High-tech advances such as cyber currency bitcoin and its blockchain transfer technology are creating opportunities to modernize the way vital remittances are transferred across borders, but strict banking regulations and banks’ unwillingness to work in “risky” sectors threaten to make it more difficult for many to send money home, experts say.
The Sustainable Development Goals have recognized the key importance of remittances for global development. Goal 10 includes reducing the average cost of sending money from the current average of 7.4 percent of the sum being transferred, to below 3 percent.
Money which migrants send back to developing countries now officially totals approximately $440 billion every year, three times higher than official aid flows, according to the World Bank. Experts say the market could actually be worth far more considering the value of transfers which flow through unrecorded channels.
However, currently at least $32 billion in remittances is failing to reach recipients due to high transaction fees associated with sending and receiving money across borders.
Remittances, delivered through informal or formal channels, are credited with reducing poverty and acting as insurance for the poor in developing countries, according to Dilip Ratha, head of Global Knowledge Partnership on Migration and Development at the World Bank. Remittances are often the first form of aid to reach disaster-hit countries. Many money transfer companies waived fees during the aftermath of the Nepal earthquake in 2015, in recognition of that, Ratha said.
Furthermore, remittances are also seen as a key stepping stone to improving financial inclusion by encouraging more people to have bank accounts and through opportunities to link consumer and even small business loans to remittances, Ratha said.
Formal remittances enter a country through official banking channels and specialized money transfer companies, of which Western Union is the biggest. Commercial banks, post offices, credit unions, and niche money transfer companies, also offer formal methods of transferring money.
Informal remittances refer to money transfers which occur through private, unrecorded channels such as cash brought home by friends and relatives, and parallel informal money transfer systems such as “hawala” in South Asia, and “fei ch’ien” in China.
While technological advances and virtual currencies such as bitcoin could hold the key to reducing remittance fees, challenges around regulation and identification issues threaten progress, according to experts convened to discuss remittances during a panel hosted by the World Bank as part of a conference on migration and development hosted in Washington, D.C.
Here are the highlights of the discussion.
1. De-risking is threatening the industry.
De-risking is the single biggest threat facing the remittance industry, according to Mohit Davar, chairman of the International Association of Money Transfer Network, the trade body for the remittance industry. It is “stifling competition and concentrating business on four or five incumbent players,” he said.
De-risking, or de-banking, refers to the practice of financial institutions exiting relationships with, and closing the accounts of, clients perceived to be “high risk,” and there has been a trend toward de-risking entire sectors, including money service businesses. The World Bank found that money transfer operators and other remittance companies are the most affected by de-risking activities.
This trend is in part caused by restrictive anti-money laundering and anti-terrorism financing regulations which have resulted in increased scrutiny from regulators on the formal and informal financial sectors. Combined with declining risk appetites in the wake of the 2008 financial crisis, many financial institutions are choosing not to work in sectors assessed as high-risk, unprofitable, or complicated, including working with money service businesses. This has the effect of diverting remittance payments to informal channels.
While the money transfer system “is not immune to misuse,” Davar said the small size of the average remittance transaction, which is between $200 and $300, makes it “inherently inefficient to use for money laundering.” Unless the de-risking trend changes, the industry will see “money moving back to the informal sector when we worked very hard to move it to the formal sector,” he said.
2. Regulators and banks are behind the times.
The socio-economic profile of immigrants and their needs as customers have changed in recent years according to Kanchan Kumar, the CEO of Remitr, a cross-border foreign currency payment service. In the past, immigrants were low paid, but now they earn more and as a result are looking for new services beyond simply sending cash home. Migrants now want capabilities to transfer bank credits and manage money in more than one country, Kumar said.
Keeping up with the demands of these new customers is difficult when there are regulatory, banking and technology challenges holding money services businesses back, according to Kumar. MSB is a term used by financial regulators to describe businesses that transmit or convert money.
