When David Vélez walked into a Brazilian bank branch to open an account six years ago, he was appalled by the experience.

First, he had to check his bag in a locker outside. Next, he waited to pass through a security line manned by three armed guards. He sat there for 45 minutes and finally spoke to someone, who acted like they were doing him a favor by deigning to talk about opening an account. Then, he was sent off to make a phone call to bank employees elsewhere and was later forced to return to the bank a half-dozen times over the next four months.

Vélez knew his experience was common throughout Latin America, where about half the population is "unbanked," with no bank accounts and often no credit histories. In Brazil, five banks control almost all of the market and charge high fees -with annual interest rates on credit cards recently averaging nearly 300% on unpaid balances, according to the Wall Street Journal.

So Vélez decided to build something entirely new, aptly named Nubank: a financial institution that would offer no-fee accounts and credit cards, welcoming the largely ignored Brazilian unbanked population to their first-ever bank accounts after they answered a few simple questions via an app.

In Brazil, as elsewhere, unbanked status makes everyday life difficult: Customers must make purchases in cash, or shell out for preloaded debit cards or money orders. If they receive a check, they have to pay extra at a check-cashing facility. And with little to no chance of securing a traditional loan, they may be forced into high-fee services similar to the US payday loans if they need to borrow money.

Six years after its founding, Nubank is a bona fide tech unicorn reportedly raising money at a $10 billion valuation. One of the most valuable startups in all of Latin America, Nubank has already attracted marquee investors including Sequoia Capital and Goldman Sachs, and it has signed on nearly 20 million customers in Brazil alone. The company is also expanding to Mexico and Argentina.

Clearly, Vélez's bet has paid off so far. But Nubank's simple premise belies complex competitive, regulatory and unbanked-customer challenges that early critics thought would be impossible for Vélez -or anyone -to overcome.

"When I started talking to the experts in the industry everybody told me, 'David, you're a foreigner. You don't understand Brazil -these are the most powerful companies in Brazil that you're going after," Vélez, who is originally from Colombia, told CNN Business in an interview. They said, "nobody competes with the five banks that own the market. They're going to crush you. It is impossible to compete."

He knew the unbanked were a potentially risky customer base. He knew that as a foreigner he would need a presidential decree to get a permit to start Nubank in Brazil, a process that could-and later did -take years. And he knew Brazil's banking oligarchy was powerful.

The comments were "intimidating," Vélez said, especially when attempts to fundraise locally in Brazil failed with people telling him: "You're crazy. There's no way I'm going to invest."

But Vélez also saw the massive opportunity in the Brazilian market, where 55 million people were unbanked, and in Latin America at large. And he felt a responsibility to them. He partnered with two other cofounders Edward Wible, an American, and Cristina Junqueira from Brazil to bring the vision to fruition.

"There was a lot of conventional wisdom around banking...like [it] was almost sacred and that entrepreneurs could not go compete with them," Vélez said. "But as I dig deeper and talk to consumers and felt firsthand the pain of being a banking consumer, I realized that people just really needed more alternatives. Technology was going to create a window of opportunity to build a fully digital bank."

How Nubank is upending traditional banks

In Brazil, which is Latin America's largest economy, the banking industry has historically been highly concentrated: Last year, the five largest banks controlled 81% of the country's total financial system assets and 85% of all loans. With precious little consumer choice, the banks have been able to set the parameters most favorable to them: high fees and rates, confusing loan terms and sometimes blasé service. After all, customers didn't really have anywhere else to go.

"In emerging markets like Brazil, for years monopoly banks hadn't had to stay competitive," said Lindsay Davis, a senior intelligence analyst at CB Insights who focuses on the fintech industry. "They were able to charge their fees and serve only part of the population and do just fine that way."

But then, the cost of technology started to come down, and suddenly there was better access to Wi-Fi, Davis explained. Meanwhile, venture capital was starting to pour into Latin America, and consumer demand began to put pressure on governments to foster a more competitive banking market.

Enter Nubank. The company launched its first product to Brazilians in 2014: a no-fee, low-interest international Mastercard credit card completely managed by a mobile app. In 2018, it launched a digital savings account called NuConta -after Nubank finally received its special banking permit from the Brazilian government -and earlier this year the company unveiled a personal loan product.

For Nubank, the digital focus helps keep costs low. The company is able to strip out some fees because the company doesn't have the overhead of hundreds of banking branches, Vélez explained; instead, revenue comes from interest and from interchange, the fees merchants pay to Nubank for the processing of card payments to make a purchase. (The interchange fees average 1% on every credit card transaction, Nubank said.)

