/alumni space; and OnDeck and Kabbage in the SME space; Oportun and Aura (in the underbanked/immigrant space).

According to a recent Experian study, personal loan originations have increased 97% over the past four years, with fintech share rapidly increasing from 22.4% of total loans originated to 49.4%.

How FinTech Can Rise Up to the COVID-19 Challenge

Once again, we believe that the global economic shock has created a window of opportunity for some FinTech companies to fill a growing void in the underbanked market. However, the industry is better equipped to rise up to the challenge as the technological infrastructure (and accessibility) has evolved significantly in the last decade. Companies can now integrate APIs to solve for critical parts of the financial services value chain — from KYC to account verification to communication — with their customers. As a result, fintech solution providers can more cost-effectively serve their underbanked customers.

The API economy in financial services could result in more options for consumers. However, for FinTech and — the VCs investing in the space — this also means a lot more competition. One of the by-products of Open Banking is that many FinTechs are reversing a decades-long trend of “unbundling” financial products. Instead, FinTechs are increasingly “bundling” financial services, offering multiple products from debit to credit to investment products under one platform. Some of these “NeoBanks” launched a multi-product offering from the beginning. Others waited until they scaled a core product first before attempting to cross-sell additional products to their customers.

Whether one strategy is better than the other misses the bigger point in the race to serve the underbanked. As in any financial services relationship, the key to winning in the underbanked market over the long-term will be based on customer trust. This is particularly the case with underbanked consumers, which as we saw pay an egregious amount of fees for financial services and have a healthy degree of skepticism for financial services products. In the near-term, consumers might be swayed by an additional 10 basis points APY on a deposit account or a 10-basis reduction on the APR charged on a personal loan. But pricing alone won’t cut it over the long run.

Here are some lessons from the first wave of FinTechs that were successful in acquiring underbanked sectors following the financial crisis. Current and future FinTechs that want to help “Bend the Curve for the Underbanked” should keep these in mind:

1. Understanding the target demographics is critical. When targeting the underbanked, it is important to understand who these customers are. As noted above, race is still an important driver in the underbanked population, Black and Hispanics are more likely to have issues accessing mainstream financial services than other demographics. In addition, younger, lower-income, and unmarried female-headed households are more likely to be underbanked, according to the FDIC.

Understanding the key characteristics of these demographics are important because they will inform product, distribution, and marketing strategy. If you are focused on solving issues for the underbanked. Companies that have designed their business strategy around their customers well include Oportun (which went public in 2019), Aura and Finhabits, all of which have done a good job targeting the Hispanic/low-income populations); SOFI/Upstart which has targeted the student/alumni population; and NOVA Credit, which is focusing on the immigration population. All of these companies have created successful strategies to target their demographics through product/distribution/marketing strategies.

2. Security and Transparency are paramount. Companies need to make the proper investments in data security, fraud prevention, and compliance that are critical foundations to build trust. These are the important “back-office” operations that digital financial services consumers are demanding more of.

But the external strategies around pricing and communication are equally important. Product fees, interests and other costs need to be transparent and clearly communicated. Many of the early breakthrough companies in fintech for the underbanked were not necessarily “low-cost”. But they were transparent about the pricing and about ways to avoid certain costs.

Think about the early days of GPR Prepaid Debit Cards, where customers paid for every load, reload, and other items. These fees were transparent on the packaging, along with options on how to avoid those fees (from direct deposit to minimum load amounts to the number of monthly transactions). This concept did not just apply to consumer-focused fintech companies, by the way. On the merchant side, payment processors like Square/Braintree/Stripe took a novel approach of presenting a transparent fee structure in an industry long accustomed to complex, opaque pricing schemes.

3. Be creative with distribution and retention strategies. The underbanked market is large but also complex. Social media and other digital channels can help, but companies and VCs should be willing to think “outside the box” when it comes to distribution strategies in the underbanked market. Traditional Silicon Valley scale-up strategies may not entirely work for this segment of the market or might need to be tweaked. The same goes for strategies focused on customer retention.

One interesting case study is that of the prepaid industry, where some of the early leaders in the market scaled through the “J-hook” distribution model. Companies like Green Dot and NetSpend partnered with retailers or convenience were underbanked consumers went shopping (i.e. Walmart, 7/11) or alternative financial services providers where these consumers went for certain financial products (i.e. check cashers, payday lenders). Depending on physical retail stores for distribution was not a traditional model necessarily applauded by VCs. But it proved effective to acquire underbanked consumers.

In addition, these early prepaid card managers realized that despite given access to digital accounts/debit cards, many of their bank customers still relied heavily on cash. This distribution network thus also proved critical to customer retention in the early days (hence the Green Dot @ the Register reload network). Over time, more and more of the strategy for these prepaid card managers shifted to digital — ranging from online account transfers to payroll direct deposit.

These methods might not work for all products, particularly in a post-COVID-19 world. But they exemplify how founders that think creatively about their distribution strategy can build sustainable companies, and the VCs that back them could be rewarded.

4. Use data to “super-serve” existing customers. This might sound very intuitive, but we have spoken to a number of companies that want to offer the next checking account or savings account without necessarily justifying it through the data. To be clear, at a certain scale and with a certain cost structure, it might make economic sense to launch multiple additional financial services products. But unless existing customers are demanding these products, FinTechs may not see the type of conversion rate they need to move the needle on their business or to drive further customer retention.

Additional products and services can help drive more customer engagement even if they don’t necessarily result in near-term monetization. Think about how long it took banks to fully roll-out their mobile banking channel. Mobile banking might not generate significant revenue for large financial institutions, but they are now the key driver of customer engagement for banks. Going back to our prepaid industry analogy — early prepaid debit card pioneer Green Dot rolled out a large, accessible cash-out network — including its retail stores and ATM Network. These were both important for customer engagement beyond the initial customer load.

Our Investment in LISTO Financial

We have learned a great deal about the underbanked market through our investment in Listo Financial. Listo (Spanish for “smart, ready”), is co-founded by Samuel Ulloa (a previous executive at Oportun) and James Gutierrez (former CEO of Oportun and current CEO of Aura), both with in-depth experience navigating the complexities of serving the underbanked. Listo financial has the vision to build a trusted source for financial services for the underbanked population.

The company’s core offerings center around three key aspirational and foundational financial services namely: access to fair, transparent, credit building loans; affordable protection with insurance products; and wealth building through investment products, such as Roth IRA and 529 plans.

Listo crafted its go-to-market strategy and customer experience with its target demographic in mind. Listo went to market with a few carefully selected physical, tech-enabled stores. This decision was backed by data indicating that underbanked Hispanics highly valued live interaction with their financial services provider. These physical stores were important to building initial trust and engagement with their target market.

