Dilip Ratha is the chair of the KNOMAD thematic group on remittances and an adviser to the VP, of Operations at the Multilateral Investment Guarantee Agency, World Bank.
Remittances – money sent to family and friends back home in low- and middle-income countries – by international migrants rose to nearly $650 billion in 2022. The true size of these flows, including flows that are not recorded in official statistics, is believed to be even larger. The recorded amount of remittances is more than three times the total development aid. Even more impressive, remittances have surpassed the foreign direct investment flows to developing countries.
Remittances reduce poverty. They provide funds to households for purchasing food and medicine and essential goods and services. They also support children’s education and healthcare for family members. Remittances act like an insurance to the recipient households – they tend to go up when the recipient economy is facing hardship, say, an economic crisis or a natural disaster. Thus, unlike private investment flows, remittances tend to be stable or even counter-cyclical.
Yet, a major roadblock to sending money across international borders continues to be cost. Multiple currency conversions, exchange controls, and a lack of interoperable payment systems all add to the expense of sending money.
Remittance service providers, especially commercial banks, tend to charge fees in excess of 6 percent. The fees on remittances to Africa are often higher than 8 percent. Lowering the fees by 5 percentage points is technologically feasible, and it’d save migrants and their families over $30 billion per year. For comparison, this saving would be similar in magnitude to the annual aid budget of the United States, the largest donor country. Reducing the cost of remittances, therefore, is a low-hanging fruit.
Money transfer operators tend to provide remittance services at a lower cost than the commercial banks. But the lowest cost providers are those taking advantage of mobile phone technologies. Digital remittances sent using mobile phone technology greatly increases the efficiency of remittance transactions. The sender and the recipient don’t have to physically travel to an agent location to send or receive money. This feature is very useful in rural or remote areas that may not have bank branches nearby. The sender and the recipient don’t need to have cash in hand as money can be directly deducted from the sender’s account and directly deposited into the recipient’s account. Perhaps even more importantly, smartphones can make customer identification easier through biometric verification, thus facilitating compliance with regulations to combat money laundering or terrorist financing.
By making compliance with regulations easier and cheaper, mobile phone technologies increase competition in the remittance markets and reduce remittance costs.
While the fees charged by remittance service providers are on a downward trend, the fees associated with converting currencies remain high and sticky, on average around 3 percent of the remittance volume, and frequently as high as 5 percent of the remittances. The foreign exchange mark-up can be doubled or tripled in cases where several currencies must be used, for example, while transferring money from East Africa to West Africa or from a US dollar currency zone to a Euro zone.
Additionally, regulations aimed at combating money laundering and terrorism financing have led to over-compliance with existing regulations, treating remittance transactions with distrust. To avoid the risk, banks may refrain from providing correspondent banking services to money transmitters, especially fintech start-ups, and those serving fragile economies, in fear of falling foul of the regulations.
In theory, using emerging technologies, like blockchain and cryptocurrency, to move funds can significantly reduce the foreign exchange mark-up and the cost of remittances. However, scale and presence in remittance-recipient countries and the international acceptability of cryptocurrencies, including stablecoins, continue to present challenges. It will take continued investment and appropriate regulatory frameworks that address meaningful consumer protections and risk management before realizing any potential upside of this technology.
As the income gap between richer and poorer nations grows, demographic pressures increase, and changes to the planet continue, the number of people who migrate in search of economic opportunity will only grow. And as a result, so will the flow of remittances. We must continue to make progress to improve how money travels home to protect this vital lifeline for millions of people.
Through technology, right-sized regulation, and lower costs, remittances have the potential to improve financial inclusion, providing stable income to millions and playing a vital part in the global economy.