Central America’s Fintech Revolution: Navigating through Economic Challenges to a Digital Future
Central America’s Fintech Revolution: Navigating through Economic Challenges to a Digital Future
Central America is experiencing a digital revolution despite economic and political challenges. Historically known for low technology adoption, the region promises great potential for Fintech companies. Several factors have contributed to economic strain in the region. These include low bank penetration, low credit and debit card usage, and high informality rates. These factors have created a space desperate for financial inclusion in which Fintech companies have been able to grow.
Overview of the Fintech Sector in Central America
The number of Fintech companies in Central America increased by 25% from 2022 to 2023. This region, which includes Belize, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and Panama, is experiencing a transformation in financial services as Fintech companies compete for dominance. For instance, Tigo Money offers a digital wallet that enables users to transfer money, pay bills, and top up their phones, all from their mobile devices. Neobanks such as Nequi in Panama have played a crucial role in bridging the gap between the banked and unbanked populations by providing access to basic financial services that would otherwise be unattainable through traditional sources. These examples demonstrate the success of companies in a market where demand is highest among those needing basic financial services.
This demand has led to significant growth in Fintech users, with a CAGR of 17% from 2018 to 2022. Fintechs thrived during the COVID-19 pandemic even as the region’s GDP and FDI shrank in 2020. Moreover, total transaction value, which measures the total user’s spending on Fintech applications, had a CAGR of 23.4% from 2018 to 2022. People are not only using more services from Fintech companies, but they are also spending more money on them. This is mostly in the form of digital payments and digital loans. But why are Fintechs so attractive in not just Central America but all of Latin America? [1] [2] [3] [4]
Increased adoption
A recent report by cybersecurity company Kaspersky revealed that people in Latin America and the Caribbean are adopting financial technologies primarily for their convenience, ease of navigation, and financial information administration. These factors are particularly relevant in the context of the Central American region. With almost 40% of the population living in rural areas, the 24/7 availability and convenience of mobile financial transactions allow for greater flexibility in managing payments. Moreover, according to the same report, the pandemic accelerated the need for this convenience; 50% of users in Guatemala and 46% in Panama started using digital banking services during the COVID-19 pandemic. [5]
Fintech’s Effects on Inequality
A 2023 study by the IMF found that Fintech technologies have a positive effect on income distribution in Latin America. These technologies mostly target underbanked and unbanked consumers, who make up two-thirds of Fintech users in Central America. Based on data from 2010 to 2019 and using the Gini index as the primary dependent variable, the IMF discovered that Fintech development disproportionately benefits the lower income share of the population. Countries with higher Fintech development experienced a significant decline in the Gini coefficient score, indicating greater equality.
In the case of Central America, this may only be partially true. Costa Rica and Panama have the most developed Fintech ecosystems in the region. However, they rank as the fifth and third most unequal countries in Latin America, respectively. According to data from the World Bank, the Gini index in these two countries has remained relatively stable since 2012. This suggests that while fintech companies may have benefited the country’s population in other ways, this has not yet translated into a more equal society. [6]
Interest rates
Historically, countries in Latin America have had higher interest rates than those in more developed economies. This is due to three main factors. First, central banks in the region often maintain higher policy rates to mitigate currency depreciation pressures and attract foreign capital. This, in turn, leads to commercial banks offering higher interest rates. Secondly, the banking sector is highly concentrated in the region. In Nicaragua, for example, approximately 84% of the country’s bank assets are held by just three banks. Additionally, in countries with high inflation rates or where banks must consider political or economic stability, the added interest rate risk premiums can impact net interest margins.[7]
According to the IMF, an increase in the adoption of digital bank usage has a “statistically and economically significant positive effect on competition among banks”.[8] With neobanks like Nequi in Panama and Wink in Costa Rica gaining traction, have they managed to successfully compete against banks to lower interest rate spreads?
Since 2012, net interest margins in Latin America have steadily decreased, coinciding with the fintech boom in the region. However, the COVID-19 pandemic has caused inflation to rise. As a result, most of the region’s central banks have set their highest policy rates in recent years.
This trend of quantitative tightening has hindered the progress of fintech companies in the region during the pandemic and in the few years since. Furthermore, fintech companies in Central and Latin America may face limited competitiveness in the future due to the current interest rate environment.