Everything within the store is carefully designed to cater to this demographic as well. The staff is bilingual — as US Hispanics are increasingly bilingual. The stores have a section for kids with mini iPads, which keep the children entertained while the parents engage with a Listo agent, nurturing the beginning of a trusted advisor-type of relationship vs. a typical transactional relationship.

A typical customer engagement experience usually involves the customer approaching the “Listo bar” (“akin to Apple Genius bar”) where the customer interacts with thoughtfully designed, highly intuitive and educational content on an Ipad. This content provides the customer with information and transparency to make well informed, smart financial decisions (a.k.a. to be “Listo”). Through this process, customers learn how to use their mobile device to access these financial services. The customer walks away having initiated a trusting relationship with the listo brand and with the listo experience in their “pocket”.

Listo’s technology marketplace distills the complexity of financial products for its target customers. Its loan product, as an example does not require an SSN, accepts foreign IDs and uses alternative data and creative methods for address verification. As an example, Listo mails a unique notification to a customer’s address on file and the customer has the option to present that unique notification in a Listo store to complete address verification.

Listo’s store agents help customers create and access their online profile in store and assure them that they can receive the same service online. Despite these efforts, thousands of customers visit a Listo store in a given month. Even throughout the COVID-19 pandemic, (Listo stores remained opened as they were deemed an essential service for its underbanked customers) thousands of customers have chosen to enter a Listo store to speak directly with an agent.

Listo’s financial products are competitive and fully transparent. The company presents its financial services offerings in kayak-like experience. Customers clearly see pricing — both one-time and recurring fees to compare across different options. The company acts as a marketplace for loan and insurance products, which means it charges its lending and insurance partners — not consumers. Still, customers rely on Listo as a trusted financial advisor and as a result, Listo does not partner with insurance carriers or lenders that have opaque pricing schemes.

Listo employs a hybrid offline/online distribution model. The company’s physical retail distribution goes against the status quo for venture backed companies. But it is a critical driver of customer engagement, the company’s 90%+ retention and online organic growth through referrals. In addition, the stores provided Listo with the ability to “be there” even in the darkest of times (i.e. during the COVID-19 shut down).

That said, the company recognizes that its online presence is important to grow its customer base beyond the stores. Thus, while the offline presence are important pillars for trust and retention, their online distribution model will be important for overall market share.

Data is informing Listo on future products. Listo Financial launched with credit, as over half of the US Hispanic underbanked population are “credit invisible”, having little to no credit history. While the company’s mission was to offer multiple financial services under one trusted brand from the start, Listo has prioritized new product launches based on the demand from its customers. This is why auto insurance, its second launched product, quickly grew to drive more revenue than loans. The company is now adding more partners to its life insurance offering, given increased demand by customers in light of the current pandemic.

FinTech Can Seize the Moment

COVID-19 will push more US households into underbanked/financially vulnerable status. As in the 2007–2008 downturn, this will present an opportunity for nimble fintechs. And this time around, FinTechs will be equipped with more tools to launch financial service products as well as more flexible digital distribution models. That said, newcomers should learn from the accomplishments (and mistakes) from the first wave of FinTech companies focused on the underbanked. By fully understanding their demographics, offering transparent solutions, leveraging data to inform their roadmap and being flexible on distribution, FinTechs can help bend the curve for the underbanked.

How FinTech Can Help Bend the Curve for the Underbanked (Part 1) was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.

In a previous article, “Why B2B Payments Automation is Finally Having Its Moment” we laid out our thoughts on how COVID-19 will accelerate US B2B Payments away from inefficient manual processes like paper invoices and checks. In this article, we turn our attention to B2B Payments in Mexico — and — to a lesser extent — the Latin American region as a whole.

While there are some notable structural differences between the financial/payment markets within the Latin American economies, they face similar obstacles when it comes to B2B Payments Automation. Namely, the region is still behind on the adoption curve of digital payments and automation. In the US, the legacy B2B payment method is paper checks, which still represent 42% of all B2B payment volumes. In Latin America, however, checks are virtually non-existent. Cash is still king. Across the B2C and B2B landscape, cash has remained stubbornly dominant.

Current State of Payments in Latin America

The world has been in a war on cash for over half a century, as governments, businesses and consumers have moved to more efficient, secure, and traceable digital payments. However, some emerging markets have lagged behind, due to a number of structural and banking challenges. In Latin America, the numbers may look daunting, leading some to understandably suggest that the region is “Losing the War on Cash”. In Latin America, 81% of retail spending was still transacted through cash. The two top countries in the region — Mexico and Colombia — had a cash penetration of close to 90% in 2018. This compares to cash penetration of 24% and 18% in the US and China, respectively.

Figure 1: Penetration of Cash vs Cards

There are several contributing factors that could explain why Latin America has struggled with the war on cash. A large percentage of the population remains low-income, underbanked; the informal sector continues to thrive; and the e-commerce market, which has been a bright spot for the region as of late, is still 2% of the region’s GDP. All of these factors have partly contributed to cash’s dominance in the region.

But over the last decade, the ingredients for accelerated adoption of digital payments have gradually fallen into place. These include:

Favorable demographics. Latin America has one of the youngest populations in the world, second only to Africa. This means the bulk of their population is digitally native, more prone to adopt digital solutions in their personal lives, and in the workplace. Younger generations are far more willing to adopt digital financial solutions than older generations, including savings accounts, credit, and mobile payments.

Figure 2: Latin America Has One of the Youngest Populations in the World

Widespread internet and mobile connectivity. Latin America has made. great strides in internet penetration and mobile adoption. According to the World Bank, nearly 70% of the region has access to internet activity, well above the 53% world average. In addition, the mobile phone has reached ubiquity in several markets, with over 70% of the population estimated to have a mobile phone in several key countries. That penetration will continue to rise given the introduction of lower-priced smartphones. The combination of high mobile adoption and internet connectivity are paving the way for new, digital solutions that address the gaps in the banking and payment systems.

Figure 3: Latin America Is One of the Fastest-Growing Regions for Internet and Mobile adoption

A surge in Fintech startup investment. Fintech Startups and Venture Capital investors have begun to seize the moment. Financing for Latin American fintech deals increased gradually from 2013, but that growth accelerated in recent years. In 2019, over $2B was invested in a Latin America fintech company, which accounted for nearly 44% of the total investment in the region.

