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Remittances Boom: what does it mean for the work of development?
More than US$93billion in remittances poured through
formal channels into developing countries in 2003, and these cash
flows have nearly quadrupled over the last seven years. While
the explosion in migrant remittances has received a lot of attention,
less has been said about the specific implications these massive
transfers have upon the work of development, and vice-versa.
There is no doubt, however, about their relevance.
“We know that remittances really reduce poverty in developing
countries,” says Richard Adams (DECRG). Adams, along with
colleague John Page (AFRCE), analyzed data from 74 low and middle-income
countries last year and found that international remittances,
defined by their share of country GDP, have a strong statistical
impact on poverty reduction. Adams’s analysis of household
survey data from Guatemala, Pakistan and Egypt shows that domestic
and international remittances also reduce the level and depth
of poverty, and that migrant households tend to spend remittance
income on housing and education— investments with a high
welfare payoff.
So, the 93 billion dollar question is: how do
we enhance remittance flows and maximize their development impact?
There is one obvious answer: by reducing costs, which are typically
between 10-20% of the amount remitted. How to achieve cost reduction
is a more difficult question, and a basic understanding of cross-border
money transfer systems is needed even to approach it.
How do remittance systems work?
Simply put, there is an agent in the sender’s
country, or province, known as an “originator”, who
takes in the remittance and communicates the amount and the recipient’s
name to a partner, or “distributor”, in the recipient’s
country or province. The sender alerts the recipient, who collects
her money from the local distributor, or from his sub-agent. The
originator and distributor must then have a way to settle the
debt.
Informal remittance agents commonly use trade
networks to reconcile their accounts. To send money to a customer’s
relative in Kinshasa, for example, a shopkeeper in New York City
may rely directly on a contact there or on a network of traders,
and their contacts. Either way, the shopkeeper communicates the
amount transferred and the intended recipient to his counterpart
in Kinshasa. The resulting debt is usually settled through shipments
of goods, from one agent directly to another or through a circuitous
network of traders. Sam Maimbo (SAFSP), who has studied informal
remittance channels in Afghanistan, Pakistan and several African
countries, points out that these systems have been a relatively
safe, low-cost, fast and accessible means of sending money overseas
for centuries.
They are also used, in some cases, to launder
money and finance illicit activities, and some efforts to protect
the integrity of remittance flows have sought to suppress informal
remittance channels altogether. But informal agents have long
responded to the legitimate needs of people who may not speak
the language of formal service providers, or even know how to
read the forms they’re required to fill out. Informal networks
generally have better geographic reach into recipient towns and
villages, as well. Maimbo and others are working on practical
and realistic guidelines to better monitor these systems, but
most would agree with him that “the best way to deal with
the informal sector is to improve formal channels— to make
them more attractive.”
Formal remittance systems generally rely on a
series of bank account debits and credits. The remitting migrant
makes a payment to an originator. Usually, the originator deposits
the payment into a bank, crediting the account of a distributing
agent in the recipient country. This bank must either have a branch
in that country, so the local distributor can claim the funds,
or a relationship with a bank that does. At the same time, the
local bank may have reason to credit an account that belongs to
it’s foreign partner, for instance if a local vendor of
imported goods wants to “send” a payment to his foreign
supplier.
In some cases, the origination and distribution
functions are provided by the same firm, like Western Union, or
a bank that has branches in both the sender and recipient countries.
These companies may also contract grocery stores or other banks,
for instance, to act as originators or distributors in exchange
for a small portion of the commission. But each of these business
models rely on banks to settle the accounts between originators
and distributors, even when they are part of the same company.
(Western Union has its own banking subsidiary, but sometimes relies
on other financial institutions as intermediaries, depending on
the country.)
Where separate financial institutions are used
to make the transfer between originator and distributor, the local
bank and its foreign partner must net out, or “clear”
their accounts at the end of some period. They will then settle
the balance due through a wire transfer, or by transferring ownership
of a short-term treasury bill, for instance. Correspondent banking
partners simply maintain the balance as an asset or liability
on their respective balance sheets. In each case, reducing the
costs of clearing and settling accounts between banks is one of
the keys to reducing the costs of remittance payments— lowering
payment distribution costs is another.
Cooperate on infrastructure, compete on services
When more banks share the use of a clearing house—
where the debits and credits of all the member institutions are
tallied up and netted out over a certain period— the costs
of clearance are lower. While some countries have separate clearing
houses for credit cards and for payment instruments, the important
thing is that banks use the same infrastructure for the same types
of transactions, according to Massimo Cirasino of FSE. Similarly,
the expense of settling final balances decreases as the number
of payments included in the settlement increases. The cost of
handling a single remittance payment, therefore, is partly a function
of the number of banks participating in the clearing house, and
of the number of payments each institution settles at once.
To more efficiently clear and settle payments
across borders, Cirasino recommends that banks join one of the
existing international clearing houses. Companies like Visa and
MasterCard provide these services for thousands of institutions
worldwide, thus offering tremendous network benefits to member
participants and scale economies that lower processing costs.
There are other options but again, domestic banks (and their customers)
would benefit from cooperating when it comes to choosing a clearing
house and negotiating fees as a group.
