Can Latin America’s fintech revolution help defeat corruption?

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Reactions to the astonishing rise of fintechs in Latin America tend to focus on how they cut through the red tape of traditional banking and boost financial inclusion. Rather than travelling to a branch, standing in line with an armful of paper ready to be stamped, customers can get started with just a few clicks on their mobile from the comfort of their own home.

However, an often-overlooked secondary impact could be on Latin America’s historically high levels of corruption. According to Transparency International’s 2023 Corruption Perceptions Index, Latin America boasts three of the ten worst-ranked countries in the world: Venezuela; Nicaragua; and Haiti. A long history of institutional weakness, poorly paid public officials and thriving criminal networks has boosted the incentives for corruption, which ranges from low-level backhanders to vast networks of illegal financial flows involving politicians, officials and judges.

It would be naively optimistic to think fintechs could help with the latter - in fact the opposite may be true - but it could have a positive impact on lower-level corruption. Simply carrying less cash and carrying out more transactions online automatically reduces the scope for bribes (or propinas) to be demanded. For example, a corrupt local government official, who habitually asks for an extra dollar or two in cash to process a small business’ tax return, won’t be able to do so to online tax filings.

Whereas before, the business owner would need to travel to the office with cash and paper documentation now it can be filed remotely, removing a potentially illicit channel and increasing productivity. This extends to all kinds of transactions that were previously exploitable, as more people are able to access basic banking services. Over time it could even lead to a drop in Latin America’s large informal sector and boost tax compliance, as more economic activity is moved online and formalised.

Fintech boom

Fintech trends in Latin America are certainly pointing in the right direction, as the continent develops a thriving tech ecosystem.  The number of fintech startups in Latin America has grown by more than 340% in the last six years, rising to 3,069 in 26 countries in 2023, from 703 companies in 18 countries in 2017, according to the fourth Fintech in Latin America and the Caribbean report, carried out by Finnovista and the Inter-Americas Development Bank.

The number of fintech startups in Latin America has grown by more than 340% in the last six years

Investors have benefitted from a lack of competition in the banking sector, limited access to credit and improvements to the continent’s digital infrastructure. Brazil continues to be the country with the largest number of fintech ventures, with 24% of the total, followed by Mexico (20%), Colombia (13%), and Argentina and Chile with 10% each.

And, according to the IMF, about three-quarters of digital banks’ customers are previously unbanked and underbanked consumers, and small and medium enterprises (SMEs).

Acute risks at the other end of the scale

However, while the rise of digital banking and payments brings obvious benefits at one end of the scale, at the other it raises risks substantially. This is most clearly underscored by the rise of largely unregulated and invisible cryptocurrency exchanges, which, combined with Latin America’s seemingly unstoppable trade in illegal narcotics, provide a platform for huge illicit financial flows.

Where money launderers in the past had to find innovative ways to move paper dollars across borders, these can now be moved at the touch of a button. Worse, the use of technology has enabled money launderers to bypass foreign exchange channels entirely. A recent indictment unveiled in a California court in June offered an insight into a global money laundering system for Mexican cartels enabled by digital transactions.  

The money laundering groups, as reported by the Financial Times, are made up of networks of Chinese nationals living in the US and Mexico, as well as individuals in China. What are essentially underground informal banks, sell the cartels’ dollars to wealthy Chinese nationals, who are looking to circumvent capital controls and transfer their money out of the country.

Under this scheme, the currencies involved remain in their respective markets, the US, Mexico and China. Encrypted communications and digital wallets allow the funds to be offset against equivalent transactions in one of the other markets, eliminating the need for cross border foreign exchange.  

This is an extreme example but the ability to move funds rapidly and invisibly via crypto and other digital exchanges will filter down through the system, cutting out many of the inefficiencies involved in money laundering in the past, such as the traditional Black Market Peso Exchange Rate, which involved buying goods in the US, shipping them to Latin America for resale and then depositing the clean funds from the resales. 

Technological innovation brings undoubted benefits to Latin America. In particular, fintech is delivering financial services to millions of unbanked, lower-income Latin Americans, while cutting time-consuming bureaucracy. However, tech can’t defeat the region’s long-standing weaknesses on its own. Fragile institutions, the immense power and influence of criminal gangs and a lack of state enforcement capacity will always provide fertile ground for corruption. Until those challenges are tackled, Latin America won’t feel the full benefits of its booming tech sector.

Author: William Lee is a Director at business intelligence consultancy, SecureValue.