Figure 4: Latin America is Experiencing a Fintech Boom

COVID-19: An Unexpected Catalyst for Digital Payments in Latin America

The ingredients for the wide adoption of digital payments in Latin America had fallen into place. All that was needed was a catalyst. We believe COVID-19 is that catalyst. Since the onset of the COVID-19 pandemic, we have already seen a meaningful uptick in online commerce, which is positively correlated with growing digital payment adoption. According to Forbes, over 63 million people (50% of the population) are now shopping online and are expected to drive online commerce growth of over 20% YoY in 2020. Based on a survey of Mexican Consumers, moreover, the Asociación Mexicana de Ventas Online (AMVO), (which studies trends in Mexico e-commerce) many consumers are shopping online for the first time. These consumers are going online to purchase a wide range of products and services, ranging from groceries to online banking…

Figure 5: Products and Services Bought Online For the First Time During the Pandemic

This is a window of opportunity for online commerce to get more widespread adoption. The COVID-19 pandemic forced Mexican consumers to get online. But that is half the battle. The overall experience — from discovery to delivery to the safety of transactions — will be critical to retain these customers online post COVID. According to AMVO, the early indications are that consumers who have shopped online for the first time had an overall positive experience. In fact, there was a 78% increase in positive sentiment over internet purchases and a 90% increase in neutral sentiment. By contrast, there was a sharp decline in the percentage of people that had a negative sentiment for online sales.

Figure 6: Mexico Consumer Sentiment On E-commerce Has Improved

An uptick in e-commerce could help pave the way for a long-awaited shift to digital payments in Mexico (and Latin America). A JP Morgan 2019 Payments Trends Report found that card (mostly debit card) accounted for 45% of Mexico’s e-commerce purchase volume. Cash decreased significantly from 90% of transactions in total retail sales to just 17% of e-commerce volume. Digital wallets, which also reached 17% of e-commerce volume is set to overtake cash in 2020. The fact that cash has remained so important in e-commerce is a testament to creative retailers and payment service providers who have tried to bring a cash-intensive society online (mostly through “prepaid vouchers”). But the upshot is this: more e-commerce, means more digital payments and less cash circulating in the system.

Figure 7: Card Represents the Bulk of E-commerce Volume In Mexico

Implications for B2B Payments in Latin America

Latin America offers an impressive growth runway for digital B2B Payments solutions as the market is significantly underpenetrated. In the US and much of the developed world, B2B Payments Automation is playing catch up to B2C Payments when it comes to digital. But in emerging markets, including Latin America, both B2C and B2B Payments are allies in the war on cash. This is particularly the case for Small and Medium-Sized Enterprises (SMEs). A World Bank report on Global B2B Payments estimated that the Latin American B2B market reached $1.4 Trillion in 2016. Only 45% of that was electronic with the remainder being cash. This was lower than the global average for SMEs (53% of B2B Payments were electronic) and significantly below the High-Income OECD average (81%).

Figure 8: B2B Payments in Latin America are Battling a War on Cash

One of the key factors driving cash’s dominance in Latin America B2B Payments is a low level of B2B e-commerce. The growth in SMEs willing to buy or sell online has been gradual to date. INEGI (Mexico’s National Institute of Statistics and Geography) found that less than 5% of companies in Mexico reported using the internet for purchases or sales as of 2019.

Figure 9: Less Than 5% of Mexico Based Businesses Reported Buying or Selling Online

We expect more and more businesses to embrace online commerce and digital automation as they adjust to remote work and a cost-conscious environment. As we noted in our previous article on B2B Payments Automation, there are four key reasons why CFOs are accelerating their efforts to adopt digital B2B Payment tools. We believe these also apply to Mexico and Latin America, including:

(1) Accounts receivable: Number One Priority for CFOs Today.
In an uncertain economic environment, CFOs must convert Accounts Receivable into cash. According to the “Atradius Payment Practices Survey”, businesses based in Mexico and Brazil had a lower proportion of their sales on credit (i.e. Accounts Receivable) compared to the average for the Americas. In addition, Mexico based businesses asked their business clients to pay quicker — on average within 21 days (down from 33 days in 2018). This compares to an average of 32 days in the Americas (and well below the average payment terms of 38 days in Brazil). While this relatively conservative stance could potentially lose business in normal times, it could also pay off in an economic downturn through lower “uncollectible receivables”.

Figure 10: Proportion of Total B2B Sales Made On Credit (AR) in Mexico and Brazil

Despite a lower proportion of sales on credit, however, Mexico and Brazil-based businesses reported more incidents of late payments in the Americas. Atradius found that 87% of Mexican businesses and 93% of Brazilian businesses reported late payment by B2B customers. These were significantly higher than the late payments reported by their US (74%) and Canadian (73%) peers.

Figure 11: The Americas: Percentage of Businesses reporting Late Payments by B2B Customers

The Accounts Receivable risk appeared particularly acute in Mexico, where businesses reported that as much as 27% of invoices were past due in 2019. In order to protect cash, 39% of Mexico and Brazil-based firms needed to pay their own suppliers late in 2019. As we mentioned previously, not collecting on Accounts Receivable could have detrimental economic effects across the B2B supply chain as businesses manage cash flow.

Figure 12: A Snapshot of B2B Receivables in Mexico

In 2019, approximately 35% of Mexico and Brazil-based firms were expecting either a slight increase or a significant increase in the percentage of outstanding B2B invoices over 90 days old. This was above the 29% average for the Americas. We expect that the economic shock in 2020 has driven these expectations higher across the board, leading CFOs to heighten their focus on collection on AR.

Figure 13: The Americas: Expected Changes In Percentage of Outstanding B2B Invoices Over 90 Days Old

(2) High Costs of Paper Too Difficult To Ignore In This Environment

In our previous article, we noted the Federal Reserve Bank estimated that US businesses spent $150 billion per year in direct and indirect costs of processing paper invoices and checks. According to McKinsey, the costs of processing cash and check payments — as well as overall payment fees — are disproportionately higher in emerging markets such as Latin America and the Asia Pacific. Comparing regions by payments revenue relative to GDP, McKinsey found that the cost of payments in Asia Pac and Latin America is 50% to 60% percent higher compared to Europe and North America. This is despite the fact that the share of digital payments transactions in Asia Pacifica and Latin America is 60% to 65% lower than in Europe and North America. This is a particularly tough challenge for businesses in Mexico, where 90%+ of payment transactions are still cash-based across all industries, according to a 2019 INEGI study.

Figure 14: Percentage of Payment Transactions Reported By Mexican Businesses

(3) Automation is A Must in the New Normal
In the current economic environment, CFOs urgently need to have a full grasp of real-time budgets and results in order to make mission-critical decisions that balance capital allocation, cash management, and growth. In Latin America — this will undoubtedly lead business leaders to rethink how to automate their finance workflow. And they are starting from way behind. In Mexico, for example, 40% of businesses relied on manual processes for their accounting/bookkeeping according to INEGI. Only ~5% had adopted a third-party accounting software.

