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What Do We Know About the Impact of Remittances on Financial Development?

Maria Soledad Martinez Peria's picture

Remittances, funds received from migrants working abroad, to developing countries have grown dramatically in recent years from U.S. $3.3 billion in 1975 to close to U.S. $338 billion in 2008. They have become the second largest source of external finance for developing countries after foreign direct investment (FDI) and represent about twice the amount of official aid received (see Figure 1). Relative to private capital flows, remittances tend to be stable and increase during periods of economic downturns and natural disasters. Furthermore, while a surge in inflows, including aid flows, can erode a country’s competitiveness, remittances do not seem to have this adverse effect.

Figure 1: Inflows to developing countries (billions of USD), 1975-2008

As researchers and policymakers have come to notice the increasing volume and stable nature of remittances to developing countries, a growing number of studies have analyzed their development impact along various dimensions, including: poverty, inequality, growth, education, infant mortality, and entrepreneurship. However, surprisingly little attention has been paid to the question of whether remittances promote financial development across remittance-recipient countries. Yet, this issue is important because financial systems perform a number of key economic functions and their development has been shown to foster growth and reduce poverty. Furthermore, this question is relevant since some argue that banking remittance recipients will help multiply the development impact of remittance flows.

Too Big to Fail, or Too Big to Save?

Asli Demirgüç-Kunt's picture

Too big to fail has become a key issue in financial regulation. Indeed, in the recent crisis many institutions enjoyed subsidies precisely because they were deemed “too big to fail” by policymakers. The expectation that large institutions will be bailed out by taxpayers any time they get into trouble makes the job of regulators all the more difficult. After all, if someone else will pay for the downside risks, institutions are likely to take on more risk and get into trouble more often—what economists call moral hazard. This makes reaching too-big-to-fail status a goal in itself for financial institutions, given the many implicit and explicit benefits governments are willing to extend to their large institutions. Hence, all the proposed legislation to tax away some of these benefits.

But could it be that some banks have actually become too big to save? Particularly for small countries or those suffering from deteriorating public finances, this is a valid question. The prime example is Iceland, where the liabilities of the overall banking system reached around 9 times GDP at the end of 2007, before a spectacular collapse of the banking system in 2008. By the end of 2008, the liabilities of publicly listed banks in Switzerland and the United Kingdom had reached 6.3 and 5.5 times their GDP, respectively.

In a recent paper with Harry Huizinga, we try to see whether market valuation of banks is sensitive to government indebtedness and deficits. If countries are financially strapped, markets may doubt countries’ ability to save their largest banks. At the very least, governments in this position may be forced to resolve bank failures in a relatively cheap way, implying large losses to bank creditors.

Low Cost Banking: How Retail Stores and Mobile Phones Can Transform Access to Finance

Ignacio Mas's picture

More than 3 billion people in the world today don’t have access to savings accounts. Many of these 3 billion fall below the less-than-$2-per-day benchmark of the world’s poorest people. Why are banks not doing a better job to help them manage their financial lives?

The problem is largely one of cost. Providing financial services to the poor is prohibitively expensive for banks. Each time a client stands in front a of a teller’s window it costs most banks from $1 to $3. If poor clients make transactions of $1 or $2, or even less, banks won’t be able to support the costs.

It’s also too costly for the poor. Most poor people, especially those in rural areas, live far away from bank branches. Let me give one example of a woman in Kenya. The nearest branch may be 10 kilometers away, but it takes her almost an hour to get there by foot and bus because she doesn’t have her own wheels. With waiting times at the branch, that’s a round-trip of two hours – a quarter or so of her working day gone.  While the bus fare is only 50 cents, that’s maybe one fifth of what she makes on an average day. So each banking transaction costs her the equivalent of almost half a day’s wages.

Making the Case for Financial Openness

Ryan Hahn's picture

Rich countries and emerging markets alike have participated in a rapid integration into global capital markets over the last 25 years. Proponents of financial globalization believed this would bring a myriad of benefits via improved financial intermediation, with a more efficient allocation of capital to productive firms and increased access to finance to those outside the halls of political power.

But the recent financial crisis has given pause to the pro-globalization advocates. The marked increase in capital flows to emerging markets quickly reversed in the wake of the financial crisis, leaving these countries looking vulnerable. Might the globalizers have gotten their prescriptions wrong?

A recent paper entitled Does Financial Openness Lead to Deeper Domestic Financial Markets? finds that, in fact, developing countries have reaped a number of benefits from financial globalization. In particular, the authors of the paper have found that greater financial openness:

The Fad of Financial Literacy?

Bilal Zia's picture

Financial literacy has become an immensely popular component of financial reform across the world. As a response to the recent financial crisis, the United States government set up the President’s Advisory Council on Financial Literacy in January 2008, charged with promoting programs that improve financial education at all levels of the economy and helping increase access to financial services. In the developing world, the Indonesian government declared 2008 “the year of financial education,” with a stated goal of improving access to and use of financial services by increasing financial literacy. Similarly, in India, the Reserve Bank of India launched an initiative in 2007 to establish Financial Literacy and Credit Counseling Centers throughout the country which would offer free financial education and counseling to urban and rural populations. The World Bank also hasn’t been missing out on the trend – it recently approved a $15 million Trust Fund on Financial Literacy. 

