Latin America's Need for Credit Scores
The Latin American credit card market is once again seeing double-digit growth in 2005, proving that it is one of the most dynamic card markets in the world. Including both purchase and cash activity for all card products, transaction volume will rise to more than $50bn in 2005, up by nearly 40 per cent over the previous year. There are more than 120 million general-purpose cards in circulation in Latin America and more than 1 million associated merchants. Although the market continues its historic domination by the trinity of Visa, MasterCard and American Express, the region’s competitive landscape is still far from consolidated. To some extent growth will come from emulating tactics used in more mature markets such as the US and Europe, but longer-term achievements will require companies to successfully navigate the unique perils of the Latin American market.
One major obstacle is the fact that banking penetration is comparatively low and significant only in larger economies. Even in countries such as Mexico and Brazil where banking penetration is nearly 40 per cent, one-quarter of the population lives in abject poverty and will provide few prospects for any form of banking product for at least another generation. Fewer than 10 per cent of all merchants accept credit cards and most towns still do not even have automated teller machines.
With banking penetration increasing at about 7 per cent annually, much faith has been placed in increasing card penetration by issuing debit cards. Nearly all new account holders are issued an ATM card that doubles as a debit card. If cardholders can be motivated to use these cards for shopping and not just cash withdrawals, they can be gradually weaned into more sophisticated credit card products. Moreover, greater debit card use will justify the installation of more point of sale (POS) card terminals by merchants. The cycle will complete itself as consumers find it more convenient to use debit cards where merchants accept them.
This model of card market development is strongly supported by governments, banks and card organizations. During the peak of the corralito in Argentina, the government virtually forced use of plastic on its cash-strapped population. It went as far as providing VAT rebates for the use of both debit and credit cards as a means of driving cash transactions into the formal economy. For similar reasons, in March 2005, Mexican banks announced a $250m plan to increase use of debit cards by expanding the country’s POS terminal network to 475,000 by 2010. Eventually, Visa and MasterCard would like to approach levels of POS debit card use seen in Belgium, the US and even Korea, where purchases approach 20 per cent of debit card transactions. In contrast, the rate in Latin America ranges between 1 per cent and 5 per cent.
This faith in the debit card model is likely misplaced in Latin America. Even in markets such as Belgium where deferred debit cards dominate the market, there is a trend towards rapid migration to credit cards. Moreover, debit-card use is directly correlated with the average balance in an account, and Latin American savings rates cannot support the level of debit card use seen in Europe or Asia. Latin Americans continue to have trouble saving, and what liquidity they do have, they are reluctant to front-load with purchases. Even in Argentina, where debit card purchases were encouraged through aggressive marketing and tax incentives, the use of debit cards at POS terminals is barely 5 per cent of all transactions, having declined since the country’s economic crash of 2002. In Mexico, one of the healthier economies of the region, the average is only about 2 per cent.
Another important obstacle to debit-card use is the aggressive marketing, convenience and prestige of credit cards. As recently as 2000, credit cards were mostly the domain of the wealthy because only they were able to establish a credit history through continuous income and healthy bank balances. Moreover, reward programs and benefits were tailored to fit an affluent customer. As a result, credit cards confer social status in Latin America in a way not seen in the US and Europe.
Over the past few years, credit cards have penetrated more deeply into the middle and lower-middle class. This increased accessibility has not compromised their cachet, however, creating income opportunities for issuers. Latin American credit card users are three times more willing to pay premium fees for cards than American or European cardholders. American Express offers a Latin American Platinum Card for the same annual fee as in the US, but with far fewer benefits. Potential clients that do not yet have cards are even more willing than existing cardholders to pay a premium for access to credit cards. A 2004 study of Mexican, Brazilian and Argentine cardholders conducted by InfoAmericas showed that new applicants are quite willing to pay interest rates up to 25 per cent higher than the market average to obtain a card and begin establishing a credit history. Credit cards are often the easiest if not the only means of obtaining credit from a bank.
The willingness of consumers to pay annual fees plus additional premiums for benefits will continue to shelter card programs from the APR wars common in the American market, and introductory offers such as zero or low interest rates are simply unnecessary. Although interest rates remain considerably higher in Latin America than in the US, they have fallen to nearly a three-decade low. APRs obtained by some Brazilian banks continue to hold above 40 per cent annually, compared with 12 per cent paid on savings accounts. In Mexico, a dollar-denominated premium card product offered by Citibank-Banamex offers a comparatively low APR of 21 per cent, but the fee is $125 per year. Such rates and fees are generally unheard of in the US and Europe but are seen as good deals by Latin American standards. Another charge that many Latin American cardholders are accustomed to paying is the overseas tax or exchange rate fee – something that might actually be introduced to the US market by MasterCard in 2006.
Although Latin American cardholders remain willing to pay a premium for having a credit card, they are nonetheless becoming more demanding. Travel reward plans were the pioneer co-branding programs in the region, but customer satisfaction levels have fallen because most cardholders do not spend enough to accumulate sufficient points to claim travel rewards. Banco Santander in Brazil reports issuing fewer than two travel rewards per month. As a result, reward programs are shifting towards offering benefits such as household goods and local meals or entertainment.
Another emerging trend is repositioning of credit cards to more prestigious levels for Latin America’s most affluent cardholders. Gold Card members are being upgraded to platinum and ultra-premium programs are being developed for the most privileged. One reason for this move is that repositioning opens the door to cross-selling opportunities. Taking a cue from the American market, Banco IXE in Mexico is cross-selling credit programs for surgery to its most affluent card base. The market for a similar program in Argentina is estimated at 35,000 policies.
The corporate card segment is also undergoing aggressive repositioning, driving growth in annual billings of more than 20 per cent, a trend that is expected to continue for at least another five years. Small business cards that were previously issued to corporations are now being upgraded to corporate cards. There is demand for products that more accurately reflect business needs, and the banks are also moving into territory previously dominated by retailers, such as gasoline cards.
Cards for fuel purchases were historically in the domain of the major gasoline companies, and voucher suppliers such as Accor. Amazingly, many of the largest companies in Latin America do not have a standardized payment processing solution for their fleets, generally paying by invoice or by reimbursing drivers. Banks are moving into this market with fleet and fuel cards, saving companies as much as 15 per cent through efficiency gains and decreased fraud.
Rapid growth both in the business and consumer segments is beginning to create problems that warrant industry attention. Growth has been driven by moving down the income ladder, without the benefit of sophisticated credit information about potential customers. This has led to higher write-off levels among Latin American credit card issuers. Banks in Peru and Brazil have been forced to write off as much as 6 per cent of card balances, double the rate three years ago. The upward trend in bad debt will continue in the short term, until issuers update their credit scoring models and until the region’s credit bureaus improve their records. Santander has spent the better part of two years updating and implementing its GARRA credit-scoring model for Latin America. The market for similar solutions is estimated at more than $320m over the next four years. This is a large enough market to pique the interest of US-based credit rating firms such as Equifax and Experian.
Banks are definitely worried about carrying large amounts of risky and non-performing debt, but they see this as a short-term risk. Until credit scoring systems are improved and expanded, short-term losses will be offset by high interest rates on ever-increasing levels of revolving debt. Higher debt is regarded as a sign of strong consumer confidence. This in turn points to higher retail sales and economic growth, because in Latin America high consumer confidence correlates with a willingness to leverage debt rather than save. The instrument best suited to fit this cycle is the credit card.