Based on a Sana Commerce report, 38% of Mexico based businesses pointed at the difficulty of connecting the flow information across finance/operations as a key barrier to adopting digital payments. cited that a barrier to adopting digital payments was the difficulty of connecting the flow of information across the sales/operations team. But over 40% of businesses stated that a key barrier to adopting digital payments was due a “culture of resistance to IT adoption”. We believe the current health and economic crisis will help break through some of that cultural resistance, as CFOs seek more visibility into the organization.

Figure 15: Nearly Half of Mexican Companies Rely on Manual Accounting/Bookkeeping Process

(4) Health Conscious Is A New Driver in B2B Payments
In the US, MasterCard noted a 40% jump YoY in the use of a card and mobile contactless payments, mainly driven by concerns over COVID-19. We are seeing a similar uptick in e-commerce/online sales in Mexico, which as we noted above is positively correlated with increased digital payments acceptance. The key driver, according to AMVO, was to avoid the COVID-19 pandemic in physical stores. The first and second most popular reasons why customers bought online during the Pandemic was to avoid leaving the house and to avoid crowds. We believe both of those reasons were at least partly driven by a desire to avoid contracting COVID-19. We believe that business leaders are just as worried about the potential health risks of managing manual processes — including cash payments.

Figure 17: Key Reasons Why More Mexican Consumers Are Shopping Online During The Pandemic

Our Investment in Yaydoo, the “Coupa of Latin America”

The COVID-19 crisis has opened a window of opportunity for companies focused on accelerating digital transformation initiatives in Latin America. We are convinced that CFOs across the region will need to adopt new technologies that automate the finance stack in order to better understand their cash positioning and make better capital allocation/budgeting decisions. While there are several structural challenges at the microenterprise level, we believe that the mid-market and enterprise-level will embrace increased automation of their finance/payment workflows.

Despite a recent surge in Latin American fintech investment and the large B2B Payments Automation market, only a fraction of total VC funding has been directed to new, innovative B2B Payments solutions. This is a key driver of our investment in Yaydoo, a procurement payments platform that helps companies plan, manage, and track their spending. Yaydoo has an opportunity to capture a significant share of an underpenetrated — and relatively underinvested — B2B space in Latin America.

Yaydoo is unique in the Mexican and Latin American market as it has two complementary business models:

1) A vendor marketplace that brings together hundreds of vendors and pre-negotiated agreements for more than 20,000 workspace related products and services. This aggregation of vendors results in meaningful (up to 30%) cost-savings for its customers. We believe this part of the business will benefit from a continued increase in overall online commerce, as more and more Mexico businesses embrace B2B e-commerce.

2) A procurement platform that digitizes and streamlines the B2B purchasing process, allowing the whole finance and operations teams to collaborate across the finance work-flow: from creating purchase requests, defining budgets, managing to spend, approving purchase orders, and handling accounts payables.

Given the historic reluctance to change in the Latin America finance department, Yaydoo opened the door to conversations about automation through cost-savings on recurring purchases. A platform that could generate 30% savings on monthly/quarterly expenses proved attractive to CFOs. Once on the platform, however, the CFO and the finance team witness the power of automation. CFOs can set and manage budgets, see spending trends, and manage outstanding payables all within one platform. While the cost-savings generated through the marketplace is a great acquisition channel, the procurement platform is the key driver of the company’s 97% retention rate.

As a cross-border fund, LEAP looks for Founders that have a deep understanding of their local market and are creative in how they customize solutions (or distribution strategies) that reflect the reality of that market. Yaydoo has demonstrated that since its founding 3 years ago and is now poised to benefit from a new normal that embraces more automation and digital payments in Mexico and Latin America. Their hybrid business model, combined with direct integrations to specific regional governmental/financial systems (Latin America is a global leader in digital invoices, for example), position Yaydoo well to win in Mexico and — eventually — in other key Latin American countries. We are excited to see how the company continues to evolve now that B2B Payments is finally having its moment.

Digital B2B Payments Will Surge in Latin America as the Region’s War on Cash Intensifies was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.

This week my family participated in a peaceful protest in our small community of Castro Valley, CA. As thousands of others across the nation — and across the world — we did this to stand in solidarity with our black brothers and sisters to say that we are tired of centuries of injustice, hatred, and outright violence against them. Equally important, we agreed as a family that it is not enough to say we are not racist. We must stand up against racism. We must be #Anti-racist.

My 8-year old son, whom we nicknamed “Tico” from birth, was puzzled by the protests. Now Tico is a very inquisitive boy. He can tell you everything about the big bang, how and why gophers are messing up our backyard, and about why the sky turns from blue to black every day.

But this week Tico asked me questions about racism. And it reminded me how uncomfortable these conversations are. But I also appreciated that this would be a very important lesson for him as a human being.

In the protest, he saw several of our fellow protestors displaying: “We are tired of living in Fear” and he asked me “why are so many people living in fear?”

I shared with him for the first time that I grew up living fear most of my young life. My father and mother immigrated to the United States from Mexico and El Salvador, respectively. My father was deported back to Mexico once and it devastated our family. It took us almost two years to gather up the resources and network to bring him back again. And once again he came back illegally.

But things were never the same. For the rest of their lives, my parents lived in fear. It is the reason why my father never flew on a plane and never dropped me off at the airport — even on the day I left home to go to college. He was concerned that INS would be rounding up immigrants at the airport or if he was pulled over for any reason — a routine stop would turn into another deportation.

I shared this with my son for a couple of reasons:

First, I wanted to contextualize what living in fear meant to my son. I asked my son to take my experience and multiply that fear factor by 1,000. That is what our black brothers and sisters live with. Fear of getting over-incarcerated, humiliated, and — as we saw with the gut-wrenching murder of George Floyd — even killed.

“No dad, 1,000 is not enough. You need to multiply that by 1 million at least. They are living in fear of their lives. You got to see your father again. But George’s family won’t see him again.”
-Tico

Second, I shared with my son that my fear ultimately led to shame, something I have never confessed before. I am ashamed that I didn’t do more for my parents while they were still alive. Both my parents passed away without becoming US Citizens. I was blessed to become the first in my family to go to college and ended up working in some of the largest, most reputable companies in the world. But no matter what I accomplished personally; I could never eliminate the fear that my parents lived with.

“Dad, you don’t need to be ashamed — you are just one person. You can’t do it on your own. I am sure others felt like you. Why didn’t you guys team up or something?”
-Tico

At this point, I was a little teary-eyed. But my son interrupted my self-reflection with another question: “Dad why are they chanting Black Lives Matter? Don’t All Lives Matter?” I responded that of course all lives matter. But the point is that we can’t diminish the pain that our black brothers and sisters are going through.

