How the downturn may affect Latin American Fintech Startups

August 11, 2022

February 23, 2021

Famous short selling hedge funder Jim Chanos spoke with Joe Weisenthal and Tracy Alloway on the Odd Lots podcast about gig economy and fintech companies. It’s worth a listen. Chanos has a vested interest since he’s a short seller in many of these gig economy, marketplace and fintech companies, so he’s biased. The whole “don’t ask a barber if you need a haircut” idea. But that doesn’t mean he doesn’t have something important to say.


I’ll first unpack a few of Chanos’ ideas, and then evaluate how his ideas might play out in Latin America.

Chanos Rule 1: Overearning: Companies that charge out of market fees will likely be susceptible to margin compression

 Chanos likes to short companies that he views are over earning. Over-earning companies are likely to come under pressure from competitors who seek to earn those high margins that the over-earner is generating, which leads to lower margins, lower earnings and margin compression.

 For example, Chanos shorted Coinbase “not because I don’t like crypto or thought crypto was going down,” but because he saw that Coinbase was charging “60x higher fees” on retail customers vs. their institutional investors. In his view, 60x the fees are not sustainable long term.

 When a company is over earning, an investor has to believe one of the following to continue to underwrite these earnings:

  • The company is so much more efficient/better than everyone else and that nobody will catch up and be able to compete
  • Competitors won’t notice these margins/fees
  • Competitors will use price fixing or informal cartels to keep margins high (which has been common in Latin America historically).


Overearning in Latin America: First an advantage for startups, now likely a risk

 In Latin America, many fintechs have been beating banks because banks have been over earning. ROE for Latin American banks is generally 2-5x higher than US and European banks, and can be up to 20x higher than US banks.

 Fintechs have filled the gap. Nubank is the best example, launching its original Brazilian product with up to 80% lower interest rates and 100% lower fees compared to banks.

 Because banks over earn, while at the same time having huge legacy brick and mortar footprints and perks like executive dining rooms, it’s likely that fintechs can be very profitable simply by improving distribution, having lower costs by having fewer/no branches, and eating into Latin American banks’ over-earning ROEs they’ve had for the past 30+ years.

But as more fintechs compete in the market, will margin compression happen to the fintechs, just like fintechs have been doing to traditional banks? And will banks get with the program, improve services, and have slightly lower ROEs, but still be more competitive than fintechs? Which fintechs are the most exposed to these potential changes?

 The neobank industry is one of the first places to look. If many of these neobanks didn’t run sustainable unit economics during a credit cycle boom, will they be able to do it now? Especially now that there’s more competition from fintechs, legacy businesses like Oxxo and traditional banks, which should bring fees/prices down.

 Look at fees that Latin American startups charge users and compare them to the more competitive US. While the US market is more competitive than Latin America, US fees are likely directionally correct to where LatAm fees might end up when new competitors come into the market or decide to start competing on fees and interest rates.

 In some industries, LatAm fintechs are charging 5-10x higher fees than their US competitors. Is that sustainable going forward? Or will these LatAm fintechs end up charging similar, or slightly higher fees as their US competitors?

 To be clear, I’m not talking about comparing LatAm interest rates to US interest rates because of inflation, currency risks etc. I’m talking about pure commission or transaction fees. Startup fees might be lower than the banks, but are they sustainable with increased competition?

 Startups that charge 5-10x what their US comparables do are likely to be under pressure from other Latin American startups that have figured out how to operate more efficiently, and the more well capitalized traditional financial institutions may smell blood and try to cut fees to try to crush startups that have been eating their lunch the past few years.

 I look for the startups that are charging something that seems sustainable compared to US competitors, or startups that are charging “too much” but that could still thrive with 30-50% margin compression if over-earning stops or slows down.

 I’m not sure how many investors are looking this closely yet, but I think we’ll see this dispersion and discrimination from later stage investors during this downturn. So far, investors pay for distribution, rather than unit economics. Will that change now?

 This isn’t to say that some of the companies that are overearning are bad businesses. They just might not earn as much money as founders/investors might predict using today’s over-earing numbers, and might have trouble supporting their valuations at scale.

Chanos Rule 2: Credit Cycle: Most fintech lenders didn’t invent anything new, they’re just doing subprime lending via an app, benefiting from a strong credit cycle at their back

Chanos believes that while most fintech lenders claim that they have created a better risk system to lend to people that banks are mispricing, most fintechs are just doing subprime lending via an app. They didn’t figure out anything new about risk.

