Global Money Transfer Monthly

G8 Nations agenda to cut remittance transfer cost

Global remittances, as estimated by the World Bank, stood at $433 billion in 2008. A major share of this, about $328 billion, flowed to the developing world, with India, China and Mexico being the top recipients. Remittances from migrant workers are an important source of family income in developing economies, and represent a significant portion of the GDP for many recipient nations. For as many as 29 countries, remittances amount to more than 5% of GDP.

Remittances grew rapidly during 2007 and 2008, but have slowed down in many corridors since the last quarter of 2008, due to deepening of the global economic recession. Accordingly, the World Bank has forecasted that remittance flows to developing countries would decline 7.3% in 2009. However, the cost of sending remittances continues to remain high relative to the low incomes of migrant workers, the amount of money sent, and the income of remittance recipients.

Hence, any reduction in remittance transfer fees would result in more money remaining in the pockets of migrants and their families, and would have a significant effect on the income levels of remittance families. This added income could then provide remittance recipients more opportunity for consumption, savings, and investment in local economies.

For example, in Vietnam, remittances add up to nearly 8% of GDP. According toWorld Bank data, the average cost to send $500's home is about 25%. Fees are lower for senders in some countries (e.g. US to Vietnam), but higher in some others (France to Vietnam). The average cost of remittance implies that nearly 2% of the country's GDP is shelled out as fees paid for sending money home. If these fees can be halved, the country gains both in terms of a reduction of fees for the sender, and an increase in GDP of about 1%.

Michael Klein, World Bank Group Vice President for Financial and Private Sector Development, said, “Any reduction in remittance prices will enable more money to remain in the pockets of migrants and their families. If the sending cost could be reduced by 5 percentage points relative to the value sent, recipients in developing countries could receive $12 billion more each year. This is equivalent to t rans fer r ing the Wor ld Bank' s International Development Agency credits and grants, each year, straight to the people.”

Remittance prices

The World Bank Group has created a global database of remittance pr i ces to make pr i c ing more transparent, so as to put pressure on providers to improve services and reduce their charges. Peer Stein, IFC Manager for Financial Infrastructure and Institution Building, said, “Transparency in pricing is a big issue for migrants. Shedding light on prices also creates opportunities for new operators to enter the market and offer services at lower prices.”

Data shows that for a remitter, it is more costly to send money through banks than non-bank money transfer operators. Remittance fees vary from 4% to 35%, depending on the mode of transfer and the geography. Remittances sent from Saudi Arabia, Russia, Singapore, Italy, Spain, and the US tend to cost less, while the cost of sending money from South Africa, the Netherlands, Japan, Canada, and Germany are among the highest.

Factors determining remittance prices

Remittance prices have been expensive mainly due to the following reasons:

• Lack of transparency in the market: The single most important factor leading to high remittance prices is the lack of transparency in the global money transfer market. It is difficult for consumers to compare prices because there are several variables that make up remittance prices. Remittance prices are often made up of a fee charged for sending a certain amount, a margin taken on the exchange rate when remittances are paid and received in different currencies, and sometimes, a fee charged from the recipients of the funds. These fee component s may al so vary according to how the receiver is paid (i.e. in cash or by crediting an account), the speed of the transfer, and the ability of the sender to provide information about the recipient (i.e. bank account number). The lack of transparency in the market has had the impact of reducing competition, as consumers tend to continue to patronise traditional market players because they are not aware of and cannot compare the services, fees and speed of their existing remittance services against other products.
• Infrastructure issues: Remittance service providers find it difficult to create suitable infrastructure for supporting remittance services. In many remi t tance receiving countries, the domestic financial infrastructure is underdeveloped. Banking network or other potential networks of agents may not be very extensive, especially in rural areas, creating a serious physical access problem for many receivers. The lack of standardisation for particular types of payment instruments and lack of interoperability between systems or arrangements also affect the cost and speed of remittances services.
• The legal and regulatory framework: The remittance industry is likely to flourish when the general legal framework in which it operates is sound, predictable, non-discriminatory and proportionate. A core and crucial objective of the regulation of remittances is the prevention of money laundering and terror financing. In some countries, certain types of institutions such as non-bank deposit-takers may be prohibi ted f rom prov iding remittance or other payment services, and this may make such markets less competitive. The licence fees or registration fees for remittance service providers may also be very high, creating entry barrier for new players.
• Lack of competitive market conditions: Remittance service providers enter into agreements with agents or other service providers in receiving countries to gain exclusivity, thereby restricting choice.
• Risk: Remittance service providers face financial, legal, operational, fraud and reputational risks. A basic risk faced by remittance senders and receivers when making a fund transfer is that of losing the money in transit.

G8 approves proposal to halve remittance costs

The recently concluded L'Aquila Summit of the Group of Eight (G8) industrial nations has approved an Italian proposal to cut by half the commission paid by immigrant workers to send money home. The proposal was mooted as part of a package aimed at helping more vulnerable countries weather the global recession. The final statement said that wire transfer costs would be halved by improving transparency and competition among the intermediaries that transfer remittances.

