Inter-American Development Bank
facebook
twitter
youtube
linkedin
instagram
Abierto al públicoBeyond BordersCaribbean Development TrendsCiudades SosteniblesEnergía para el FuturoEnfoque EducaciónFactor TrabajoGente SaludableGestión fiscalGobernarteIdeas MatterIdeas que CuentanIdeaçãoImpactoIndustrias CreativasLa Maleta AbiertaMoviliblogMás Allá de las FronterasNegocios SosteniblesPrimeros PasosPuntos sobre la iSeguridad CiudadanaSostenibilidadVolvamos a la fuente¿Y si hablamos de igualdad?Home
Citizen Security and Justice Creative Industries Development Effectiveness Early Childhood Development Education Energy Envirnment. Climate Change and Safeguards Fiscal policy and management Gender and Diversity Health Labor and pensions Open Knowledge Public management Science, Technology and Innovation  Trade and Regional Integration Urban Development and Housing Water and Sanitation
  • Skip to main content
  • Skip to secondary menu
  • Skip to primary sidebar
  • Skip to footer

Ideas Matter

  • HOME
  • CATEGORIES
    • Behavioral Economics
    • Environment and Climate Change
    • Macroeconomics and Finance
    • Microeconomics and Competitiveness
    • Politics and Institutions
    • Social Issues
  • Authors
  • Spanish

What Happens to Small Firms When Big Banks Go Digital?

August 29, 2024 by Razvan Vlaicu Leave a Comment


In Latin America and the Caribbean, a region historically marked by financial exclusion, a rapid shift to digital banking in the last decade has created new opportunities for credit provision to underserved populations. But the transformation, accompanied by a reduction in traditional banking infrastructure, such as physical branches, is not without its risks and challenges.

According to an IDB report, the fintech ecosystem in the region grew 112% between 2018 and 2021, with especially strong growth in South America, which alongside the digital transformation of banks, has significantly expanded access to credit. This shift in financial technology has been critically important. New digital banking platforms have enabled financial institutions to reach people in remote and low-income areas who were traditionally excluded from formal credit markets. For example, in Brazil, digital lenders have started using alternative credit scoring models based on non-traditional data, such as mobile phone usage and social media activity, to assess creditworthiness. This has allowed consumers and microentrepreneurs without traditional credit histories to access loans, effectively broadening the pool of potential borrowers and fostering greater financial inclusion.

Cost of Credit in a Digital Age

The transition to digital banking has also influenced the cost structure of credit in Latin America. In a sector with significant concentration of market share at the top, the decline in local outlets of the large banks has affected the cost of credit, particularly for small and medium-sized enterprises (SMEs). The reduction in physical branches has led to decreased local banking competition, potentially increasing borrowing costs for SMEs. On the other hand, the rise of digital banking has countered this trend by reducing operational costs for lenders, enabling them to offer more competitive interest rates, especially in countries like Mexico and Colombia where fintech innovation is robust.

But while digital finance has on balance helped expand access to credit in certain market segments, it has also introduced new challenges in assessing risk and creditworthiness. As we point out in a recent IDB study, the closure of physical bank branches can lead to a decline in the availability of credit for local businesses, as these branches often play a critical role in collecting “soft” information about borrowers, based on personal relationships and interactions, which can be extremely valuable for assessing credit risk. This is particularly problematic for micro and small enterprises, which rely heavily on local banking relationships. In contrast, digital lenders tend to use automated and data-driven methods for credit assessment, which may overlook nuanced local knowledge. The World Bank also emphasizes that while digital credit scoring models are efficient in collecting and analyzing data, they can inadvertently exclude individuals with limited digital footprints, leading to potential biases and inequalities in credit distribution.

Risks of Bank Digital Transformation

The decline in physical bank branches due to digital transformation can also negatively impact local economies. Our study examined firm data from municipalities in Brazil where the only local branch, typically owned by one of the five large banks, closed during the 2010s. We found that such closures led to significant reductions in firm activity, employment, and wages in affected municipalities. Roughly one percent of firm establishments become inactive three years after a bank branch closure, and the share of inactive establishments increases from 1.2 percent to 8.4 percent four to seven years after the closure. Average wages also register a decline, by 1.5 to 1.7 percent in the first three years. For employment there is no significant short-term effect but a potentially negative effect in the longer term. The types of firms most affected are micro firms in sectors such as trade, services, and agriculture.

