Microcredits: Why are Informal Loans or ‘Drop by Drop’ an Option in Latin America?

The phenomenon of 'drop by drop' (or 'daily pay' as it is known in various sectors of Latin America) is an economic and social problem that afflicts the region's population, especially those considered unbanked. This population requests money (often from illegal businesses) from criminal groups, risking their lives to obtain a few cents to support their home or boost their micro-enterprises.

This system is easy to understand: a loan is granted immediately without needing collateral but with an interest rate exceeding the usury limits (between 20 and 40% per month). In addition, if the beneficiary does not meet the established deadlines, collections are made violently.

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According to an investigation by the Connectas journalistic laboratory, in support of El País de Cali, this phenomenon was born in the 1990s in Colombia as a necessity to 'launder' drug money. Thus, in cities such as Bogotá, Medellín, Barranquilla, Cali, and the Coffee Region, the 'drop by drop' became powerful, especially among people who could not access bank microcredits in this country.

Between 2008 and 2017, the exodus of Colombians to nearby countries in the region also became a bridge to take this informal loan system to territories such as Ecuador, Peru, Chile, Argentina, Bolivia, Brazil, Mexico, Honduras, Guatemala (with support from the gangs of El Salvador), Panama and Uruguay. In short, it has spread throughout almost all of South America and a large part of Central American territory like a virus that seeks one thing: to launder money at the expense of the needs of others.

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One Problem as an Attempt to Solve Another

Now, what appears to be a problem for many people is also a solution (and, in many cases, the only one) for many citizens who see 'drop by drop' as an alternative to the few opportunities to obtain credit with the help of a bank.

According to the World Bank's Global Findex 2021, between 2011 and 2021, the number of adults with at least one bank account increased by 25%, from 51% in 2011 to 76% in 2021.

Likewise, according to official data from the Andean Development Corporation (CAF or the Development Bank of Latin America), “between 2014 and 2021, the proportion of adults who made digital payments doubled from 26% to 51% worldwide. For Latin America and the Caribbean, this figure went from 5% in 2014 to 20% in 2021, an increase of 15 percentage points”.

For the CAF, this phenomenon is primarily due to the increase in access to mobile money accounts, especially from the subsidy payments the region's governments made in response to the COVID-19 crisis. This measure allowed more women, low-income populations, and other groups traditionally excluded from the financial system to access these products.

However, the fact that more people have opened bank accounts, either in traditional banking or in 'fintech,' is not synonymous with the fact that the opportunity to obtain credit will also increase.

A recent report by the Economic Commission for Latin America and the Caribbean (ECLAC) states that "the increase in the importance of the financial sector and the greater financial depth that this implies does not ensure greater financial development or greater financial inclusiveness." In other words, having a savings account is different from having the opportunity to have more excellent financial and productive development.

In this sense, ECLAC assures that there is still low and unequal access to the financial system by people in informal employment conditions and by Small and Medium Enterprises (SMEs).

According to a World Bank report, the financial situation of small businesses in Latin America and the Caribbean is problematic since only a little more than 45% of these companies have access to credit offered by formal financial institutions. This financial constraint may affect your ability to grow, innovate, and compete in the marketplace.

Consequently, SMEs have seen their use of the financial system reduced to “mobilizing deposits and as a means of payment; while the use of it for credit products is significantly lower, which may restrict its capacity for expansion and future growth.”

"This context gives rise to vicious circles that keep smaller productive units in a constant state of vulnerability (and resorting to options such as 'drop by drop') and low growth, with the immense consequences that this entails regarding poverty and social inequality," added ECLAC.

The Poor Getting Poorer?

Now, this does not mean that there are no microcredit options for this population that requires an economic boost to improve their productivity and grow within society. However, the problem remains, first, because few banks offer these alternatives, and second, because those that offer them do so with a stratospheric interest rate.

For example, in the case of Colombia, by 2021, only 11 banks offered the microcredit option, of which at least 5 had an interest rate higher than 40%. According to María Clara Hoyos, president of Asomicrofinanzas, it is not that the banks want to see “the poorest poor.” It is just that they must protect themselves as well.

"When we analyze the characteristics of microentrepreneurs, we see that they have neither savings nor assets. The rate goes up as the risk is greater and many debts are not being paid. A longer term and more risk equal a higher rate," said the expert in conversation with La República.