A recent Bloomberg report stated that interest rates on loans in the region have surged to over 790%, resulting in a significant decrease in funding for startups. The 2023 Fintech in Latin America report also revealed that high interest rates were the main obstacle to Fintech funding that year, hindering growth and competition.[9] [10] [11] [12]
Outlook for 2024
2024 is expected to be a year of change. Interest rates are set to decrease in most Central American countries as inflation slows down. This may reignite the growing Fintech flame in the region by allowing credit lending to Fintech startups once again. To assess the potential growth of the Fintech sector in each country, there are four main factors to consider: usage, technological infrastructure, the need for financial services, and country risk. Below is an overview of the outlook for the seven Central American countries. [13] [14] [15]
Belize:
Belize, the smallest country in the region, also has the least developed Fintech ecosystem. In the next five years, Fintech users in Belize are expected to grow by 6.96%, which is lower than other countries in the region. The country’s challenging environment is highlighted by its small population, credit rating, and risk premium.
Costa Rica:
The country has one of the most developed economies and Fintech ecosystems in the region. Around 50% of the population already uses digital payment or lending platforms. Additionally, the country has a highly skilled workforce and the technological infrastructure to support it. Costa Rica has significant potential for the development of not only financial technology but also a wide range of technological innovations.
El Salvador:
In 2021, the country made headlines by announcing that Bitcoin would be considered legal tender, making it the first country to do so. El Salvador has undergone a massive transformation in recent years, with a significant reduction in crime rates and an attempt to become a leading technological hub. However, the country’s massive fiscal deficit and substantial debt owed to the IMF hinder further investment, increasing the country’s risk premiums and the likelihood of credit default. Financial instability may hinder the nation’s potential for growth and investment in the Fintech sector.
Guatemala:
Guatemala is home to 50 Fintechs, mostly focused on digital payments, with the goal of increasing financial inclusion. Shockingly, 40% of the population does not have a bank account, only 6% of adults own a credit card, and 2% of adults use online banking. These statistics, combined with Guatemala’s projected Fintech user growth rate of 8.82% CAGR from 2023 to 2028, highlight the urgent need for Fintechs and the potential for significant growth ahead.
Honduras:
Political instability has recently been rampant in Honduras, causing a lack of investor confidence in the country. This is affecting the amount of funding that Honduran Fintechs receive. Additionally, Honduras has the lowest internet and smartphone penetration in Central America, which complicates the reach of Fintechs. However, there is room for growth. Most Fintech companies in the region concentrate on digital payments or financial software. In recent years, there has been a significant increase in the number of Fintech users and transaction values.
Nicaragua:
Nicaragua has the lowest online banking penetration in the region, which has left its population behind in terms of financial technologies. Fintech companies are leaving Nicaragua due to a lack of banking technology and low profitability. However, according to Statista data, the country is expected to experience increased user and transaction value growth with an estimated CAGR of 8.08% and 11.87%, respectively. Nicaragua is also making strides to improve its technological infrastructure. In 2020, internet access was available to only about 45% of the population. By the end of 2023, this number had grown to 78%, indicating significant growth potential in the country.
Panama:
Panama is poised to become a regional Fintech hub due to its highly mature banking sector, high internet penetration, and the best credit scores in Central America. Additionally, the Superintendency of Banks, which oversees the Panamanian banking system, aims to modernize banking laws and develop a regulatory framework to support digital wallets, virtual asset providers, and other financial services. These efforts will bring more clarity and trust to Fintech investors.
Conclusion
Fintech offers hope for economic development in Central America. The growth of fintech in the region highlights resilience and a shift towards financial inclusivity and digitalization. However, there are still challenges to overcome. These include poor technological infrastructure, a lack of comprehensive regulations, and an unstable economic and political environment that reduces fintech funding and investor confidence. In 2024, Central America may implement looser monetary policies, which could lead to increased funding for Fintechs and greater competition in the banking sector. Furthermore, the COVID-19 pandemic showed the impact that Fintechs can have on facilitating people’s finances, and the expected increased growth is further evidence of the sector’s massive regional potential.
[1] Statista | Fintech Market Insights 2024
[2] World Bank | Data Bank | GDP
[3] Trading Economics | Indicators | Foreign Direct Investment
[4] Finnovista | Fintech in Latin America and the Caribbean: A Consolidated Ecosystem for Recovery
[5] Kaspersky | El estado de uso y seguridad de pagos digitales en América Latina 2023
[6] World Bank | Data Bank | GINI Index
[7] The Global Economy | Bank Concentration | Nicaragua
[8] IMF | The Rise and Impact of Fintech in Latin America 2023
[9] Bloomberg | Interest Rates on Loans Hit 790% in Latin America’s Big Fintech Shakeout
[10] Money Control | Sky High Interest rates
[11] Trading Economics | Indicators | Interest rates
[12] Intersect | Sustained Interest rates
[13] Fintech Nexus | As rates fall, LatAm fintechs gear up for credit expansion in 2024
