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A thought-out plan

In 2016, the Brazilian Central Bank launched the BC# agenda to modernize the Brazilian economy around 5 main pillars: inclusion, competitiveness, transparency, education, and sustainability. Historically, a couple of major institutions have monopolized the Brazilian banking sector. Brazilian banks were some of the best performing in the world, given that they usually chose to serve only rich segments of the population. When they did decide to serve lower socio-economic segments, it was often through absurd interest rates, sometimes breaking 300% a year.

This left large swaths of the population unbanked, reliant on cash, and unable to access essential financial services such as credit and insurance.

In the past decade however, the exponential growth of startup activity in Brazil has led to the creation of numerous “fintech” startups, aimed at disrupting incumbent financial institutions. The Brazilian government facilitated this rise through the unbundling of banking licenses, which enabled fintech founders to launch their products without needing to become regulated banks. a16z aptly breaks down some of the new, narrow licenses such as:

1. Postpaid instrument issuers – i.e., non-financial institutions that issue postpaid accounts like credit cards

2. Electronic money issuers – i.e., non-financial institutions that manage prepaid accounts like food vouchers

3. Payment acquirers – i.e., non-financial institutions that help companies accept payments

The epitome of this Brazilian fintech revolution is Nubank, a neobank founded in 2013 that eventually went public on the NYSE in December 2021.

In short, the previously exclusive and old-school Brazilian financial system has been severely shaken up in the past decade, thanks to forward-looking legislation enabling fintech innovation to flourish. Customers now have more choices than ever, and the dispensing of “financial services” isn’t exclusive to only banks.

The story of Pix

Pix is the instant payment system built by Banco Central do Brazil, which launched in November 2020. Brazil already had a system for same-day transfers named TED, which was cumbersome due to high fees and offered a complicated user experience that required the sender to have the recipient’s complete bank details before sending.

Pix is akin to other instant payment systems around the world such as PromptPay in Thailand or more famously, UPI in India. Compared to these other systems however, Pix has been unmatched in both the velocity of its growth and the enthusiasm surrounding its adoption.

Pix is a payment infrastructure that enables instant and extremely cheap account-to-account transfers. This means that any participating bank or fintech which provides so-called “transactional accounts” can offer Pix as either a payment method or a money transfer method.

A traditional credit card transaction

VS

A real-time payment network such as Pix

Pix’s secret weapon

The catch with Pix is that the Banco Central do Brazil (BCB) mandated banks with more than 500,000 accounts to implement the system. This conferred Pix with a consequential initial user base from the get-go. On the other hand, fintechs offering pre-paid cards were strongly incentivized to integrate Pix, given the revolutionary customer experience it provided compared to old methods.

Indeed, one of Pix’s main goals is to modernize and fluidify the Brazilian economy. Until then, financial transactions in Brazil were a hassle due to fees charged by debit/credit cards, long settlement periods, or a combination of both. The striking improvement Pix bought to this antiquated system is responsible for Pix’s skyrocketing adoption.

“Merchants love Pix. It’s significantly less expensive, faster, and simpler. In Brazil, debit card transactions cost about 1-2% of a retail transaction, credit cards are 3-4%. Pix costs about a quarter of 1% or about 10X less than debit or credit. And, in the case of credit, a merchant might not get their money for up to 30 days so they often have to get a cash advance to manage cash flow which can cost them 5% of the value of the money they’re borrowing. With Pix, they get their money instantly. It’s common to see merchants in Brazil offer as much as 15% off when consumers pay with Pix.” - Source

Pix also focused on a simple UX, aimed at boosting adoption. Anyone can sign up for Pix using the transactional account they have (either from a bank or a fintech). To receive transfers more easily, users can also get a Pix alias/key, which can be attached to a person’s phone number, email address, taxpayer ID, or randomly generated.

“All people need is to have an account, including a payment account, with one of the nearly 800 Pix participants. Pix allows the transfer of funds between people and between companies the payment of purchases in physical store e-commerce and m-commerce, the payment of invoices and bills (request-to-pay) – even with the possibility of scheduling  – payments from companies to persons, and even transactions involving the government  both in the collection of taxes and fees and for the payment of citizens and service providers.” - Source

The ease of installation, mobile-first UX (in a country with more than one smartphone per citizen), and a drastic improvement over traditional payment methods have all made Pix’s adoption rate quite staggering. Undoubtedly, those numbers were also buoyed by the pandemic context in which Pix was launched, an extremely favorable period for fintech innovation and decreased use of cash. Just over a year after launch, around 70% of the Brazilian population had a Pix account.