But what do we know about financial literacy? Does it work, and if so, through what mechanisms? Despite the money being ploughed into financial literacy programs, we know very little to address these important questions. While it is true that there is a large and growing body of survey evidence from both developed and developing countries that demonstrate a strong association between financial literacy and household well-being, we are still in the process of learning whether this relationship is causal.

What Drives the Price of Remittances?: New Evidence Using the Remittance Prices Worldwide Database

Maria Soledad Martinez Peria's picture

Remittances to developing countries reached U.S. $338 billion in 2008, more than twice the amount of official aid and over half of foreign direct investment flows.1 Numerous studies have shown that remittances can have a positive and significant impact on many aspects of countries’ economic development. Hence, monitoring the market for remittance transactions has become critical for understanding the development process in many low-income countries.

Remittance transactions are known to be expensive. The Remittance Prices Worldwide database collected by the World Bank Payment Systems Group shows that, as of the first quarter of 2009, the cost of remittances averaged close to 10 percent of the amount sent.2 At the same time, the data also reveal a wide dispersion in the price of remittances across corridors, ranging from 2.5 percent to 26 percent of the amount sent (see Figure 1 below the jump).

The Africa of Tomorrow

Ryan Hahn's picture

Is Africa the next hotspot for international investment? That's one of the contentions of the McKinsey Global Institute in a recent report entitled Lions on the Move: The progress and potential of African economies. Collectively, African economies saw a significant uptick in growth over the last decade, with GDP growing at a 4.9 percent annual rate from 2000 through 2008.

As part of Asli's FPD Chief Economist Talk series, Susan Lund, the principal author of the report, came to the World Bank last week to discuss her findings. A video of her talk appears below the jump. The talk itself runs to the 29-minute mark, and the Q&A that follows runs another 52 minutes. Clearly, this presentation captured the attention of World Bank staff.

The Status of Bank Lending to SMEs in the Middle East and North Africa Region

Roberto Rocha's picture

Editor's Note: The following post was submitted jointly by Roberto Rocha, Senior Adviser, MENA, Rania Khouri, Director, Union of Arab Banks, Subika Farazi, Consultant, MENA, and Douglas Pearce, Senior Private Sector Development Specialist, MENA.

Small and medium-size enterprises (SMEs) are increasingly a priority for policymakers in the Middle East and North Africa (MENA) region, who see SMEs as key to solving the challenge of improving competitiveness, raising incomes, and generating employment. Data from the World Bank’s Enterprise Surveys suggest that access to finance for SMEs is more constrained in MENA than in other emerging regions, with only one in 5 SMEs having a loan or line of credit. Yet until recently there has been no comprehensive survey of the supply of SME finance in MENA. SME policymakers may therefore lack comprehensive information to design reforms, while SME finance providers may not have access to valuable market information to inform design of SME financial services and delivery channels.

To fill this knowledge gap, the Bank recently carried out a survey in cooperation with the Union of Arab Banks of SME lending in the region. We were fortunate to receive a very high response rate – we have data from 139 banks, which account for about half of MENA banks and almost two thirds of the banking system loans in 16 countries. The survey covered the following themes: i) strategic approach to SME lending, ii) main products offered to SMEs, iii) risk management techniques employed, and iv) SME lending data. This is the first dataset of its kind for this region, and builds on similar efforts in the Latin America and Caribbean region.

Lions on the Move: The Progress and Potential of African Economies

Editor’s Note: The following blog post was contributed by Susan Lund, Ph.D., Research Director of the McKinsey Global Institute, McKinsey & Company’s business and research arm. Dr. Lund will be making a presentation at the World Bank on July 20th summarizing the institute’s new report, Lions on the move: The progress and potential of African economies, which can be downloaded for free at www.mckinsey.com/mgi.

Tomorrow I will have the opportunity to present new research on Africa's economic prospects at the World Bank, home to many Africa experts and the source of so much invaluable research on the region. I have no doubt the combination of expertise from the McKinsey Global Institute and the World Bank will produce a lively discussion. As you well know, Africa continues to face many challenges, including poverty, disease and hunger. But our report shows Africa is also a land of great progress and potential. In this blog entry, I briefly summarize some of our key findings. We hope our report will provide a useful fact-base for the World Bank in its lending programs and dialogue with Africa’s policy makers and private sector.

We at McKinsey find many of our business clients are eager for insights into Africa’s recent acceleration in GDP growth. Africa’s collective economy grew at a 4.9 percent annual rate from 2000 through 2008, twice as fast as the pace of the preceding two decades. Africa is the third fastest growing economic region in the world, after emerging Asia and the Middle East. The continent’s combined economic output, valued at $1.6 trillion in 2008, is now roughly equal to Brazil’s or Russia’s. Africa offers investors the highest rate of return of any developing region.

Same All About Finance Blog, New Blog Platform

Ryan Hahn's picture

Readers of the All About Finance blog may have noticed a change in our format over the weekend. That's because we have moved to the platform that supports the World Bank Group's family of blogs, located at http://blogs.worldbank.org. We'll share a common face with the Bank's many blogs, but continue to bring you the same content from Asli and colleagues.

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