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

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).

In the L’Aquila 2009 G8 Summit, leaders pledged to reduce the price of remittances by half (from 10 to 5 percent) in 5 years. Yet, empirically, little is known about what explains the price of remittances. Is the problem of high prices mostly due to sending country or to recipient country factors? Are high prices related to socio-economic factors, industry market structure, or government policies and regulations that affect the costs faced by remittance service providers and/or the mark-ups they are able to charge? Are there significant differences between banks and money transfer operators (MTO)? Given the importance of remittances for many developing countries, explaining the variation in prices is of interest for academics and policy makers alike.

In a recent paper I co-authored with Thorsten Beck, we use the Remittance Prices Worldwide database to analyze the factors driving remittance prices across 119 corridors or country pairs. The corridors we studied include 13 major remittance sending countries and 60 receiving countries, representing approximately 60 percent of total remittances to developing countries. Furthermore, the dataset includes the largest providers in each corridor, be they money transfer operators, banks, post offices, etc.

We find that remittance prices are associated with three main factors:

1. The number of migrants in a corridor is negatively and significantly associated with remittance prices across different samples and different providers. This seems to suggest an important volume effect that works either through scale economies and/or higher competition in a larger market.
2. Corridors with higher income per capita in sending and receiving countries exhibit, on average, higher prices, which could reflect higher prices of non-tradable goods.
3. Competition and market structure matter. Corridors with a larger number of providers and countries with more competitive banking sectors exhibit lower prices. On the other hand, prices are higher in corridors with a higher share of banks among providers. Overall, country characteristics associated both with the cost structure of remittance service providers and with their pricing power are significantly related to cross-corridor variation in remittance prices.

It is also interesting to note which factors do not enter significantly. In particular, we find no evidence that regulation, exchange rate stability, capital controls or financial literacy matter. Of course, some of this might be due to the fact that the variables used to capture these policies are imperfect. But so far the evidence indicates that efforts by policy-makers to reduce remittance prices should focus primarily on improving competition in the remittance market.

Figure 1: Average remittance costs per $200 dollars sent
(% of US$ 200)

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¹ This blog post is based on a paper by Thorsten Beck and Maria Soledad Martinez Peria entitled “What explains the cost of remittances ? An examination across 119 country corridors” World Bank Policy Research Working Paper 5072.
 ² The Remittance Prices Worldwide database can be found at http://www.remittanceprices.org. The World Bank Payment Systems Group has also issued (together with the Bank for International Settlements) the General Principles for International Remittance Services. These can be found here.