Pix’s impact on the Brazilian economy

Two of Pix’s main numerical goals are to drastically reduce the percentage of transactions carried in cash as well as drastically reduce the percentage of unbanked Brazilians. A large part of that population works in the informal sector and has traditionally expressed a distrust for banks, given exorbitant fees and lengthy bureaucracy.

What Pix did was change the narrative around digital financial services, while also convincing large parts of the unbanked population that digital money was more convenient than cash. It is important to note that the banking of the unbanked population in Brazil has been happening for quite some years, with Pix being the cherry on the cake following many years of previous progress.

“Pix took out the need of dealing with traditional banks and the cultural baggage that led some Brazilians to not trust them, besides cutting off the high fees of credit and debit card usage. This payment methods has been bringing these people into the financial system legitimizing the way they move money around and reducing the cost of maintaining paper-money in circulation.” - Source

By being so effective and convenient, Pix is enticing parts of the unbanked population to open a transactional account either at a bank or through a fintech provider. For the already banked population, Pix allows for a more active economic experience. For merchants, the instantaneous deposit of funds makes it easier to manage stock, inventory, and cash-flow.

Criticism of the system

Anxious banks

Such a shakeup in a financial system doesn’t come without its fair share of skeptics and critics. For starters, big Brazilian banks were not necessarily pleased with the government mandating them to shave off one of their revenue streams, transfer fees. The BCB justified this move by advancing that while painful in the short term, Pix would usher more people into the financial system and subsequently grow the demand for the banks’ other financial services.

The BCB has already been trying to make the Brazilian financial system more competitive for a number of years now, notably through the implementation of Open Banking, aimed at giving banking customers better control over their data.

Fraud

The widespread use of Pix has also given way to a new form of “lightning kidnappings”, where an aggressor takes someone hostage and releases them once the victim had transferred a certain amount of money to the aggressor’s Pix account. While the issues of insecurity and kidnappings in Brazil long precede Pix, the velocity of the system and instant payout functionality do have the potential to improve a kidnapping’s ROI, to put it bluntly.

The fast and instant nature of Pix payments also make fraud easier, by way of transactions being settled almost immediately. While the BCB has stated that it privileged speed over safety at this point, the actors involved in Pix (namely the financial institutions providing the transactional accounts needed to use the system) need to be more robust on their KYC process.

“Real-time payments come with ease of movement of cash and better visibility of available funds, but their instantaneous nature means fraudulent transactions are settled more quickly, making them harder to fix once fraud has occurred. With real-time payments, there is a greater need for all parties in the payment process to block fraud as it happens.” - Source

Conflict of interest

Other financial analysts find it problematic that the BCB regulates the sector it operates in. Indeed, the BCB gets to write the rulebook for the Brazilian payments industry, while having the opportunity to push up its payment system above any other (the BCB even banned WhatsApp Pay in 2020). For some, this creates a clear conflict of interest and stifles competition in the sector.

The reason to institute clear separation of regulatory from operational functions is to avoid the risk that the regulator may favor an in-house operator, either through leniency toward that operator, excessive zeal toward competitors, or both. Such policies are applied by several central banks, including those of the United States and Australia. - Source

Conclusion

While Pix now seems ubiquitous within the Brazilian economy, it is important to keep in mind that it has only been launched 2 years ago and is thus at the very beginning of its roadmap. The BCB is working on new features in order to expand the scope and impact of Pix such as a credit feature, an ATM withdrawal feature, and an international transfer feature to name a few. One does wonder if Pix providing more and more financial services creates unfair competition for existing fintech startups.

What’s clear is that Pix is one of the rare examples where a government is at the forefront of fintech innovation. The fact that Pix is government-owned and thus doesn’t have a profit imperative grants them the opportunity to innovate for and onboard lower economic classes, even if it’s at a loss.

While not perfect, Pix provides an interesting use-case for what we could call a “public startup”. Indeed, the initiative of Pix’s breaks many misconceptions we all might have about the slowness and ineffectiveness of government innovation. As a generation that grew up with and on the internet enters governments around the world, Pix might be a premonitory example of a new breed of government initiatives.

The Realistic Optimist provides weekly, in-depth analyses of some of the hottest stories from our now-globalized startup world. Subscribe below to receive it directly to your inbox and don’t hesitate to share it with colleagues :)