That’s likely true for many fintechs in the US.

In Latin America, I think this is less of an issue since most banks were only lending to the top 20-30% of Latin Americans. There’s clearly space to lend profitably to lower income segments.

Startups can make big money with better distribution, better customer service, and lowering costs with few/no physical branches. 

LatAm startups can win with these advantages, while US fintechs likely can’t. Why? Latin America’s traditional banking system only services the top 20%-30% well, has horrible customer service and high distribution costs.

This advantage could start to go away as traditional banks or retailers like OXXO catch up. So far, it’s taken legacy actors 15 years to start to get their act together, and many won’t ever do it.

Latin American fintechs that don't have a better risk algorithm or have a worse risk and/or collections department than the banks will likely face pressure from other fintechs that did figure it out, or from the banks that have better risk and collections departments.

Chanos Rule 3: Credit cycle: benefiting from lower than normal interest rates

 Chano’s thesis is that fintechs win on the way up a credit cycle, but many crash and burn when the credit cycle flips because margins get compressed via higher costs of capital and more defaults when the economy gets worse. He says he’s seen this dynamic through multiple fintech credit cycles since the 90s.

 Latin American fintech lenders are less exposed to rising rates than their US counterparts.

 Latin American fintechs have up to 100x higher spreads than their US comparables. A typical Series A Latin America fintech in Mexico, Colombia, Chile and Brazil has been able to borrow at 6%-20%, depending on the country, type of lending they do and how much equity they’ve raised. 

And then they lend it out at 8-15% for long term things like mortgages, and up to 250% loan-shark like annual rates for consumer credit products. You can read my thoughts on anyone charging loan-shark-as-a-service rates, and the risks that this type of lending has, not to mention the moral problem of doing it.

Some spreads for our portfolio companies (USD:

17% cost of capital – 45% interest rates

10% cost of capital – 16% interest rates

20% cost of capital – 55% interest rates

15% cost of capital – 60% interest rates

14% cost of capital – 25% interest rates

 US fintechs could be as low as 10-50 basis points, which get crushed when interest rates rise.

Chanos Rule 4: Credit cycle: benefiting from lower than normal default rates

 Chanos believes that most fintechs, especially lenders, haven’t really built a better risk model. They are simply benefiting from a favorable credit cycle: there will be fewer defaults during a good economy, and their “better risk model” will turn out to be the same or worse than the banks models when the markets turn. 

Default rates go up in a down economy. If lending companies are not making money hand over fist in an up market, how do their margins change when defaults go up?

 In the US, micro spreads mean even small changes in default rate, or even collections can crush a business. In Latin America, since spreads are higher, there’s more margin for error, but if fintech lenders don’t have exceptional numbers now, they are at big risk for pain in a down market.

Chanos Rule 5: If a company was struggling to make big money on the up part of a cycle, it's likely to get crushed on the downside.

 According to Chanos, gig economy companies should have had a golden age during the pandemic: people were stuck at home, and couldn't use other substitutes. But in reality, they lost even more money during the pandemic since their unit economics were broken. These companies had much higher revenue, but lost much more money too. The same thing can happen to fintechs.

 What will happen to LatAm gig economy companies, vertical marketplaces and embedded lenders in a worse economy? If there’s no path to profitability and fixing unit economics, those companies could be in a world of hurt.

 The good news for Latin American vertical marketplaces, gig economy companies and fintechs is that it's easier to reduce costs and improve unit economics than in the US, but if the model is broken today, it's much harder to fix in a down market than in good times.

Conclusion: The downturn has many risks for Latin American fintechs, but fewer risks than their US counterparts.

 I can’t predict the future. But here’s some of the trends we think might happen over the next 6-18 months, especially if the VC market doesn’t recover quickly.

  • Some well-known startups that are amazing at distribution are going to struggle to fix unit economics and won’t be able to get to a sustainable ARPU. 
  •  Some of the under the radar, or underestimated, companies with incredible ARPUs, know how to do lending, but didn’t raise much money may surprise their better funded competitors.
  • Well funded startups that haven’t figured out their unit economics or want to grow more quickly in a downturn and have cash in the bank will look to acquire startups that didn’t raise much money
  • Loan-shark as a service startups firing cash out of a firehose may be in trouble with rate compression, higher default rates, and better products from traditional banks and other startups
  • Responsibly run crypto/Web3 startups have a big chance to win over clients in countries like Argentina, Colombia and Brazil as traditional liquidity for fintechs gets harder to get at the earliest stages