How Mexican Fintechs are Having a Social Impact While Disrupting the Remittance Market
How Mexican Fintechs are Having a Social Impact While Disrupting the Remittance Market
Remittances are a lifeline for many struggling families and communities in developing countries. They are directly used to provide food for families, access health services and quality education, as well as clean water and sanitation. The nature of remittances makes them an important and direct vehicle in achieving accelerated poverty reduction.
Financial Technology startups (FinTechs) have emerged with the promise to open the gates of the financial world to the overlooked parts of the population. And thus, lift them out of poverty.
Mexico, being the third-largest remittance corridor in the world, and home to the leading FinTechs in the region, is the perfect playground for disruption.
Part 1 - The mechanics behind the word “Remittance”
Let’s be honest, we all have a general idea of what a remittance is, but if we were asked to explain it, we would start to stutter.
There are different ways a remittance payment can work. Circumstances for choosing a payment path include bank account access, payment preferences, desire for quick transaction, or the cost of the transaction. No matter the method, transactions take a basic route to complete the payment cycle.
When executing a remittance, funds of the remittance amount must be present in the sender’s bank account. After the transaction has been issued, the funds will be transmitted to the recipient’s bank for processing. Once the money is in the bank, a foreign exchange rate and banking fee are applied. The funds are now available as local currency, minus the fees, for the recipient to access. Obviously, the latter applies when the chosen remittance route is a legal and electronic one.
Ok, cool, but how much does it cost to send a remittance payment and why is it such a big deal?
Here’s a quick summary:
Transfer fee: Most remittance providers charge a fixed fee for transferring funds overseas. This transfer fee can range anywhere from $1.99 to $30, or even more, depending on the transfer provider you choose, the amount you are sending, where it is going and the currencies involved. On more common currency routes, the fees are lower compared to less common routes.
Exchange rate margin: The exchange rate margin is the additional percentage a company adds on top of the mid-market exchange rate when facilitating a transfer between different currencies. Quite often, remittance providers claim that they charge no fee for their transfers. This does not mean they charge no fee at all, but simply means they’re charging you through an exchange rate margin. Exchange rate margins differ significantly from provider to provider and commonly fall somewhere between 1% and 5% on top of the mid-market rate. Usually, only banks will charge on the higher end of this, with specialized remittance services applying margins in the region of 1%-2%.
Additional fees: Apart from the two main costs described above, there can be other fees applied to remittance payments. For instance, you may have to pay some additional fees for making a payment using your credit card or for home delivery of cash. The fees can quickly add up if you don’t choose your provider carefully or lack available options.
Grosso-modo, remittance costs result from a fee and the FX differential. The former is easier to track. Broadly speaking, fees have significantly dropped from an average US$30 in the 1990s to US$10 today. That means about 6% of a transaction, which is still above the 3% sustainability goal set by the UN for 2030 but heading in the right direction.
As the third largest route, and knowing that on more common currency routes, the fees are lower compared to less common routes, the average transaction cost of sending USD 200 in remittances to Mexico is 4.61% charged by each remittance service provider (RSP).
Part 2 - The Growth Loop Between Remittance and FinTechs
The Group of Twenty (G20) recognizes that remittance flows are an important driver for economic growth and prosperity in developing countries. When leveraged properly and when confined to regulated and monitored channels, remittance flows can better help to lift people out of poverty, improve economic infrastructure, and encourage more engagement in the regulated financial sector. Among other positive spill-over effects, remittances can be an accelerator for financial inclusion and participation in the digital economy.
Let’s repeat: improve economic infrastructure, help to lift people out of poverty, financial inclusion and participation in the digital economy. Does that ring a bell? You have probably come across this exact same line on every FinTech website you’ve visited. And most of them, if not all, are offering some sort of remittance services in addition to their core product.
More remittance brings more people to the digital economy; more people in the digital economy bring more users to FinTechs; and more FinTech users bring more remittance; resulting in what the Startup world calls a Growth Loop.
