Growing up in El Salvador, Rhina Margarita Ibanez de Salvador was inspired by her entrepreneurial mother to start a business of her own. Her mother’s ventures grew over time from chicken egg sales to a stationery and book store for university students, despite the lack of access to formal capital.
Four years ago, Salvador immigrated to the United States and opened a “one-stop” shop for weddings and quinceanera needs, called “Celebracion de Todo.” At her store, Salvador uses the lessons learned from her mother’s micro-businesses on a larger scale. Like many successful emigrants she sends money back home to help grow her mother’s business.
A handful of companies, nonprofits and donor agencies are seeking to channel money transfers through microfinance institutions, which hold an estimated $35 billion or more in worldwide assets, to create “leveraged remittances” that develop small businesses, create savings and build credit histories for unbanked emigrants and their families back home.
An Inter-American Development Bank survey estimates that about 30 percent of remittances in Latin America are used for purposes other than the one-time payment of bills, medical emergencies, food or school fees. But the exact amount of remittances that are leveraged is still unknown.
A nascent market
Salvador is part of a pilot project spearheaded by Washington-based Microfinance International Corp., which provides the necessary information and repayment services to microfinance institutions. These institutions then turn remittances from abroad into loans for local businesses.
Salvador’s mother, for instance, is seeking to convert an old family home into the first hotel in Moraza, a small town near ancient Mayan ruins. After hearing about the pilot project, Salvador’s mother approached MFIC sub-contractor TechnoServe to start the loan application screening process. Successful candidates borrow from Apoyo Intergral .
Back in the United States, MFIC’s subsidiary Alante screened the younger Salvador’s history of money transfers to determine her credit worthiness. MFIC combined the credit reports of both the money sender and borrower and provided verification that Fundacion Salvaorena de Apoyo Intergral, a microfinance organization in El Salvador, issue a loan for the hotel business.
MFIC and Alante then take the responsibility of collecting repayments from Salvador and transferring them through a remittances settlement platform to the micro-lender.
For institutions like Apoyo Integral, the key to successfully turning emigrant remittances into loans for local businesses is finding the right partner - like MFIC - that can bridge the distance between money senders and borrowers in this complex process.
Due to the process’s complexity, only a handful of small and medium-sized enterprises with capital needs greater than a few thousand dollars have been chosen to take part in this pilot project, which is sponsored by the International Fund for Agricultural Development.
Linking microfinance and remittances
A more common way for microfinance institutions to tap into the remittances market is by serving as a money transfer agent, which creates opportunities to sell recipients other financial services such as saving accounts or loans when they come to pick up cash.
Microfinance institutions in Latin America greatly expanded their membership and created loyal customers by graduating them from money transfers to other products, according to a recent USAID study prepared by Manuel Orozco. This practice is often referred to as “cross-selling.”
Some microfinance institutions offer “transfer to account” services, which allow senders to deposit remittances directly into a receiver’s savings account. These savings accounts can be used to build a credit history for both the sender and the recipient while increasing the lendable assets of the microfinance institution.
Emigrants may also directly pay their families’ utility or insurance premiums through a microfinance institution. For senders, such direct payments allow for greater control of how funds are spent.
These simpler transactions offer the most scalable remittances services for microfinance institutions and the most useful services for clients. According to Gregory Watson, program specialist for the IADB’s Multilateral Investment Fund, micro-creditors are best position to reach emigrant families since “traditional financial institutions are not set up to handle this type of client [and] MFIs are close to members and are channels for financial education.”
Barriers to entry
Major donor agencies first took notice of the potential impact of remittances payments on development, especially in rural communities, in the early 2000s. But only a handful of banks and microfinance institutions have successfully turned money transfers into wealth-generating assets for the working poor and middle-income families.
Barriers to linking remittances to financial services include a “lack of trust in banking, financial illiteracy, access to money transfer services, and transfer costs” by emigrants and their families back home, said Watson. Another factor, according to Romi Bhatia, MFIC vice president for international operations, is the fact that many households will consider using remittances as an investment only “after all other immediate expenses (like food or school fees) have been taken care of.”
Barriers to microfinance institutions offering remittance-backed financing include government regulation, the lack of Internet connectivity in rural areas, and a scarcity of branch locations. Also, microfinance institutions in Latin America and elsewhere had to increase security and thus incur higher costs due to the increased cash on hand that comes with offering money transfer services.
For a microfinance institution to offer a direct payment service, “it must be linked to the national payments system, which many traditional banks hold a monopoly over and do not want to open up to other intermediaries,” said Jennifer Isern, a lead microfinance specialist at the Consultative Group to Assist the Poor. CGAP has published a report titled Making Money Transfers Work to help guide microfinance institutions develop remittances products.
Microfinance institutions that have forayed into this market tend to have large branch networks that are connected to a management information system and are located in a country that has positive regulatory environments for microfinance and remittances, such as Mexico, El Salvador and the Philippines. Almost all of the MFIs that achieved success in cross-selling are also deposit-holding institutions.
Testing the incumbents
For a microfinance institution, it is key to find the right money transfer partner and negotiate a fee structure. So, what are the major money transfer organizations such as Western Union and MoneyGram International doing to expand the money transfer market into leveraged remittances? Development and microfinance experts gave mixed reviews of how these MTOs support MFI efforts to turn remittances into leveraged financing.
“They just don’t see the opportunities [and] they do not make a natural partner for an MFI,” said one practitioner in the microfinance field, critiquing established MTO systems and their supposed resistance to sharing information about senders that could be used to gauge credit risks. “Their model just doesn’t fit their needs.”
In response to these critiques, Tom Jahnes of Western Union said that “not all information” collected by the company can be shared “due to privacy concerns and consumer protections.” Large MTOs like Western Union do have extensive networks of MFI payer agents because “we like MFIs in our network as they are familiar with cash management and close to the customer,” he continued.
Transaction costs are still a major barrier to scaling the development impact of remittances. Money transfer fees vary drastically depending on the sender’s location and because of the competitive and legal environment for money transfers. A Web site started by the U.K.’s Department for International Development called www.sendmoneyhome.org lists various fees for sending money abroad at different locations.
But money transfer costs in Latin America have decreased dramatically since 2000 - from 15 percent to 5.6 percent per transaction - due to more competition among MTOs, according to the IADB. If this trend continues and spreads globally, then leveraged remittances, like Salvador’s, may become common practice.
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