Remittances represent 18% to 26% of GDP[1] in the northern triangle countries (Guatemala, Honduras, and El Salvador). If we focus on the case of El Salvador, close to one in three[2] people report having received international remittances in the last 12 months. It is also a rising trend in the Central America region.[3]

The economic situation of most people in this region is not easy, so remittances play an important role. We have to understand, therefore, that they are not simply another form of money movement; that money comes to a family in which, according to data collected in El Salvador’s National Financial Inclusion Survey, they are used for:

In other words, they are mostly spent on current expenses or emergencies. In 2022, the average remittance was around USD 315 according to the Central Reserve Bank of El Salvador.

These are usually people living from hand to mouth, and understanding this situation of almost compulsory short-termism is key to coming up with and implementing strategies to help alter the current dynamics.

Financing Does Not Exist

According to recent announcements, the northern triangle will receive investments of USD 950 million in 2023 to curb migration to the US.[4] Yet how can we help people who are historically mired in the informal economy if they are practically invisible to the financial system? How can we better get to know them?

Close to 90%[5] of El Salvador’s economy is led by micro, small, and medium businesses, and the vast majority move in the informal economy: a mixture of informality, a lack of financial education, the digital divide, necessity, and distrust continue to make cash king. All these data help us to understand the enormous relevance of microfinance in Central America, and specifically in El Salvador. This is because these “invisibles” do however gain access to financial products, just in unfavorable conditions. A clear example are the infamous loan sharks, who give out loans with rates that can reach as much as 100% interest in USD, and who may also even use physical violence to collect from defaulting borrowers.

Why, then, are there not more microfinance initiatives? Although there are around 600 microfinance institutions in Central America that have loaned roughly USD 12 billion to more than 10 million low-income customers[6], the challenge is scalability

Open finance: One Solution to the Lack of Scalability in Microfinance

The big challenge to making microfinance impactful is that it is difficult to scale. For example, microloans often have a very low default rate (several studies concur on a range of 2% to 3%) when time and resources are put into assessing and administrating the loan. Technifying this sector is likely the key. One possibility would be to use remittances as a starting point to begin tracking this reality: products could be offered to help people get out of poverty, and both open banking and open finance can play a fundamental role.

Like it or not, financial inclusion must be cost-effective for it to become a vehicle for real social inclusion. As it stands, sending remittances from the United States to El Salvador can cost the sender up to 15%, which means these people are currently paying for the service. What would happen if business models were redesigned so that their profitability came from movements that contribute to a constant improvement in these people’s financial lives?

Cash is difficult to use because of the physical distance between the sender and the family member receiving the remittance. Other ways could therefore be invented in order to digitalize that cash in (as seen from the side of the family receiving the money) and also turn it into a starting point for tracking the behavior of the remittance recipient:

It all comes down to the fact that no serious impact can be hoped for without data. And microfinance is dominant in these economies. We should remember that people, particularly micro-entrepreneurs, end up resorting to all kinds of financial products, but in the informal economy. If we consider the evidence that those living in these conditions are 2 to 5 times more likely to find themselves in poverty,[7] it follows that microfinance in this context will have to become scalable as a matter of course.

What Impact Might It Have?

Clearly, to incorporate open finance into microfinance will require cooperation between the public, private, and voluntary sectors. The consequences of incorporating open finance could include:

1. Increased efficiency and lower costs for sending remittances.
2. New regulations, such as those on data governance and tax incentives to encourage initiatives aimed at financial inclusion.
3. Better access to, and use of, financial products in formal institutions (traditional banks and/or fintechs)—at present, just 28% of adults in the country have a savings account.[8]
4. Hybrid models where basic transactions (such as means of electronic payment for these enterprising families) are subsidized by other types of products, for example, equipment loans with drawdowns in specific products/services.
5. Finance embedded into the value chains of micro-traders.

To name just a few.

This framework could be applicable to several economies with low banking rates and high informality levels if public-private sector cooperation is secured. In El Salvador, we know that the public sector is lobbying for regulatory changes and incentives to generate these changes to facilitate the inclusion of the informal sector. This means that, from an innovative perspective, we are moving closer every day to a scenario of development among micro, small, and medium businesses in El Salvador.

We are all aware that development means growing the pie, and that this is eventually going to happen. Those taking the initiatives with this in mind will be the ones leading the change (and they are also likely to be the ones most benefited in every respect).

---

Sources

[1] BNAmericas

[2] Encuesta Nacional de Acceso y Uso de Productos y Servicios Financieros (Banco Central de Reserva de El Salvador)

[3] BID

[4] US Department of State

[5] PCMI Analysis

[6] BID

[7] OIT

[8] Encuesta Nacional de Acceso y Uso de Productos y Servicios Financieros (Banco Central de Reserva de El Salvador)

Keep up to date with our Payments and Crypto insights