Beyond clearance and settlement, cooperation among
financial institutions is key to the efficient distribution of
payments from points A to B. By sharing communications networks
and entry points into the payments system— including ATMs
and Point of Sale (POS) devices— banks and other institutions
can significantly lower the costs of moving cash from one location
to another. Achieving interoperability among ATM and POS devices
and cards would make their placement in less densely populated
areas more economical. This is why “financial service providers
must compete on services,” says Cirasino, “but cooperate
on infrastructure.” Ideally, remittance senders should be
able to deposit funds into an account or remotely load value to
pre-paid cards, so that recipients can use ATM or POS systems
to efficiently access those funds.
The role of the regulator
Getting banks to share clearing houses and proprietary
payment systems, among themselves and with other intermediaries,
like financial cooperatives, is tricky. There are ways that central
banks can encourage cooperation, however. Regulation (and the
threat of sanctions) are important, but concerted effort and moral
suasion, according to Cirasino, are usually effective.
Beyond these infrastructure issues, regulators
are essential to the development of more competitive and trustworthy
systems. Dilip Ratha (DECPG) and Jose de Luna-Martinez (FSE),
who are surveying central banks and money transfer agents, have
found that there are many different players in the remittances
business and, as Ratha explains: “Regulation varies widely
depending on the type of business and specific services they provide.”
Harmonizing the licensing or registration requirements,
the reporting rules, and the foreign exchange controls that are
applied to the various operators of money transfer services would
spur more competition. Requiring transfer agents to divulge fees
and commissions in a standardized way would also help.
These issues and others will be treated by a joint
World Bank - Bank for International Settlements Task Force, which
is in the process of developing general principals for remittance
systems policies and oversight, and includes central banks in
both predominantly sender and receiver countries. In addition
to providing for competition and efficiency, regulators on both
sides of the borders share responsibility for protecting the consumers
of remittance services and complying with international anti-money
laundering standards.
Development impact: the importance of good
numbers
The careful tracking of remittance channels and
flows that good oversight requires is also vital to development
in a number of ways. As Tracey Lane (ECSPE), the Country Economist
for Kosovo, puts it: “Remittances have a huge impact on
macroeconomic stability.” Lane recently commissioned a study
by the Development Prospects Group to review workers’ remittances.
Over the last four years, economic growth in Kosovo has been driven
by massive external financing in the form of both aid flows and
remittances. These are expected to continue to decline and could
potentially produce a negative multiplier effect on economic growth.
Forecasting the potential macroeconomic impact from changes in
remittances, and planning to mitigate those effects, requires
accurate estimates of the amounts involved.
Information about the volumes of remittances flowing
to and from different locations is also vital for the development
of strategies to attract competition— especially from financial
services providers. Raul Hernández-Coss (FSEFI), who has
recently completed an extensive study of the remittance corridors
that exist between the US and Mexico, and from Canada to Vietnam,
emphasizes this point.
For the US-Mexico corridor, Hernández-Coss finds that average
remittance costs are significantly lower for transfers sent from
Chicago to Michoacan, compared to those sent from Las Vegas to
Guanajuato, though the volumes are similar. Such differences suggest
that the US and the Mexican governments may want to focus on bringing
migrant workers who are living in Las Vegas into the US financial
system. In Chicago and other cities, the US Federal Deposit Insurance
Corporation and the Mexican consulate have sponsored Finance Festivals
in conjunction with local banks, inviting Spanish-speakers to
request official ID documents and open new accounts. And the costs
of sending money to Mexico from these cities is lower.
Involving financial services providers
On the distribution side, information about the
volumes of remittance flows has motivated Mexican banks to set
up mini-branches in some areas, where they offer a range of savings
and credit services to clients receiving remittances. Places that
receive less volume may be unattractive to commercial banks but
appeal to specialized micro finance institutions (MFIs). With
Bank support, the government of Mexico is building the capacity
of financial cooperatives to handle remittances and provide other
financial services, especially in rural areas.
In some other cases, MFIs or their umbrella institutions,
including the ICICI, in India; the Equity Building Society, in
Kenya; and the World Council of Credit Unions, have forged alliances
with national or international banks or transfer agents such as
MoneyGram and Western Union. These arrangements allow the MFIs
to distribute remittances as agents or sub-agents of other financial
institutions, and to cross sell their products to recipients.
Forging agreements between MFIs and international
money transfer agents is a promising way to extend the reach of
the remittances distribution network, and add to their value by
providing financial services to recipients. There are a number
of challenges and policy considerations involved in developing
MFIs to act as remittance distributors, however. CGAP is preparing
a note on strategic and operational issues related to the incorporation
of MFIs into money transfer networks that will explore some of
these specific issues. Remote areas that receive low volumes of
funds or have too few recipients to support even the most efficient
MFI will require more innovative solutions, perhaps including
some form of government-sponsored service provision, potentially
through post offices. This may be the case in many parts of Vietnam,
says Hernández-Coss.
Facilitating productive investment at the
last mile
The role of government is better understood when
it comes to ensuring safer, more competitive, and transparent
remittance flows, and in facilitating access to complimentary
financial services. Strategies for maximizing development impact
at the last mile are less clear. With better information, however,
there are some specific actions that governments can take to enhance
productive investment in recipient communities.
Targeting scarce public funds for transportation
and energy infrastructure to areas that receive high volumes of
remittance payments may be appropriate. Local economic development
initiatives and targeted improvements to the local investment
climate, like one-stop shops for business regulation at the municipal
level, for example, could also help boost the economic punch from
remittance flows. One reason why coming up with specific recommendations
is difficult, however, is because oftentimes the data just isn’t
there.
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