Earlier, raising the issue of high money transfer costs borne by migrant workers, Italian Foreign Minister Franco Frattini commented that commissions of up to 10% are “an immoral and unjust profit” for banks and other operators. He said that additional annual remittances of about $13 billion could be sent home by workers in foreign countries and be used to help poor countries. He further added that due to the current global economic downturn, rich countries are cutting back on aid and seeking alternative ways to help the developing nations. In this regard, cutting transfer costs on remittances could be part of an “innovative financing” strategy to raise funds for these countries.

Regulatory issues to be addressed by the G8

To achieve the goal of halving remittance costs, the G8 needs to address some regulatory issues. The regulators in the G8 must encourage the banking industry to extend its reach and also encourage remitters to participate in the banking system. Some of the issues that need to be addressed are as follows:

• Easing of stringent regulatory barriers for users: In order to encourage the remitters use formal channels such as banks, the regulators and bankers in the G8 countries need to ease the stringent regulatory barriers currently in place. Although banks offer the most efficient electronic services, the stringent barriers prevent a large section of potential customers from opting for this route. Thi s in turn helps unregulated services, such as hawala, to thrive in the foreign remittance market. According to an estimate, hawala deals account for more than half of all remittance transactions globally.
• Easing the barriers for service providers: The entry barriers for the service providers are also needed to be eased considerably. In Europe, the Payments Services Directive, which is slated to come into effect in November 2009, would help reduce the entry barriers for non-bank service providers, imposing minimum service level standards for the providers. The situation in the US however is still not very conducive as there remain substantial financial barriers to entry of new players. In the US, the largest sender country in the world, a non- resident bank must obtain a licence separately from each State to be eligible for collecting funds. Thanks to the wide variations in the regulatory requirements across the States, a service provider planning to open offices in all the 50 States would require bonds and net worth of nearly $10 million. Such a large initial investment requirement is a major inhibitor to the growth of the formal channels in US remittance industry. The regulators also need to take steps to harmonise and reduce the regulatory and reporting overhead in order to bring in greater competition. The new International ACH Transaction (IAT) rules which come into force in September 2009 would improve the automation of the necessary regulatory scrutiny for low value cross border payments. This would help reduce the entry barriers for the electronic banking services and bring more transactions into the financial system.
• Encouraging development of 'value delivery networks' in recipient countries: In a bid to maximise financial inclusion, the regulators should al so encourage the development of 'value delivery networks' in the recipient countries. In most developing countries, banking infrastructures are far less developed than in the G8. Although mobile phones and smartcards are cost effective methods of providing services, these involve substantial initial cost of setting up. Also, a remittance service alone cannot justify the cost incurred by these alternative value delivery channels. In brief, the regulators need to encourage projects that would have extensive value delivery networks providing complementary services. The M- Pesa project in Kenya is a case in point. Such projects would also help in attracting local and overseas investments.
• Encouraging national payments policies in G8 to serve second generation nationals having ties with emerging nations: In G8 countries, a large section of the second generation nationals have strong commercial and social ties with the emerging nations. Also, there are many who have business, residential and leisure assets abroad, or who have emigrated or retired abroad. The regulators while framing national payments policies in G8 nations should consider the requirements and convenience of this section as well, rather than only focusing on domestic scheme sand instruments.
• Reducing remittance costs by developing local credit unions: Remittance costs can be reduce by promoting local credit unions who can handle such transactions. The World Council of Credit Unions (WOCCU) has a significant presence in Latin America where it works with local credit unions to provide money transfer services at a much lower cost.
• Increasing competition to reduce transaction costs: In order to inc rea se c ompet i t i on, the regulators may consider various measures such as abolition of the monopoly position of Post Office Service Banks (POSBs), further growth of the commercial banks network, and setting up of microfinance and credit union entities.
• Allowing disbursements in hard currency: In many countries, particularly in the Europe and Eurasia (E&E) region, the central banks do not allow funds to be disbursed in foreign currency. Remittances received in dollars are needed to be converted to local currency at official rates. This practice may significantly raise the cost for the transfer, particularly in countries where the official and commercial exchange rates vary substantially.
• Setting up of a microfinance institution to handle remittances: This can help increase access to remittance flows, particularly in rural areas. Such institutions can provide broader savings and investment opportunities to un- banked population.
• Educating banks and customers: Both the banks and potential customers should be educated about the benefits of establishing a relationship. The banks can help increase the remittance flows and reduce costs by offering services on a competitive basis. This in turn would help generate demand and potentially attract new customers. Once the customers are educated about banking services, this would create a win-win situation for both the parties.

Conclusion

Remittance services that can deliver about 50% fee reduction are already in place. However, the mass adoption of such services in G8 and emerging countries is likely to take time. Moreover, this may not be feasible without some degree of encouragement from the policy makers. A major problem is that the service providers who earn revenues from fee income may not be willing to make investments and change the model. Also, the banks, affected by the global credit crunch, are currently focused more on cost reductions and may not be enthusiastic about launching innovative products. The remittances enders and beneficiaries are simply not organised enough to adopt the changes required. Overall, some degree of regulatory encouragement is a must if this novel attempt by the G8 is to be made a success.