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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.

Whether and how remittances might affect financial development—banking in particular—is a priori unclear. On the one hand, money transferred through financial institutions might pave the way for recipients to demand and gain access to other financial products and services that they might not have otherwise. As an added benefit, providing remittance transfer services allows banks to “get to know” and reach out to unbanked recipients or recipients with limited financial intermediation. For example, remittances might have a positive impact on credit market development if banks become more willing to extend credit to remittance recipients because the transfers they receive from abroad are perceived to be significant and stable (i.e., serve as collateral, at least informally). However, even if bank lending to remittance recipients does not materialize, overall credit in the economy might increase if banks’ loanable funds surge as a result of deposits linked to remittance flows.

Furthermore, because remittances are typically lumpy, recipients might have a need for financial products that allow for the safe storage of these funds, even if most of these funds are not received through banks. In the case of households that receive their remittances through banks, the potential to learn about and demand other bank products is even larger.

On the other hand, because remittances can help relax individuals’ financing constraints, they might lead to a lower demand for credit and have a dampening effect on credit market development. A rise in remittances also might not translate itself into an increase in credit to the private sector if these flows are instead channeled to finance the government or if banks are reluctant to lend and prefer to hold liquid assets. Finally, remittances might not increase bank deposits if they are immediately consumed or if remittance recipients distrust financial institutions and prefer other ways to save these funds.

Two recent studies provide evidence in favor of the first hypothesis. They show that remittances have a positive and significant impact on financial development. Using municipality-level data for Mexico for 2000, my coauthors (Demirguc-Kunt, Lopez-Cordova, and Woodruff) and I show that remittances are strongly associated with greater banking breadth and depth, increasing the number of branches and accounts per capita and the ratio of deposits to GDP. These effects are significant both statistically and economically, and are robust to the potential endogeneity of remittances. The most conservative estimate suggests that a one-standard deviation change in the percentage of households receiving remittances—roughly a doubling of the mean remittance rate—leads to an increase of 1 branch per 100,000 inhabitants (against a mean of 1.79), 31 accounts per one thousand residents (relative to a mean of 42 accounts), and an increase of 3.4 percentage points in the deposit/GDP ratio (compared to a mean of 4.2).

In another paper I wrote with Reena Aggarwal and Asli Demirguc-Kunt, we add to the previous study by showing that the contribution of remittances to financial development is not specific to Mexico, but holds across countries and over a longer time period. We utilizes data on remittance flows to 109 developing countries during 1975-2007 to examine the association between remittances and the aggregate level of deposits and credit intermediated by the local banking sector. The paper provides evidence of a positive, significant, and robust link between remittances and financial development across a large sample of developing countries. Both these studies’ findings add another important channel through which remittances can affect the development of recipient economies.
   
References:

Aggarwal, Reena, Asli Demirguc-Kunt,  Maria S. Martinez Peria, 2010. “Do Remittances Promote Financial Development?” World Bank. Mimeo. (A previous version of this paper came out as Policy Research Working Paper Series 3957.)
 
Demirguc-Kunt, Asli,  Ernesto Lopez-Cordova, Maria S. Martinez Peria and Chris Woodruff, 2010. “Remittances and Banking Sector Breadth and Depth: Evidence from Mexico”. Policy Research Working Paper 4983. Forthcoming Journal of Development Economics.

Comments

Submitted by Emiliana Vegas on
I enjoyed reading this very clear article... I am not a finance economist but have been interested in the impact of remittances on human development outcomes in recipient countries. Your findings on financial development suggest that remittances are an important and still understudied factor in development. Thanks so much!

Submitted by TANKARI on
I'm interested in the remittances' issues. I think you made a very good analysis. But i also believe that research should focus on the analysis of the causal link between remittances and financial development; specially in developing countries. Thank you!

Submitted by Ameya Narvekar on

Remittances are playing an increasingly large role in the economies of many countries. They contribute to economic growth and to the livelihoods of less prosperous people (though generally not the poorest of the poor). According to World Bank estimates, remittances totalled US$414 billion in 2009, of which US$316 billion went to developing countries that involved 192 million migrant workers. For some individual recipient countries, remittances can be as high as a third of their GDP.

Overall global remittances also totaled $583 billion.Some countries, such as India and China, receive tens of billions of US dollars in remittances each year from their expatriates. In 2014, India received an estimated $70 billion and China an estimated $64 billion.

Submitted by Ameya Narvekar on

All of those countries created policies on remittances developed after significant research efforts in the field. For instance, Italy was the first country in the world to enact a law to protect remittances in 1901 while Spain was the first country to sign an international treaty (with Argentina in 1960) to lower the cost of the remittances received.

Since 2000, remittances have increased sharply worldwide, having almost tripled to $529 billion in 2012. In 2012, migrants from India and China alone sent more than $130 billion to their home countries.

In 2004 the G8 met at the Sea Island Summit and decided to take action to lower the costs for migrant workers who send money back to their friends and families in their country of origin. In light of this, various G8 government developmental organizations, such as the UK government's Department for International Development (DFID) and USAID began to look into ways in which the cost of remitting money could be lowered.

In September 2008, the World Bank established the first international database of remittance prices. The Remittance Prices Worldwide Database provides data on sending and receiving remittances for over 200 "country corridors" worldwide. The "corridors" examined include remittance flows from 32 major sending countries to 89 receiving countries, which account for more than 60% of total remittances to developing countries.The resulting publication of the Remittance Prices Worldwide Database serves four major purposes: benchmarking improvements, allowing comparisons across countries, supporting consumers’ choices, and putting pressure on service providers to improve their services.

At the July 2009 summit in L'Aquila, Italy, G8 heads of government and states endorsed the objective of reducing the cost of remittance services by five percentage points in five years. To drive down costs, the World Bank has begun certifying regional and national databases that use a consistent methodology to compare the cost of sending remittances.

At the G20 2011 Summit in Cannes, Bill Gates stated that, "If the transaction costs on remittances worldwide were cut from where they are today at around 10% to an average of 5%…it would unlock $15bn a year in poor countries." A number of low-cost online services such as Azimo have emerged with the objective of lowering the cost of money transfers to developing and emerging economies.

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