What explains the cost of remittances?

Thorsten Beck, Maria Soledad Martinez Peria, 28 September 2009

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In 2008, remittances to developing countries reached $328 billion dollars, more than twice the amount of official aid and over half of foreign direct investment flows (World Bank, 2009). Numerous studies have shown that remittances can have a positive and significant impact on economic development along a number of dimensions, including poverty alleviation, education, entrepreneurship, infant mortality, and financial development.

But remittance transactions are known to be expensive, with estimates averaging 10% of the amount sent (World Bank, 2008). At the same time, there is a wide variation in these costs across remittance markets – also known as remittance corridors – ranging from 2.5% to 26% of the amount sent. Furthermore, case studies have shown that remittances flows are very sensitive to costs and are likely to increase significantly as costs go down (Gibson, McKenzie, and Rohorua, 2006).

Policy promises to reduce transaction costs

At the L’Aquila 2009 G8 Summit, leaders pledged to reduce the cost of remittances by half (from 10% to 5%) in five years (G8, 2009). Yet, empirically, little is known about what drives the cost of remittances.1 Is the problem of high costs mostly due to sending country or recipient country characteristics? Are high costs related to socio-economic factors, industry market structure, or government policies and regulations? Should policymakers emphasise increasing competition, improving financial literacy, or broadening the scope of regulation? Are there significant differences between banks and money transfer operators? Given the importance of remittances for many developing countries, explaining the variation in costs is of interest for academics and policy makers alike.

New data on remittances

We analysed recently published data on remittance fees across 119 corridors from 13 sending to 60 receiving countries, linking them to an array of corridor-specific variables, sending country characteristics, and receiving country characteristics.

The data on remittance costs were recently collected and published by the World Bank Payment Systems Group.2 Within each corridor, the data were gathered on the same day to control for exchange rate fluctuations and other changes in fee structures. In general, cost data were collected for eight to ten major service providers in each corridor, including both the main money transfer operators and banks active in the market. Companies surveyed within each segment were selected to cover the maximum remittance market share possible.

Across all corridors and all providers, remittance costs average 10.2%. At 12.4%, the average cost among banks is higher than the average for money transfer operators, which equals 8.8%. Across money transfer operators, costs for Western Union, a leading participant in the remittance market, exceed those for other money transfer operators. In particular, costs average 10.8% for Western Union, while they average 8.8% among all money transfer operators combined.

There is also significant heterogeneity in costs, even when we consider the same sending or the same remittance-receiving country. For example, Figure 1 shows the costs associated with sending remittances from the US to 22 receiving countries, while Figure 2 shows the costs associated with remittances received by India from 8 sending countries. The costs of remittances sent from the US vary between 3.7% to Ecuador and 14.1% to Thailand. Remittances to India cost between 3.1% from Saudi Arabia and 13.3% from Germany.

Figure 1. Cost of remittances from the US to 19 receiving countries

Figure 2. Cost of remittances to India from 8 sending countries

Costs and competition

Relating remittance fees on the corridor level to an array of corridor-specific variables, sending country characteristics, and receiving country characteristics yielded the following findings.

  • The number of migrants (migrant stock) is statistically and economically significantly associated with lower average fees across corridors.

This seems to suggest an important volume effect that works through scale economies and/or higher competition in a larger market.

  • Corridors with higher income per capita in both sending and receiving country exhibit, on average, higher costs, which could reflect higher costs of non-tradable goods, such as services, in general.

There is strong evidence that competition matters.

Corridors with a larger number of providers exhibit lower fees. Bank competition in the receiving country seems to be negatively associated with the cost of sending remittances. Corridors with a higher share of banks among providers, on the other hand, exhibit higher average fees.

  • There seems to be only a limited role for regulation.

A broader regulatory framework for remittance service providers, subjecting them to registration and certain efficiency, safety and AML requirements seems to be associated with lower cost of sending remittances for banks, but not for money transfer operators.

  • We do not find any consistent evidence that exchange rate volatility or capital account restrictions are significantly associated with the average costs across corridors.
  • There is only limited evidence that geographic access to remittance service providers is significantly associated with the average fee across corridors.
  • Finally, we do not find evidence that remittance senders’ literacy matters.

The factors driving remittance costs charged by banks and, separately, by money transfer operators are similar. When comparing costs charged by Western Union across 98 corridors for which we have data, however, competition and market structure do not seem to matter. This could be due to the fact that Western Union has a dominant position in the remittance business across most corridors.

Conclusions

In summary, our preliminary evidence suggests that policymakers seeking to reduce remittance costs should focus on improving competition in the remittance market.3

While we think this column offers some interesting findings regarding this very important topic, it is only a first exploration into what drives remittance costs. We hope that future research will be able to exploit panel variation to get deeper at the issues, while at the same time addressing some of the limitations of the existing analysis.

References

Beck, Thorsten and Maria Soledad Martinez Peria (2009), “What Explains the Cost of Remittances? An Examination Across 119 country corridors”, World Bank Policy Research Working Paper, forthcoming.

Freund, C. and Spatafora, N., (2008), “Remittances: Transaction Costs, Determinants, and Informal Flows”, Journal of Development Economics 86, 356-366.

G8 (2009) L’Aquila 2009 G8 Summit, See paragraph 134 page 49

Gibson, J., McKenzie, D. and Rohorua, H., (2006), “How Cost Elastic Are Remittances? Evidence from Tongan Migrants in New Zealand”, Pacific Economic Bulletin, 21(1): 112-128.

Orozco, M., 2006. “International Flows of Remittances: Cost, Competition and Financial Access in Latin America and the Caribbean – Toward an Industry Scorecard”, Inter-American Dialogue, Mimeo.

World Bank (2008). Remittance Prices Website.

World Bank (2009). Migration and Remittances Website.



1. Orozco (2006) and Freund and Spatafora (2008) are the exception, but their data is limited to few countries or few providers. Orozco’s work focuses exclusively on Latin America, and Freund and Spatafora only analyse the costs of remittances sent from the US and the UK exclusively via MoneyGram or Western Union to 66 countries.

2. The original data covers remittance costs in 134 corridors, including 14 sending and 72 receiving countries. However, due to missing data on exchange rate spreads for Russia, we only examine costs in 119 corridors.

3. It is unlikely that policymakers would try to lower income levels or increase the number of migrants in a corridor simply to lower remittances costs. 

Topics: Development
Tags: banks, competition, Remittances

Thorsten Beck
Professor of Banking and Finance, Cass Business School; Professor of Economics, Tilburg University; Research Fellow, CEPR
Senior Economist in the Finance and Private Sector Development Team of the Development Economics Research Group at The World Bank