Vélez says customers can be approved for a bank account, credit card or loan in "a few minutes" after downloading the app, uploading a few documents and answering a couple of basic questions.

Some customers receive credit card interest rates as much as 50% lower than those of traditional Brazilian banks, Vélez said. In other cases, Nubank hedges by offering a line of credit as low as $10 to start, increasing the amount over time as customers build up a history of good payments.

Vetting the unbanked

The problem that Nubank and Vélez are tackling goes far beyond the struggles of the individual unbanked, as the effects ripple deeply into countries' macroeconomics and culture at large.

In rich, developed countries, widespread access to credit fuels the ability for consumers to purchase goods, entrepreneurs to launch small businesses, students to pursue higher education and the housing market to thrive -overall, for the economy to continue to grow.

But in emerging economies where credit is rare, consumer spending is inhibited. Small businesses have less opportunity to grow. Both problems in turn hurt companies' ability to hire. All of the interconnected issues pile up and can hold back a country's economy. Brazil, specifically, has grappled with years of sluggish economic growth.

Unlocking credit could be a key to turning around Brazil's economy. But by targeting the unbanked population, many of whom do not have credit histories, Nubank doesn't have historical data to assess potential customers — an inherent risk as customers may not have the ability to pay it back.

In the US, tools like FICO scores are paramount: Customers' histories of taking out loans, using credit cards and paying back their debts determine whether they are considered high or low-risk. In turn, lenders may grant them a high-limit credit card or loan at a low interest rate, a lower limit at a high interest rate or even deny their request altogether.

But in Brazil, this type of concept is new. Until recently, the only credit scoring system was a blacklist of sorts, with unpaid balances listed on a register and removed once they were resolved. Over the past few years, though, change has begun. Brazil's five largest banks have been working to set up a more US-like credit research company to track information on customers' bill-paying history, and companies like FICO and Equifax are moving into Brazil as well.

Nubank, however, has built its business on a wholly new foundation: unique data sets and algorithms that are based on "a lot of nontraditional information," Vélez said.

"We look at where you live...how you move, who your friends are, who invited you to Nubank, the type of people that you're sending money to," he said. "We look at whether you read the contract of the credit card or whether you don't -it turns out that people [who "read" the contract] really fast tend to be fraudsters. We look at the type of transactions that you're doing, if you're buying groceries or if you are in a bar."

Overall, Vélez said, it boils down to looking "at a lot of behavioral information to try to create a more holistic picture of that consumer."

Davis, the CB Insights analyst, said such algorithms represent how Nubank and other challenger banks "are using innovation and technology to see how customers can be underwritten. Traditional business models just haven't kept up with the pace of that technology, and it creates a huge opportunity when you couple it with the pent-up demand [of customers who want to become banked]."

Brazil and beyond

That pent-up demand has driven Nubank to sign up nearly 20 million customers so far, and Vélez said the goal is to reach 100 million customers in Latin America. The company has already expanded to Mexico and in 2020, it will begin operating in Argentina as well.

"Traditional banks' business models have been able to sustain them up until this point," Davis said. "They're are waking up to the idea that they're being disintermediated, that 'the bank' can be abstracted away from the branch. In Latin America specifically, where someone like Nubank is able to get a charter, challengers can absolutely pull power away."

With more than 1.7 billion unbanked adults around the world, there is ample room for other Nubank-style upstarts to disrupt traditional banking. Davis added: "Even more broadly than Brazil, the challenger-bank opportunity is spreading rapidly."
Nubank, at least, is still focused squarely on Latin America, where the company estimates it has saved customers $1 billion in fees alone so far. Today, the company has 50% share of all new credit cards issued in Brazil.

The company is not yet profitable -though it is narrowing losses, from 117 million Brazilian reais (USD $29.4 million) in 2017 to about a 100 million reai net loss (USD $25 million) in 2018. And looking ahead, Nubank is focused on continuing expansion rather than making a profit.

"For the next five years we're focused on Latin America, but over a very long-term horizon, we think emerging markets are very interesting -when you look at Nigeria, Indonesia, Vietnam, India, you find the same oligopoly structure," Vélez said.
In the long term, Nubank wants to explore all emerging markets to connect people with credit cards, bank accounts and other products that could change people's financial lives, Vélez said -a lofty goal that early detractors would have scoffed at, he knows.

"It's been a very surreal experience; our [original] goal was a million customers in five years," Vélez said. "It has all really happened way faster than anything we expected."