Faced with increased competition from digital newcomers, Itaú Unibanco Holding SA has ramped up its online strategy by launching its own digital bank. Analysts believe the enhancement of the bank's online offering will enable Latin America's largest bank to recover ground in its digtal clients market share.

At Itaú's most recent earnings call, recently appointed CEO Milton Maluhy Filho announced the bank had revamped its payment unit, Iti, incorporating new products such as debit and credit cards and shifting the business model toward a full-fledged digital bank.

The approach marks a change in direction from Itaú's previous reluctance to develop a separate digital brand. Analysts believe that this change of tack under new leadership could mean that Itaú is concerned about rising competition and is trying out a new strategy to obtain faster client expansion.

"We had to do a major change in the way we approach the market," Filho said. "At the very beginning, it was concerted to be a payment platform. But [now] we started to migrate to full banking."

Digital banks have strengthened in Brazil during the COVID-19 pandemic, as their client bases expanded significantly. Nu Pagamentos SA, which recently announced an investment from Warren Buffett's Berkshire Hathaway, reported as many as 40 million clients. New players from outside of the financial space are also making inroads: Large retailers such as Magazine Luiza and Via Varejo are building up their own versions of digital finance units.

"It is the right thing to do," Luis Santacreu, a bank analyst with Austin Rating, said in regard to Itaú's efforts to launch Iti as a stand-alone unit. "If [Brazilian investment firm] XP Inc. or [investment bank] Banco BTG Pactual SA have their own digital banks, why can't Itaú do the same?"

Itaú's move toward a more robust, and potentially stand-alone, version of its digital offshoot surprised analysts, some of whom reacted with a degree of skepticism about the banking giant's new digital vision.

"It sounds a bit like what Bradesco has been doing," Geoffrey Elliott, a bank analyst with Autonomous Research, said.

Itaú's biggest private rival, Banco Bradesco SA, recently carried out its own spinoff of the digital banking unit Next, which was created in 2017 as a separate business unit. In 2020, Bradesco announced it was looking to spin it off, with an IPO in U.S. or Brazilian markets as viable options.

Before Filho's arrival, Itaú had been pursuing what former CEO Candido Bracher called an "inside-out" transformation, in which the bank would evolve from within and add technology to the existing processes and product offerings, rather than launching new products separately.

But analysts believe that approach has fallen short of what its main competitor in the banking space has been doing and that Itaú would thus risk falling behind the curve.

"Itaú was not launching as many products as Bradesco," said Thiago Batista, a UBS-BB director. "Whereas Bradesco put out Next, [digital wallet] Blitz, and [investment platform] Agora, Itaú only launched Iti. They seem to be changing their strategy now, and Iti is becoming more similar to Next."

For years, Itaú had upheld its approach on digitization for the wider corporation rather than on a single business unit. The dissimilar strategy between both lenders had been a matter of discussion among experts as to the best way to tackle the growing threat of competition.

In recent years, traditional lenders have been under tremendous pressure to revamp their business to keep up with competition from tech-intensive players of the new millennium.

"Incumbents are in a really tough place," Elliott said. "Banking revenues are coming under pressure from fintechs, and it is going to be really hard for them to catch up … from a tech perspective."

In the earnings call, Filho argued that big banks' decision to grow digital banking units was also an opportunity to attract new customers. For big, commercial banks, low-cost digital banking can help reach young people and the underbanked segment in Brazil. Central data shows the pandemic has been an important driver for financial inclusion.

According to the regulator, the number of individuals with active engagement in the financial system rose to 181 million in May 2021, up from 164.7 million in December 2019.

"No one knows how fast digital will grow in Brazil," Santacreu added. "But Itaú must have at least one product available in the market in order to protect its market share."

The race for market share

But even as Itaú updates its digital strategy and aligns it with that of Bradesco, analysts are still not convinced that launching their own digital banking units will guarantee success in growing their market share.

"There have been lots of examples in emerging markets of banks setting up a stand-alone digital bank. It does not tend to work particularly well," Elliott said. "Quite often you tend to see they do it for a couple for years and then it gets folded back into the traditional bank."

But so far, the growth of both Iti and Next during the pandemic has been impressive. Next reported a 91.3% surge in its client base in the last year, to 4.4 million users. Iti now shows similar accelerated growth figures, having reached 6 million users in April and monthly growth of 1 million clients. In both banks' cases, almost 80% of the digital bank clients were not users of the traditional banking units before.

But purely digital players, such as Nubank, are growing even faster. Banco Inter SA, for instance, doubled its digital current account user base during the past year from 4.9 million in the first quarter of 2020 to above 10 million in its most recent report.

"The number of customers that the digital banks have got is really high, net promoting scores are really high. It is going to be really hard for [banks] to catch up." Elliott said.