Regulators are failing to embrace more efficient ways of identifying senders, which is one of the biggest regulatory challenges around transferring money. “There are better way to identify a person other than making them walk up to a counter and present their ID and then photocopying it,” Kumar said, but regulators are proving slow to respond.
The remittance industry needs to embrace technology and take advantage of developments which can enhance their services, such as automated identification, real-time transaction scanning, better foreign exchange management, and real-time cross-border settlements, Kumar said. Remitr has adopted these innovations and is bringing the technology to other MSBs, he said.
3. Virtual money and technology platforms can cut costs, increase transparency and save time.
Blockchain technology can be used to reduce the cost of remittances according to chief operating officer of BitPesa, Charlene Chen. BitPesa, which is currently operating in Nigeria, Kenya, Uganda, Tanzania, Senegal, Democratic Republic of the Congo, uses blockchain technology to create a global network of “market-makers” who transact with each other transparently on the blockchain database, Chen explained.
Blockchain is best known as the underlying technology behind the virtual currency bitcoin, and it is used by BitPesa as an open source digital ledger, which keeps a constantly updated record of all transactions, making the platform transparent and secure.
BitPesa is able to lower the cost of sending remittances by removing correspondent banks from the transaction chain. A correspondent bank is a financial institution that provides services on behalf of another financial institution. For example, in a BitPesa transaction, BitPesa is able to receive local currency directly which it then sends in bitcoin to a digital broker who then deposits it as local currency in the receiving country. Regular money transfers would involve at least one deposit within a correspondent bank.
The BitPesa method also removes the dependency on the U.S. dollar as a middle currency. Often local currency from one country will need to be changed into dollars before being changed into the final destination currency, which adds on fees. As a result of BitPesa’s innovation, transactions are cheaper for individuals and businesses, with costs of between 1-3 percent, and faster — a transfer which normally takes a week can occur in one day.
4. Greater interoperability in financial services is key.
Some $44.6 billion is the estimated average amount being paid in fees to move money from one country to another, including developed countries, according to according to Lisa Nestor, director of partnerships at Stellar. Stellar is a nonprofit which is “evangelizing a global payment standard” by working directly with financial institutions to make cross border (and domestic) payments more efficient, she explained.
Currently, there are two main ways of moving money; from bank account to bank account, which is the formal way, and through private remittance channels such as Western Union, and both channels are expensive, Nestor explained.
In a bank account to bank account transfer, for example from the U.S. to Nigeria, money will move from a local bank to a national one, then through several correspondent banks serving the U.S. market. It then travels through SWIFT, the messaging network used by banks and other financial institutions to send and receive information such as money transfer instructions, to a correspondent bank serving the African market, and is eventually delivered to the local bank account on the other side. This process takes several days, accrues several fees along the way, and with many correspondent banks currently de-risking, the process is becoming even more difficult, Nestor said.
Private payment channels are expensive for different reasons, Nestor said. Companies such Western Union need to have a physical presence in multiple locations so that people have a place to send and receive payments, and they also need to manage hundreds of bank accounts around the world in order to facilitate transactions, Nestor explained.
Stellar has been working to realize a more efficient payment system and have leveraged blockchain technology to create a network which financial institutions or payment service providers can utilize in order to pass transactions to any other provider also on that network. The network doesn’t use bitcoin specifically, but institutions can use any assets or currency for exchange. Once an institution joins the network, it can send payments of any size on behalf of a client in less than 5 seconds and for less than a cent.
The key to the system is “interoperability” Nestor said, the ability for different information technology systems to communicate and exchange data with each other. For example, email service providers have adopted a “common way of talking to each other” which enables customers to send and receive emails from different email providers. Stellar is working to create the same interoperability within financial institutions.
5. The future of remittances?
While Davar thinks new approaches, such as those developed by Remitr and BitPesa, will continue to get traction, he predicts that in the future remittances will be free and no transaction fees will apply.
“In my opinion in the future remittances will be commoditized and become free so nobody makes money on them. The trick will be to monetize the customer through other products such as loans and microfinance, remittances will just be an anchor product,” he said.