These results imply a significant downside of the digital shift: as digital banking expands access in some areas, it may simultaneously erode the local economic fabric by reducing the availability of personalized financial services. Another potential risk comes from the handling of client data through digital channels. The World Bank warns of the risks associated with data privacy and cybersecurity in the digital banking era, which could undermine trust in digital financial services if not properly managed. Government regulations need to adapt to the new technological reality to mitigate these problems.

Balancing Digital Innovation with Local Needs

The digital transformation of banking in Latin America has brought about significant changes in access to credit, enabling financial inclusion while generating challenges related to creditworthiness assessment and local economic impacts. As the IDB and World Bank research suggests, the key to harnessing its benefits lies in balancing innovation with the preservation of essential local banking services based on relational knowledge that digital data has difficulty capturing. Policymakers must ensure that digital transformation does not come at the expense of local communities’ economic health and that the benefits of increased access to credit are equitably distributed across all segments of society.

The ongoing evolution of banking in Latin America will require continuous adaptation, both from financial institutions and regulatory bodies. It is crucial to ensuring that the promise of digital financial inclusion is fully realized without unintended negative consequences.


Filed Under: Microeconomics and Competitiveness Tagged With: #Banking

Razvan Vlaicu

Razvan Vlaicu is a senior economist in the Research Department at the Inter-American Development Bank. His research interests are in public economics and political economics, with a focus on the role of governance and institutions in economic development. He received his Ph.D. in Economics from Northwestern University, taught economics at the University of Maryland, and held short-term positions at the Kellogg School of Management and the World Bank. His research has been published in journals such as the Review of Economic Studies, American Political Science Review, Journal of International Economics, and Journal of Public Economics.

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

Follow Us

Subscribe

Search

Related posts

  • How Bank Robberies Stoke Financial Digitalization in Brazil
  • Trust: An Obstacle and an Opportunity for Digital Transformation
  • Can AI Technologies Help Expand Credit Access?
  • Can Digital Payments Boost the Impact of Social Programs?
  • Boosting Financial Inclusion Among the Vulnerable

About this blog

The blog of the IDB's Research Department shares ideas that matter on public policy and development in Latin America and the Caribbean.

Footer

Banco Interamericano de Desarrollo
facebook
twitter
youtube
youtube
youtube

    Blog posts written by Bank employees:

    Copyright © Inter-American Development Bank ("IDB"). This work is licensed under a Creative Commons IGO 3.0 Attribution-NonCommercial-NoDerivatives. (CC-IGO 3.0 BY-NC-ND) license and may be reproduced with attribution to the IDB and for any non-commercial purpose. No derivative work is allowed. Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the UNCITRAL rules. The use of the IDB's name for any purpose other than for attribution, and the use of IDB's logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this CC- IGO license. Note that link provided above includes additional terms and conditions of the license.


    For blogs written by external parties:

    For questions concerning copyright for authors that are not IADB employees please complete the contact form for this blog.

    The opinions expressed in this blog are those of the authors and do not necessarily reflect the views of the IDB, its Board of Directors, or the countries they represent.

    Attribution: in addition to giving attribution to the respective author and copyright owner, as appropriate, we would appreciate if you could include a link that remits back the IDB Blogs website.



    Privacy Policy

    Copyright © 2025 · Magazine Pro on Genesis Framework · WordPress · Log in

    Banco Interamericano de Desarrollo

    Aviso Legal

    Las opiniones expresadas en estos blogs son las de los autores y no necesariamente reflejan las opiniones del Banco Interamericano de Desarrollo, sus directivas, la Asamblea de Gobernadores o sus países miembros.

    facebook
    twitter
    youtube
    This site uses cookies to optimize functionality and give you the best possible experience. If you continue to navigate this website beyond this page, cookies will be placed on your browser.
    To learn more about cookies, click here
    X
    Manage consent

    Privacy Overview

    This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
    Necessary
    Always Enabled
    Necessary cookies are absolutely essential for the website to function properly. This category only includes cookies that ensures basic functionalities and security features of the website. These cookies do not store any personal information.
    Non-necessary
    Any cookies that may not be particularly necessary for the website to function and is used specifically to collect user personal data via analytics, ads, other embedded contents are termed as non-necessary cookies. It is mandatory to procure user consent prior to running these cookies on your website.
    SAVE & ACCEPT