We need to emphasize the systematic racism and violence that is disproportionately targeting black lives in America. We need to acknowledge that from the early days of our country (and even before that) racism has killed, disenfranchised, and destroyed millions of lives in our black communities. We need to be intentional and root out this silent, and sometimes not-so-silent, killer.

“Wow, dad. That’s worse than the Coronavirus. I hope we can find a vaccine for that too.”
-Tico

And that’s where my lesson concluded. But somehow I don’t feel that I was the teacher in this exchange. It was the other way around. I want to share what my 8-year-old son taught me about racism:

1. No matter how much we try to contextualize what our black brothers and sisters continue to live through, we can’t. This is a time to listen to their pain and amplify their voice. This is a time to join them in a unified cry to stop systematic racism. To show that we won’t be innocent bystanders — but actively engage with them in a fight for equality. If we want to help our black community, we must be Anti-racist.
2. Racists are not born, they are made. It took a few minutes for my 8-year-old son, who did not have a full grasp of racism, to understand how evil it is. Families all across the country should take this opportunity to teach kids about the negative impact of racism and also instill in our youth the importance of voicing their views against it in their daily lives, through civic engagement — from activism to voting.
3. Racism is a pandemic. There is a clear urgency to find a vaccine against COVID-19. Those efforts should be applauded. But we need to apply that same sense of urgency to rooting out the systematic racism and discrimination that we see at all layers of society. Racism is a virus. And we can stop it from spreading. We need to ensure that those that spread this virus are accountable, whether you are in law enforcement, politics, positions of power in Corporate America, or a citizen that chooses to “weaponize” racism.
4. If you feel ashamed or powerless, don’t. You are not alone. The worst you can do is fail to act. And your actions do matter. Join the thousands of people, corporations, and non-profits in a unified stance against hate. Small wins can add up to a tremendous victory. As for me:

• I am a father and I will embrace the tough conversations around racism and injustice with my children to ensure that they are equipped to call out injustices when they see them.
• I am a global citizen and I will support non-profit organizations that fight for equality — including those organizations like INROADS, SEO, HSF, and The Achievement Awards Program that supported people of color like myself get through college and beyond. There are countless other amazing organizations fighting for equality across education, health, politics, and more.
• I am a venture capitalist and I will continue the fight for equal access to capital at LEAP Partners. Entrepreneurship is still one of the most promising and impactful ways to build wealth. But sadly, only 1 percent of all venture capital goes to our black and brown founders, who often lack the network to access the right forms of capital. I am proud to see recent announcements from Softbank and Andreesen Horowitz committing to support founders of colors. I look forward to seeing more join the fight.

This is not the time to stay silent. This is the time to act. Support our black communities with your voice, your time, and your resources. Just like we are all doing our part to stop the spread of COVID-19, we can all do our part to stop the spread of racism. That’s what my 8-year-old son taught me.

The Secular Shift to Cloud Has Continued Uninterrupted for 20 Years…

The secular shift to the cloud has transformed processes across the enterprise. Over the last two decades, this shift has accelerated globally in key areas from CRM to ERP to People Ops.

The COVID-19 pandemic will accelerate this shift as companies of all sizes think through how to increase automation, efficiency and seamless integration across the enterprise in a remote work/cost-conscious environment. As in other downturns, we expect overall IT budgets to come down. But one thing that is unique about this particular crisis is that it will accelerate and, in some cases even force, a broad shift to a more virtual work environment. This is a large reason why many publicly traded Cloud/Software companies have outperformed the broader stock market since the onset of the COVID-19 crisis despite dire macroeconomic data points.

According to Bessemer Venture Partners, the market capitalization of the Top 5 public cloud companies has surged by 44x over the last decade to $616B. It appears as if this market cap will continue to climb for the foreseeable future as public cloud companies crossed the $1 Trillion threshold in 2020.

Much of the innovation going forward, however, will likely come from the private market. As Bessemer Venture Partners also points out, there are now thousands of private cloud companies and almost 90 unicorns. The number and growth rate of these companies indicate that the shift to cloud will continue to transform the DNA of the enterprise.

…. But B2B Payments Have Lagged Other Areas of the Enterprise

We believe the Finance department is playing catch up to other key areas in the enterprise. As Seema Amble and Angela Strange of Andreesen Horowitz posit in their article “The CFO in Crisis Mode: Modern Times Call for New Tools”, many of the existing finance products are full of gaps. These include the lack of integration between key finance tools, general inaccessibility of forward-looking data and the need for manual processes. Nowhere are these problems more present than in business-to-business (B2B) Payments.

Despite the facts that B2B Payments (1) directly affect cash flow — a company’s life blood -, (2) is multiples larger than business to consumer (B2C) payments and (3) generates plenty of useful data across customers and supply chains, B2B Payments have remained stuck in the pre-digital age. Within the US, specifically, B2B payments are plagued with paper-based processes and a general lack of integration with other core systems. This stands in stark contrast to B2C, where the majority of payments are now digital.

Figure #2: Comparison of Digital Payments at Home vs Work

Although consumer payments have gotten a head start, we believe that B2B Payments is finally having its moment. The current crisis is forcing the CFO to adjust in real-time and make mission critical decisions that balance capital allocation, cash management and growth. On one hand, this is always the case for the CFO. On the other hand, an economic crisis transforms routine tasks — such as collecting receivables and managing spend throughout the enterprise — into existential imperatives. These are exactly the core issues that new, digital B2B Payment technologies address head on.

B2B Payments: A $100 Trillion Global Market

Let’s face it. B2B Payments isn’t sexy. It is hard for a headline on B2B Payments to compete with headlines from the sleek Apple Card, Millennial-focused Venmo or the rapidly evolving Facebook payment features. But that’s OK. What B2B lacks in public appeal, it more than makes up for by its sheer size and contribution to the broader global economy.

According to MasterCard, B2B payments represent a $100 Trillion opportunity globally and over $25 trillion in the US. By comparison, the total addressable market for US B2C payments (traditional retail payments for goods and services) was $11 trillion, according to the Nilson Report. The popular and growing segment of domestic C2C payments (peer-to-peer transactions through Venmo/Square Cash/Zelle), moreover, reached $219 Billion in 2018 according to eMarketer.

The US B2B market is more than 2X larger than the total B2C and C2C markets combined.

