Warren Buffett’s new embrace of neobanks on old lenders

For decades, financial institutions have been Buffett’s bread and butter, with stakes in lenders, insurers and credit card companies. That changed last year, when Berkshire gave up 84% of its stakes in Goldman Sachs Group, initially recovered during the global financial crisis, and reduced its stakes in Wells Fargo and JPMorgan Chase. Berkshire’s investment portfolio had just over 23.6% of its fair value concentrated in financial companies, including banks, at the end of 2020, up from 41% in 2019.

Berkshire watchers were shocked and worried. Buffett compared the Covid crisis to 2008, noting that there were a lot of unknowns, given that large swathes of society were shut down.

Now, it’s worth considering whether Buffett is taking this stake in Nubank a step further, and whether it’s a deliberate shift from the old world of finance to the new, digital-only variety. Customers certainly don’t need physical branches in the midst of a pandemic.

Reality can be somewhere in the middle. Buffett’s fintech bet is less testimony to his convictions about the future of the bank than a hunt for exceptional growth potential, driven by consumers. Berkshire already has a stake of around 4% in another Brazilian payments company, StoneCo Ltd, and India’s Paytm. Buffett is looking for dislocations in the market, not just efficient money generators with more or less diminishing or stable returns. After all, the benefits of technological disruption rarely show up in the bottom line of traditional lenders; they go to customers.

Virtual banks seem to have accomplished what the incumbents have had a much harder time doing. Their ease of use and accessibility are appealing to consumers, while the cost of opening an account is low. Operational expenses are not as expensive as they do not need branches and physical assets. The companies in which Buffett has reduced its stakes have tried to create their own consumer-focused digital units. But the transition from their normal functions to digital is slow and expensive. Goldman’s Marcus has battled rising loan losses and executive turnover. JPMorgan disconnected its version, called Finn, a year after its launch.

It is true that Berkshire could have brought its digital games closer to home and in theoretically safer markets. In places like Europe and the United States, however, the neo-banking space is relatively mature with limited investment potential, given all the venture capital money already crammed there. In the first quarter alone, 25 of 42 digital banking transactions in the two regions.

Meanwhile, US and EU regulators are getting more cautious (think the situation of Wirecard AG in Germany) and pushing the big players to get full banking licenses. This is a good thing, but it can also create barriers to growth. In addition, the acquisition of customers is more expensive because they have to spend more sums to compete with the large incumbent operators, who invest aggressively to defend their territory.

No wonder Buffett is looking elsewhere. Emerging markets like Latin America and Asia, where consumers have helped payments and digital currency systems take off, present a long-term opportunity. Lenders in these areas are inefficient, expensive and relatively weaker, often struggling with bad debts. The number of unbanked people remains vast, and outside of China, regulation is not a huge obstacle. The future of fintech has already shown clear success and adoption. Carpoolers and e-commerce companies have become super apps and are getting banking licenses.

Brazilian Nubank competes with the big lenders in terms of volume. It recorded more than 57 million downloads, while annualized revenue between 2017 and 2020 increased by more than 100%, according to analysts at Goldman Sachs. Its no-fee, app-based credit card for the urban middle class has been key to this success. Yet digital banks cannot completely eliminate competition. Nubank itself relies on major lenders for lines of credit and turned to traditional banks to support its Mexican subsidiary in April.

So while the big banks appear to be on the defensive, they continue to hold the reins of large-scale credit, however expensive. Their digital friends, however, will have a much more lucrative route. Buffett knows that.

Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia.