Migrant-Backed Loans: Remittances in Guatemala

Yesterday’s After Hours Seminar focusing on migrant-backed loans featured two speakers from William Davidson Institute (WDI), Khalid Al-Naif and Raul Reynoso and WOCCU’s Saul Wolf.

Background

In 2010 WDI initiated migrant-backed loans (MBL)^[1] with assistance from the Microfinance International Corporation (MFIC) in the United States and ACREDICOM in Guatemala. MFIC marketed the product to migrants in the United States while ACREDICOM helped process loans in Guatemala. According to this report, some of the benefits of MBLs are the following:

• Migrants provide 50 percent of the funding with the remaining 50 percent coming from formal banks. The overall effect doubles the recipients eligible loan size.
• The ability to obtain a loan from a formal bank enables recipients to establish credit history.
• In Guatemala recipients stated that they were more comfortable with getting a MBL than with going to the bank to get a loan; senders stated that MBL gave them more assurance that they will receive some of their money back and that their remittances would be put to good use.

Promoting Financial Inclusion

According to the report "Two Trillion and Counting" prepared by Peer Stein in 2010, the total need for credit by all formal and informal micro, small and medium enterprises (MSMEs) in emerging markets today is in the range of $2.1 trillion to $2.5 trillion. Among the estimated 365 to 445 million formal and informal MSMEs in developing countries, only 25-30 million are formal SMEs. Formal SMEs usually have 5-250 employees and some history of working with the formal banking sector.

The vast majority of MSMEs in the developing world consists of micro or informal enterprises. The credit gap for micro and informal enterprises around the world is about $1.4 to $1.7 trillion. Even though Latin America has the highest percentage of MSMEs with access to finance (about 60 percent) according to Peer's findings, the credit gap in that region is still very wide.

Access to Credit

It is very challenging for MSMEs to obtain credit because of the following reasons:

• MSMEs often have no collateral and no credit history, making lending risky and unattractive for banks.
• The remote location of some MSMEs makes transaction costs very high.
• MSMEs have lower revenue potential, making these investments less attractive for banks.

Nevertheless, providing MSMEs with access to finance (referred to as financial inclusion) is essential to fostering sustainable economic development. When meeting in Seoul in the end of 2010, the G20 established the Global Partnership for Financial Inclusion (GPFI) in order to emphasize importance of this issue.

Experts working with GPFI identified the following steps that need to be taken to address this issue:

1. Engage governments in establishing enabling environments that will encourage banks to lend to MSMEs by making necessary changes in the regulatory environment or by providing credit guarantee schemes to make it less risky for banks to lend to MSMEs.
2. Reduce barriers to property registry or reduce enforcement costs for lenders.
3. Address the problem of high transaction costs when banks deal with MSMEs located in remote areas through improved infrastructure.
4. Provide entrepreneurs in the developing countries with access to loans through migrant-backed loans.

Final Thoughts

Since the WDI project was recently completed, it is hard to draw conclusions. I thought that it was interesting to note that MBLs in Guatemala were offered at 19 percent interest rate while microcredit loans had rates of 22 percent. It is possible that the lower rate of MBLs reflects the fact that formal banks found MBLs to be less risky. While I think MBLs are a useful product, I think it is important to offer it not just for credit but also to promote savings. In addition, I think it would be beneficial if WDI considered offering training on financial literacy to the recipients of such loans.

Footnotes

^[1] A migrant-backed loan (MBL) is an instrument that allows migrants to not just send their wages back home but to use remittances that they send to help their friends and family obtain a loan from a bank. MBLs require the establishment a separate account where remittances can be deposited. Migrants provide 50 percent of the loan, and the remaining half comes from the bank. If the beneficiaries do not pay back their loan, the bank takes the funds provided from the migrant out of the separate account and the migrants do not get anything back. Once the recipient pays their loan in full, the account is unfrozen and the migrant gets their money back.

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