Remittances: Funds for the Folks Back Home

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Bibliographic details

• Authors: Dilip Ratha
• Published: February 5, 2019

Overview and definitions

• Workers’ or migrant remittances: transfers of cash or goods sent by migrants to support family members in their home country.
• Officially recorded international migrant remittances were projected to exceed $483 billion in 2011, with $351 billion flowing to developing countries.
• Unrecorded flows through informal channels are believed to be at least 50 percent larger than recorded flows.

Economic importance and distribution

• Remittances have become the largest source of foreign income for many developing countries.
• They are more evenly distributed among developing countries than capital flows, including foreign direct investment.
• Remittance flows to low-income countries are nearly 6 percent of their gross domestic product (GDP), compared with about 2 percent of GDP for middle-income countries.
• In Haiti they represented about 12 percent of GDP in 2011.
• In some areas of Somalia, remittances accounted for more than 70 percent of GDP in 2006.

Transaction process and settlement

• Typical remittance transaction steps:
  • Step 1: The migrant sender pays the remittance to the sending agent using cash, check, money order, credit card, debit card, or a debit instruction sent by e-mail, phone, or through the Internet.
  • Step 2: The sending agency instructs its agent in the recipient's country to deliver the remittance.
  • Step 3: The paying agent makes the payment to the beneficiary.
• For settlement between agents, in most cases there is no real-time fund transfer; balances are settled periodically through a commercial bank.
• Informal remittances are sometimes settled through goods trade.

Uses and poverty impacts

• Remittances are targeted to meet specific household needs and thus tend to reduce poverty.
• Cross-country analyses find remittances have reduced the share of poor people in the population.
• World Bank household-survey findings cited:
  • International remittance receipts helped lower poverty by nearly 11 percentage points in Uganda.
  • By 6 percentage points in Bangladesh.
  • By 5 percentage points in Ghana.
  • Between a fifth and half of the 11 percent reduction in poverty in Nepal between 1995 and 2004 has been attributed to remittances.
• Typical uses:
  • Poorer households: basic consumption goods, housing, children's education and health care.
  • Richer households: capital for small businesses and entrepreneurial activities.
  • National-level: help pay for imports and external debt service; banks have raised overseas financing using future remittances as collateral.

Stability and cyclical behavior

• Remittance flows tend to be more stable than capital flows and countercyclical—increasing during downturns or after natural disasters in migrants’ home countries.
• During the global financial crisis that began in 2008, remittances proved resilient in source countries such as the United States and western European countries.
• Mechanisms of resilience noted: migrants absorbing income loss by cutting consumption and rental expenditures; sectoral job shifts; discouraged return migration maintaining migrant population levels.

Costs and potential downsides

• Potential economic costs:
  • Emigration of highly skilled workers or labor shortages in origin countries.
  • Large remittances can lead to appreciation of the real exchange rate, reducing international competitiveness.
  • Possible dependency effects that could undercut work incentives; negative correlations with growth may reflect remittances’ countercyclical nature.
• Human costs: migrants often endure family separation, sacrifices, and risks to work abroad.

Transaction costs and price structure

• For smaller remittances (under $200, typical for poor migrants), remittance fees typically average 10 percent, and can be as high as 15–20 percent of the principal in smaller migration corridors.
• For large remittances, transaction costs are relatively small as a percentage of principal.
• Factors contributing to costs:
  • Sending-agent fee (typically paid by sender).
  • Currency-conversion fee for delivery of local currency.
  • Beneficiary collection fees in some small operators.
  • Interest or “float” earned by remittance agents by investing funds before delivery.

Transfer costs (reported figures; third quarter of 2011)

• Notes: Figures include currency-conversions charge, except for Russia-Ukraine. — denotes data not available. Source: World Bank Remittance Prices Worldwide database; and World Bank Global Economic Prospects 2006: Economic Implications of Remittances and Migration.
• Approximate cost of remitting $200 (as a percent of principal):
  • Australia–Papua New Guinea: MTOs 15.3, Banks 18.1, Hawala —
  • Germany–Serbia: MTOs 20.9
  • Japan–Brazil: MTOs 10.1
  • Malaysia–Indonesia: MTOs 1.9, Banks 7.1
  • New Zealand–Tonga: MTOs 9.4, Banks 18.2
  • Russia–Ukraine: MTOs 2, Banks 1–2
  • South Africa–Mozambique: MTOs 11.8, Banks 22.4
  • South Africa–Zimbabwe: MTOs 15.8, Banks 19.2
  • Saudi Arabia–Pakistan: MTOs 3.3, Banks 3
  • United Arab Emirates–India: MTOs 2.5, Banks 13.1
  • United Kingdom–India: MTOs 2.4, Banks 5
  • United Kingdom–Philippines: MTOs 6.2, Banks 4.9
  • United States–Colombia: MTOs 17.5
  • United States–Mexico: MTOs 6.7, Banks 3.6
  • United States–Philippines: MTOs 6.5, Banks 10
• Hawala: an informal remittance transfer system that operates outside traditional financial channels—largely in the Middle East and other parts of Africa and Asia.

Policy recommendations to reduce transaction costs and boost inclusion

• Make remittance fees a low fixed amount rather than a percentage of principal, since transaction costs (labor, technology, networks, rent) are significantly below current fee levels.
• Increase competition by:
  • Harmonizing and lowering bond and capital requirements.
  • Avoiding overregulation (for example, not requiring full banking licenses for money transfer operators).
• Maintain anti–money laundering and terrorism-financing safeguards, but avoid measures that make it difficult for legitimate money service businesses to maintain correspondent-bank accounts.
• Use a risk-based regulatory approach in which only suspicious transactions are checked and small transactions below, say, $1,000 are exempt from requiring proof of identity and address.
• Facilitate nonexclusive partnerships between remittance-service providers and existing postal and other retail networks to expand services without large fixed investments.
• Increase migrants’ access to banking, because banks tend to provide cheaper remittance services than money transfer operators, by:
  • Allowing origin-country banks to operate overseas.
  • Providing identification cards (such as the Mexican matricula consular) that banks accept to open accounts.
  • Facilitating participation of microfinance institutions and credit unions in the remittance market.
• Caution on incentive programs:
  • Tax incentives may attract remittances but could also encourage tax evasion.
  • Matching-fund programs may divert funds from other local priorities.
  • Efforts to channel remittances to investment have met with little success.
  • Remittances are private household funds and policies should focus on broader improvements in the investment climate, savings incentives, and financial inclusion rather than targeting remittances directly.

Remittances: Funds for the Folks Back Home — F&D Magazine, Dilip Ratha.