Figure #3: Payments Distribution by Segment

B2B Payments is Complex But Offers Multiple $100Bn Revenue Streams

There are key differences between B2C and B2B payments. In B2C payments, revenue models are more clearly defined (generally some derivation of a Merchant Discount Rate/Interchange Fees). In B2B Payments, the landscape is more complex. There are several business models, from traditional interchange-based models to SAAS license models to cross-border FX models.

In addition, B2B Payments automation needs to fit within the evolving relationship between the Finance and Operations teams of the enterprise. Today, businesses are increasingly managing customer relationships/contracts with a CRM system and key financial/operational data with an ERP system. But the actual payment/cash collection piece is generally missing. B2B Payment platforms thus have an opportunity to help enterprises manage the full customer sales cycle from the Contract to the Order/Invoice to the actual payment.

B2B Payments automation is complex, but it offers innovative companies an attractive TAM. There are 5 sub-segments in US B2B Payments space, each offering over $100 billion of revenue to both large incumbents and fintechs. According to Goldman Sachs, B2B Payments represent a $1 Trillion revenue opportunity, broken down by Cross-border payments and Domestic B2B Payments.

Figure #4: B2B Payments Revenue Opportunity

US B2B Payments Remain Stuck In Pre-Digital Age

Despite the innovation we have seen within the broader payments/fintech landscape, US domestic B2B payments seem to be stuck in the pre-digital era. Today, it is estimated that 42% of the US B2B payment volume is still paid via paper checks. To be clear, that percentage has been on gradual decline over the last couple of decades. According to The Association for Financial Professionals (AFP), as much as 80% of B2B transactions were paid by paper checks in 2004.

But checks remain the dominant payment mechanism for domestic B2B transactions, particularly with smaller and mid-sized businesses. According to a PYMTS.com study, as many as 81% of firms used checks to pay their suppliers. This usage was much higher than ACH (64%), Credit Cards (48%) and Cash (45%).

Figure #5: Popularity of Different B2B Payment Methods

That said, there is a sense that businesses continue to use checks out of necessity rather than preference. Only 51.3% of these firms said they were satisfied with this payment method (a gap of 30 percentage points). Part of the reason why paper checks continue to dominate B2B payments is the difficulty in changing both internal processes AND encouraging clients/vendors/suppliers to switch to digital payments. Checks on the other hand, are integrated directly into most banking system flows and there is a general path dependency among buyers-suppliers.

Figure #6: Satisfaction with Different B2B Payment Methods

The B2B Payments Revolution Is Underway…

The industry has begun to gradually shift away from these costly manual processes. In fact, nearly 80% of organizations said they are in the process of transitioning their B2B payments from paper processes according to the Association for Financial Professionals (AFP). Reducing costs, increasing efficiencies and combating fraud were cited as the key reasons for transitioning B2B payments.

Figure #7: Drivers of B2B Payment Transition

We expect small and medium size businesses (businesses generating up to $1 Billion of revenues) will drive the next leg of growth in B2B Payments automation. As we detail below, these are disproportionately paying high fees for manual, paper based processes. According to PYMTS.com research, businesses with $100M — $500M in sales (comprising the majority of the middle market) were most interested in digital innovation, with 73% of firms within that revenue range indicating interest in adoption of digital invoicing solutions.

In a separate study conducted by Suntrust, companies that adopted B2B Payments Automation have seen several benefits. These include a reduction in the labor portion of Accounts Receivable (62%), a boost to overall liquidity (62%) and overall faster speed in their payment processes (52%). These benefits no doubt led to a reduction in the costs (both direct and indirect) associated with processing paper invoices. We speak more about these costs below.

Figure #8: Benefits of B2B Payment Automation

… COVID-19 Is A Catalyst for Digital B2B Payments

The immediate challenges posed by the current COVID-19 pandemic will have profound and long-lasting effects on the B2B Payments landscape. We highlight the following factors:

1) Accounts Receivable: Number One Priority for CFOs Today

Cash trumps sales in a tough economic environment. Ensuring that outstanding receivables are collected is top of mind for today’s CFO. A joint PYMTS.com and Fundbox study, found that as much as $3 Trillion is owed to US companies in the form of Accounts Receivable on any given day. Not surprisingly, the report also found that 68% of the firms that received more than half their payments late experienced cash flow problems. But perhaps more alarmingly, more than a quarter (27.5%) of firms that received late payments were likely to pay their own suppliers late as well. In summary, not collecting on Accounts Receivable could have detrimental economics effects across the B2B supply chain. This risk is particularly acute for small and medium-sized businesses, which often don’t have the liquidity reserves or access to financial services as their larger enterprise peers.

Figure #9: Accounts Receivable Snapshot

2) High Costs of Paper Too Difficult To Ignore In This Environment

Manual processes, paper invoices and paper checks are very costly. And lowering costs is undoubtedly another top priority for CFOs in the current environment. In PwC’s COVID-19 CFO Pulse Survey, 80% of CFOs suggested that they are implementing cost containment measures as a result of COVID-19. The cost of paper invoices and checks could be particularly steep and we believe that CFOs will actively seek out ways to reduce them in the current environment. Direct and indirect costs of manual B2B payment processes include:

• Direct Cost: $17 average cost to process and pay a single invoice. According to the Federal Reserve Bank, small businesses spend $9 Billion a year on paper invoices alone.
• Time: Comdata estimates that it takes businesses at least 10 days to process a single invoice. This can push out the time to receive cash to as much as 30 days for a simple invoice.
• Risks: Manual processes always carry inherent risks. Companies report as much as 18% error rate in paper invoices and 75% of businesses experienced fraud.

The Federal Reserve estimates that the direct and indirect costs of processing paper invoices and checks total $150 Billion per year. These costs are particularly steep for small and medium sized businesses, where Goldman Sachs estimates that as much as 80% of paper invoices are still manual and paid by check.

3) Automation is A Must in the New Normal

CFOs are being forced to rethink the automation of the entire finance workflow, from invoice to payments to analytics. PwC found that 40% of CFOs are planning to accelerate automation and new processes post COVID-19. Another 40% of CFOs asserted that their companies are looking to make remote a permanent option for select roles (which is partly driving the need for more automation). Invoices that would have been paid with ACH or Paper Checks will migrate to digital solutions, like virtual cards as suppliers demand faster access to cash and large companies adapt their payment processes to ones that can work from home.

Figure #10: CFO Perspective on COVID-19

4) Health Consciousness Is A New Driver of Automation in B2B Payments

Businesses are as concerned as consumers about the health risks posed by traditional payment processes. On the MasterCard Earnings Call, the company noted a 40% jump YoY in the use of card and mobile contactless payments. MasterCard surveyed consumers, which confirmed that the key driver for this was cleanliness. This suggests that the COVID-19 virus remains top of mind for the average consumer. Importantly, 56% of survey respondents said they plan to continue using contactless payments post COVID-19, suggesting that wider adoption of contactless payments is part of a new normal.

