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Brazil slowly developing into a fintech powerhouse as political scandal swirls

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Brazil, attempting to extricate itself from a recession as its president fends off a corruption scandal, has a well-kept secret: A thriving financial technology (fintech) sector that has managed to defy the country's political and economic turmoil.

With President Michel Temer denying allegations that he condoned a bribe to silence a witness in Brazil's widening corruption scandal, the country may find itself in the position of having to remove its second consecutive leader before their time in office expires. Meanwhile, Temer's economic reform agenda – unpopular with the public but embraced by markets — hangs in the balance.

The political intrigue has all but drowned out a tentative rebound in the economy, and a nascent boom in fintech. Moody's Investor Service estimates that investments into digital disruption in the banking system has topped as much totaled 5 billion reais (more than $1.5 billion) per year.

At least for the moment, enthusiasm blooms for Brazil's fintech sector, which is driving innovation within the country's banking sector — an area known for being tightly held and bureaucratic. In fact, Brazil's central bank is mulling new regulations this year to oversee the growing number of fintechs, which an official told Reuters this week was "very positive" for the country's financial system.

A recent report by Moody's highlights the number of FinTech startups in Brazil has "surged" in recent years, now making it the largest financial technology market in Latin America with more room for growth.

Simultaneously, Brazil's largest banks are also investing heavily in fintech, in order to increase efficiency and appeal to millennial custumers – a significant and growing segment of the population with particular preferences.

"The structural shift in customers' demands and behavior is leading banks to increasingly focus on alternative service channels," Ceres Lisboa, senior vice president with Moody's and co-author of the report, wrote in a research note last month.

"Lenders are also attracted to digital banking because they see opportunities to reduce costs as Brazil's economy remains weak after a protracted recession," he added.

Aside from political risks, there are other factors that loom large in Brazil's fintech sector. A January report by Citi cited Brazil as a "laggard" when it comes to the ability to reduce costs, as well as its "digital readiness."

Yet with the growth in digital services forcing the country's banks to gradually downsize, Brazil is being forced to adapt to a younger and readily agile generation that is demands flexibility on the retail level.

'The system has modernized'

Banking giant Itau has closed 10 percent of its branch network over the last three years, and there are plans for Bradesco to shutter more branches after acquiring HSBC's Brazilian operations.

"Even government-owned Banco do Brasil, which has some limitation related to acquisition and partnerships, has closed branches in the past two years as it enhances its digital services through internal developments," Moody's noted.

"The system has modernized," said Philippe Buhannic, founder and board member of TradingScreen, a multi-asset trading firm. "Brazil's consumer banking is now modern, with a lot more" technology.

Yet with Temer teetering on the brink — less than a year after his predecessor Dilma Rousseff was impeached in a similar corruption scandal — a cloud now hangs over the country's maturation into a fintech power. Analysts say the political turbulence, and the paralysis that comes with it, could hurt the fintech sector's development.

"I think [Temer's woes] will delay investments across a number of sectors as it delays reform implementation," said Rachel Ziemba, managing director of emerging markets research at 4CAST-RGE.

Claudia Calich, manager of the M&G Emerging Markets Bond Fund, said that "who will run the country once the dust settles is a key question," especially if Temer is forced out.

"At present, elections are scheduled for October 2018, and there are a wide range of possible candidates, each of which would impact the markets in different ways," Calich added.

--Reuters contributed to this article.