The US-Mexico remittances corridor is the third-largest by volume in the world, after China and India. According to World Bank data, Mexico's immigrant remittance inflows represented a 4.0% share of the GDP in 2020. More impressive is when you take into consideration each country's population: China and India stand well over 1 billion people, where Mexico has a “mere” 130 million.
Ever wondered why the FinTech sector gets the lion’s share of VC funding? Here's a good place to start.
Part 3 - Who’s behind the money flow
Let’s begin with the government infrastructure. In 2001, in response to the "Partnership for Prosperity" between Mexico and the United States, Banco de México and the Federal Reserve Banks of the United States agreed to study the possibility of interconnecting their payment systems. In October 2003, the Federal Reserve Banks of the United States and Banco de México connected their payment systems to send payments to United States’ Government pensioners residing in Mexico. Subsequently, since February 2004, users of financial institutions in the United States subscribed to Directo a México have been able to send payments to any bank account in Mexico. And since July 2005, this payment service has been registered under the name Directo a México as a payment rail that speeds things-up and bypasses SWIFT.
However other actors are at play; Financial Technology Startups.
The sector’s glowing prospects have motivated companies including Global66, Revolut, Ualá, and Wise to venture into cross-border transfers to Mexico. They bring with them different business models, with some relying on alliances with other companies, to face the challenge of digitizing end-to-end transfers.
Argentine FinTech Ualá, for example, made an agreement with the remittance company MoneyGram that allows customers in Mexico and the U.S. to make physical cash deposits and then access the money on Ualá’s online platform. The Startup went as far as buying a Mexican bank, ABC Capital, in November 2021 to expand its financial offering and cut out some intermediaries.
The British neobank Revolut chose Mexico as its first destination in Latin America in 2021. Its debut product will be focused on remittance. This year, Revolut introduced the option for U.S. clients to send money to Mexico without commission and in just 30 minutes. The service allows it to start competing in an important remittance route while it sorts through regulatory requirements for operating from Mexico.
Others like Globall66 from Chile are focusing on underdeveloped intra-regional money corridors (Chile, Colombia, Peru, Argentina, Brazil, Mexico, Ecuador, and Spain) and are now moving from the pure remittance player model to a more diverse base of financial services with the launch of a prepaid card, which allows users to withdraw money in and outside the country from associated ATMs; make payments for domestic services, favorite apps, subscriptions or easily make e-commerce purchases.
Part 4 - Why Remittance is so crucial for Mexicans but a risk at the same time
Remittance answers a common need to financially support a family in one’s home country. In this global economy, Mexicans will move abroad for better work opportunities in order to provide for their family. And thus, money is transferred to loved ones through remittance payments. Don’t forget, we’re talking about a 4.0% share of GDP in 2020 here.
Nevertheless, the world is changing and most of the migration is led by agricultural – and construction – employment in California and Texas. So, the current drought and possible collapse of the real estate market might have a bigger impact than the overall drop in employment. That is because the aforementioned combination with an overall recession could well see a return to mass deportations and hence, a drop in remittances in the medium term.
On the FinTech front, they will continue to face a cash-led economy until there is a higher percentage of the population holding a bank account or at least greater use of prepaid cards that allow interoperability, i.e., routing to Mexico through its real time payment system SPEI, until the Mexican QR payment system – called CoDi and launched in 2019 – takes-off, or until there is a joint effort by the federal government, banks and other private intermediaries, that takes both increasing financial inclusion and reducing barriers to financial exclusion seriously.
Furthermore, as the era of ‘cheap money’ gives way to high inflation, it is becoming evident that many fintechs burned through investor money like mad, in large part by keeping transaction prices – i.e., fees and FX – artificially low. To become profitable, companies like Wise or Xoom are increasing their commission rates to approximately US$30 per transaction, roughly equivalent to that charged by banks, leaving ‘only’ convenience and speed as the differentiating features of their digital offering.
As the world continues to evolve, the next few years will be critical for remittance-dependent economies with real implications on people's lives and give another opportunity for FinTech companies to align their words with their actions.
Proof reading and editing by TransPerfect