Figure #11: Drivers of Increase in Contactless Payments

Similarly, according to a survey conducted by RTi Research, 30% of respondents used contactless payment methods for the first time since COVID-19 started. Of that 30%, the majority (70%) assured they would continue using this payment method after COVID-19.

Figure #12: Consumer Behavior Adjustment to COVID-19

Implications for Businesses’ Reliance on Checks

We expect COVID-19 to serve as a similar catalyst for B2B. In addition to the direct and indirect costs, we believe that processing paper invoices and checks now add an element of unnecessary health risks. Mastercard noted that half of the respondents in their survey said they wiped their credit card clean after usage since the onset of COVID-19. Unlike cards, it is very difficult to clean/sanitize paper checks and checks need to be handled by several people along the process as shown in the figure below.

Figure #13: Walkthrough of a Typical B2B Payment

Long-term Implications Could Be Profound

Just how significant can the shift to B2B Payments be? Using the broader US payments system as a potential guide, we believe check usage among businesses could decrease to low double digits in the next decade. It might be hard to believe, but checks represented 60% of all US non-cash payments in 2000. Since then, the percentage of checks has been on secular decline to just 8% of all non-cash payments in 2018.

Figure #14: Trends in Checks vs. Total Non-cash Payments, by number of transactions, 2000–2018

The role of checks in the overall US payment ecosystem has diminished. And that is overall a good thing. This is no doubt a result of tremendous innovation from banks, payment networks, point-of-sale technology providers and fintechs. However, it was B2C that led the shift away from checks over the last two decades. According to the Nilson Report, checks accounted for only 6.5 billion B2C transactions, down more than 60% since 2010 (when consumers used checks for 17 billion transactions). We expect B2B payments to carry the torch into the next decade.

Figure #15: Consumer Payment Systems in the U.S., by Purchase Transactions (in billions)

Our Investment in Paystand, “The PayPal of B2B”

There are multiple gaps — and thus investment opportunities — in the B2B payments space. Given the changing tide in B2B Payments, we expect to see a lot more innovation in the coming years. But the need for a widespread adoption of automated processes within the finance department of the enterprise has never been greater.

We are particularly excited about our investment in Paystand, which is taking a holistic approach to this large market. Like other rapidly growing fintechs in B2B, Paystand helps automate a company’s billing processes from invoice to payment to collections and integrates directly to a company’s ERP system. However, we believe that Paystand’s key competitive advantage is its ability to merge a modern digital payments infrastructure, with a SaaS architecture and delivery model.

Two decades ago, PayPal took the bold step to insert itself into the payment flow of B2C, effectively creating a hybrid payment network for the digital age that today continues to grow in importance for both their merchants (payees) and consumers (payers). Similarly, Paystand decided to insert itself into the payment flow of B2B, thus creating their own hybrid network for businesses (buyers and suppliers). As a result, in addition to eliminating the need for manual processes and paper checks, Paystand has adopted a SaaS pricing model that reduces the cost of receiving payments.

We ultimately invested in Paystand because we aligned with their vision that a digital payment rail for business transactions is necessary in order to truly automate the B2B payment stack. We believe that other companies in the space have added a useful layer on top of the existing payment stack. These AR/AP automation companies are enabling faster collections and easier reconciliation of payments compared to traditional paper processes. But by stopping short of a new digital payment rail, they have also limited the ultimate benefits of automation. A digital payment system will allow businesses to optimize the efficiencies of an end-to-end payment platform while lowering their overall costs of payments. Again, consider how PayPal addressed B2C payments by creating a new hybrid digital payments platform for the digital age.

Paystand’s unique model has significant positive implications for their clients, enabling CFO’s to (1) have quicker access to cash, (2) lower their payment fees by up to 50% and (3) — perhaps more importantly — to accurately predict the actual cost of payments. In the past, CFOs would need to “guesstimate” the cost of receiving payments as it would vary by volume, transaction, the mix of credit/debit/Bank wire or the mix of payment network (i.e. Visa/Mastercard/Amex). But Paystand charges one flat licensing fee based on the number of transactions, which allows the CFO to accurately model out the cost of receiving payments. We believe this shift in pricing, which Paystand calls the “Journey to Zero” will have even greater appeal to CFOs during this economic recession.

2020 Will Be An Inflection Point for B2B Payments

A 2019 study by Pymts.com and MasterCard found that over 80% of SMBs planned to implement automation within the next 3 years. And a significant number of enterprises have already begun digital transformation projects in finance and operations. However, the world changed in 2020 and these timelines will need to shorten drastically. The COVID-19 pandemic will change the way we do business. Businesses of all sizes — from SMB to enterprises — will need to accelerate their shift away from costly and inefficient paper based payment processes, which will unlock significant value for them and for the economy as a whole over the long-term. This is a tremendous window of opportunity for Paystand and the B2B space in general.

B2B Payments Automation Is Finally Having Its Moment was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.

PUTTING THE MEXICO AUTO INSURANCE SECTOR INTO CONTEXT

In Mexico, however, like many other emerging markets, auto insurance is still heavily underpenetrated. Over the last four decades, the number of registered autos in Mexico has exploded. In 2019, there were 44.9 million vehicles in Mexico, a 10X increase from 1980, when there were only 3.8 million registered vehicles. Given this larger base of automobiles, vehicular accidents have also been on the rise, with current estimates suggesting at 50 automobile accidents per hour across the country.

• Auto Insurance is a large addressable market. Despite the explosive growth in automobiles, increasing regulatory mandates to purchase minimum insurance and the high risks involved in driving uninsured, Condusef (Mexico’s insurance regulatory body) estimates that 7 in 10 autos remain uninsured. This means that there are approximately 13 million vehicles that lack protection against accidents or theft.
• To put the size of the business opportunity in perspective, there were nearly $5.5BN auto insurance policies written in 2019 (approximately 20% of the total insurance market in Mexico). However, only about 30% of drivers were insured, so the total potential auto insurance policy market is about $18BN. We expect the insurance penetration could approach a similar ceiling of ~85% as in the US over 10 -15 years. This would result in an addressable market of over $15BN.

On an absolute basis, Mexico is the second-largest market in Latin America in terms of insurance premiums. This is not surprising, as it is both the second-largest economy and second most populated country in the region with nearly 130M residents.

Figure 1. Latin America: Population, 2019 & Total Risk Premiums, 2018

• Risks of driving uninsured are increasingly high. Not having auto insurance poses significant risks, particularly to the underbanked and low-income populations, which simply cannot afford an economic shock brought on by a car accident. According to several surveys, these same groups see the automobile as a key investment (for some it is the largest asset they own). Not having insurance to cover repairs from a car accident or theft could put families at risk, not to mention the legal liabilities that individuals may face due to being responsible for an accident, that can go as high as ~$200K (or $4M Mexican Pesos). We believe that the rise of mobility/delivery marketplaces has increased the importance of protecting the automobile for the millions of workers in the shared economy.

HOW DOES MEXICO’S INSURANCE MARKET COMPARE?

• Relative to OECD. On most relative measures (either relative to Mexico’s size or relative to other regional economies), Mexico’s insurance penetration is below average. According to the OECD, countries should measure the size of their insured sector relative to their GDP in order to see how they compare. This is referred to as the Insurance Penetration Rate. By this measure, Mexico’s insurance sector represented 2.3% of its GDP in 2019, well below the average for OECD countries (8.9%). For reference, in the US and Chile, the insurance sectors represented 11.9% and 4.6% of GDP, respectively.

Figure 2. Country Members OECD: Insurance Penetration

Relative to Latin America. According to MAPFRE, a Spain-based insurance company with large presence in the Latin American region, Mexico also compared relatively low to its Latin American peers by a number of indicators.

• The insurance penetration rate (risk premiums / GDP) of 2.2% was below several of the larger economies in the region, including Chile (4.6%), Brazil (3.1%), Colombia (2.8%), and Argentina (2.7%).
• Measured by insurance density (premiums per capita), Mexico measured towards the middle of the pack, but still trailed Chile, Argentina, and Brazil.

Life Insurance vs. Non-Life Insurance If we were to measure Mexico by life insurance penetration (defined as life insurance premium divided by total risk premiums), the country would be within the Top 3 in the region. We think this measure hides the fact that critical non-life insurance products (including auto, health, home) are highly underpenetrated (i.e. it’s a denominator issue).

Figure 3. Latin America: Risk Premium Index Penetration, insurance density, life insurance penetration 2018 (risk premiums / GDP, %; premiums per capita; USD; Life Insurance premium/ total risk premiums, %)

A more adequate measure perhaps is what is referred to as the Penetration Gap (which compares total Life insurance premiums vs. total Non-life insurance premiums). On this measure, Mexico again is towards the middle of the pack in the region. This suggests that while insurance as a whole has room to grow across all products in Mexico, we believe that Non-life insurance products (particularly auto, health and home) will see accelerated growth rates over the long-term.

Figure 4. Penetration Gap: Life Insurance / Non-Life Insurance

OUR INVESTMENT IN ARCA SEGUROS

ARCA Seguros sees a significant window of opportunity to digitize auto insurance in Mexico due to the low level of insurance penetration, new regulatory changes in auto and a secular shift to digital financial services.

• Regulatory Tailwinds. In 2019, for example, Mexico passed a mandatory insurance regulation, requiring all drivers to carry auto insurance in order to travel on federal highways within Mexico. Lacking minimum insurance that covers damages to third parties will subject drivers to a fine of 20 to 40 days of minimum wage (~$4,000 pesos by some estimates). This fine could prove steep for a large percentage of the population.
• Secular shifts to digital. Mexico’s insurance sector relies heavily on customer call centers/insurance agents as the key distribution channel. According to Ernst and Young, individual agents and brokers generate over 60% of insurance premiums. EY foresees digital distribution channels to gain a larger share of the market over the next 10–15 years as the average age of insurance agents in Mexico is above 50 years old. The insurance sector will need to embrace digital solutions and EY expects that by 2027, over 50% of potential new insurance clients will be digitally native consumers.
• We believe the COVID 19 crisis will accelerate the shift away from these traditional models. Increased regulations/safety standards around restrictions on the number of people per square feet and increased investment in other safety measures could provide positive tailwinds for digital platforms.

Digitally native platforms like ARCA are well-positioned to ride this secular shift to more digital consumption of insurance. ARCA is not the only company tackling this unaddressed market in Latin America. There are other competitors at varying stages and across key regional markets. However, we view ARCA as competitively well positioned in Mexico given the combination of a highly experienced team, technology, and value proposition.

• Deep Domain Expertise. The company was founded by a father (Juan Gironella) and two sons (Juanma Gironella and Javier Gironella). The father, Juan Gironella, serves as the Chairman and Co-Founder of ARCA. He is the former Executive President of MAPFRE in Mexico, and former Executive Vice President of Mapre in Spain for several years. Juanma Gironella, the CEO and Co-Founder, and Javier Gironella, the COO and Co-Founder have held several relevant roles for companies like Seguros Broker, Munich Re, and Zurich. The domain expertise, in-depth knowledge of the gaps/opportunities in the Latin America insurance market, and high-level executive relationships within the Mexico insurance industry are also key differentiators for ARCA.
• Scalable Platform. ARCA automates the process of finding, comparing, purchasing and managing insurance policies online. The company’s digital insurance brokerage platform is distributed via both B2B and B2C models. In our view, this both highlights the flexibility of ARCA’s online platform and the significant need for this type of solution in the Mexican market.

On the B2C side, the company now offers consumers 8 different insurance carriers, including MAPFRE, Qualitas, Chubb, GNP, and other leading local/regional brands. The user experience is streamlined, allowing consumers to compare quotes among top insurance providers in three clicks, without registering, without calls from live agents and with a user experience that is 100% online. Consumers can also check information for their vehicles — from registration renewal dates/due to outstanding citations — and upload all outstanding policies (even those not purchased through ARCA) within the platform. While this user experience is relatively common in the US, this represents a drastic improvement for Mexico.

On the B2B side, some of the largest insurance brokers in Mexico have also partnered with ARCA to increase their digital capabilities. For nimble digital Fintech startups that do not want to disrupt their user experience, ARCA offers API integration. These Fintech startups can offer insurance-related offers in a more agile and efficient way. Notable companies leveraging ARCA’s B2B platform include Albo, General de Seguros, Kavak, MAPFRE and Up Si Vale.

LEAP ultimately invested in ARCA because we share a vision that accessible and cost-effective insurance is key to protect underbanked/low-income communities that can often not bear the economic shock of an accident. Equally important, we believe that the best way to effectively achieve this is to disrupt the status quo in Mexico, through a digital-first approach.

We are excited to welcome ARCA to the LEAP family. We are equally excited to collaborate with Peña Verde SAB (BMV: PV) and Magma Partners.

How ARCA Seguros is Expediting the Digitization of Insurance in Mexico was originally published in LEAP Insights on Medium, where people are continuing the conversation by highlighting and responding to this story.