FORMAL AND INFORMAL REMITTANCE SYSTEMS

Transcription

1 FORMAL AND INFORMAL REMITTANCE SYSTEMS Introduction Remittances are part of the centuries old product of migration from rural to urban areas. Nowadays, remittances represent the human face of globalisation, in which millions of people migrated in search of greener pastures for a better life and in order to provide for their loved ones back home. Such flows of human and financial capital have profound implications for the economies of the remitting and receiving countries. Over the last two decades remittances at the global, macro level have assumed such gargantuan proportions in development finance that they are, arguably second only to foreign Direct Investment. At the microeconomic level, remittances offer a direct opportunity to improve access to financial services, with greater pro-poor and rural outreach by linking remittances to products such as savings and loans. It is thus little wonder that remitting countries in cooperation with the recipient countries are considering a number of remittance initiatives targeted at achieving better coherence and coordination of international organisations working to enhance remittance services and development impact of remittance receipts. Such initiatives have included an interagency, intergovernmental technical group constituted by the World Bank. The International Monetary Fund and the United Nations, with a mandate to improve remittance statistics. For the

2 same reasons, regional development banks, bilateral aid agencies and other international agencies have set up units. The purpose of this paper is to attempt a taxonomy of remittance system, articulating their features. To this end, the paper is divided into four sections, for ease of preparation. Section 1 is this Introduction. Section II identifies the formal and informal remittance system, articulating their characteristic features. Section III highlights the advantages and disadvantages of the formal and informal systems. Section IV contains the conclusion. II A Taxonomy and Characteristic features of Remittance Systems International remittances are cross-border person-to-person payments, that is, unrequited transfers of money from migrants to the family members they left behind, often sent a few hundred dollars at a time, nonetheless add up globally to billions of dollars annually. For many remittances receiving developing economies, remittance flows exceed foreign direct investment and are a nontrivial fraction of GDP. The methods of remittances transfers can be classified into formal and informal. II.1 Formal Methods i ii Specialised Money Transfer Companies (MTCs) The Market for remittances transfers (person person transfers) is dominated by large, specialised money transfer companies (MTCs). These include Western Union, Money Gram, and Vigo The rest of the formal money transfer market is fragmented among: 2

3 Commercial banks; Post offices; Foreign exchange bureaus Credit Unions Niche money-transfer companies, with different players dominating specific markets. Banks process more than 70 percent of formal money transfers to Turkey, India, and the Philippines. 90 percent of remittances from Russia to Ukraine and from the United Arab Emirates to India are transferred in cash. For example 70 percent of Latin American immigrants in the USA use MTCs to transfers money home. Western Union, the largest money transfer Company in the market, reported that it processed approximately 81 million transfers in 2003, which Bezard estimates to represent roughly 25 percent of total market. Market shares of the other major international transfer providers, shown in fig 1, are estimated, using the average figure of US$300 per international transfer cited by Money Gram. These percentages are, however, indicative at best, since average transfer amounts vary widely by region (see Table 1). 3

4 Fig 1 Estimation Market Share of International Person to person Transfer Providers, (by number of transactions processed) Formal Methods of Remittances Western Union 25% Others 55% Money Gram 6% Eurogiro Vigo 11% 3% Sources: Ratha, Workers Remittances, First Data, SEC Form 10 K; Money Gram, SEC Form 10; Bezard, Global Money Transfers; Great Hill Partners, Great Hill Partners Form GMT Group; private estimates of Gera Voorrips and Hans Boon, ING Postbank. 4

5 Table 1 Average Annual Value of Transfers to Selected countries by Immigration in the USA. Country Amount (US$) India 1104 Pakistan 790 Bangladesh 562 Philippines 397 Mexico 385 Egypt 307 El Salvador 280 Dominican Republic 203 Source: Orozco, Worker Remittances II.1.1 Instruments in Transmission Mechanisms in the Formal Money Transfer Market There are five major instruments used to transfer money in the formal market, and different types of financial services providers (FSPs) have access to different instruments. i. Checks and Bank Drafts - represent the major form of person-to-person money transfer in industrialized countries. 5

6 ii. Money Orders Money orders have also traditionally been paper-based instruments, but unlike checks, they can be issued by and redeemed at a variety of FSPs. Major issuers of money orders include postal financial institutions and MTCs, such as Western Union and Money Gram. Money orders do not require a bank account; a recipient receives cash upon presenting the money order to an authorized paying agent, (a post office, MTC agent etc) Given the need for money orders to be physically delivered to a recipient, they are subject to some of the risks of delay and theft. iii Electronic Transfers At the domestic level, most common types of electronic funds-transfers systems are the automated clearing house (ACH) and the real-time gross settlement systems (RTGS) Both mechanisms allow member financial institutions to exchange payments instructions and settle obligations electronically. ACHs can accept payment instructions from a financial institution or directly from clients, who can link into these systems using their bank-issued debit or credit cards. These networks are often owned and operated by central banks, although private players such as Visa also operate ACH systems in certain countries. At the international level, the most commonly used system for facilitating electronic funds transfer is operated by the Society for Worldwide Interbank Financial Telecommunication (SWIFT), an industry-owned cooperative that provides real time payment messaging services to member institutions. SWIFT is often the cheapest option for high-value transactions between 6

7 financial institutions, but can be expensive for small transfers. For this reason most payments proceeds by SWIFT are not individual person-toperson transfers, but larger payments between businesses or between business and consumers, such as university tuition. Most transfers referred to as wires are routed over SWIFT or a national ACH. Transfers over such electronic networks are quite reliable, but nonbank FSPs may not have access, either for reasons of restrictive domestic legislation or lack of technical capacity to connect with SWIFT systems. iv Giro Giro is the term used for the electronic cross-border payments offered by post offices in many countries. The system enables holders of a postal bank account to send money domestically or overseas to another postal account, a bank account, or to a post office for cash payment. It generally takes two to four days to receive a giro transfer. The international service is often used by small entrepreneurs for import and export payments. Sending a giro requires a postal bank account. Postal giros tend to have more widespread locations than commercial banks. Postal giros also tend to be cheaper than bank transfers for small amounts. For example, postal networks in North Africa provide account-based giro services that are highly popular with students and low-and middle income groups who find it difficult to open checking accounts at commercial banks. 7

8 v. Money Transfer Proprietary Networks This type of payment system is restricted to agents of the organization or association that owns the network. However, many types of institutions can become agents, including banks, non-bank financial institutions, post offices, and retail business of all stripes. MTC services tend to be extremely customer friendly, requiring neither the sender nor the receiver to hold an account or complete extensive paperwork. Such services are also known for their speed: many MTCs offer a real-time service that allows a recipient to collect transferred funds almost instantaneously. They also have a reputation for reliability. However in return for their simplicity and in part, to finance large marketing budgets MTCs are typically the most expensive of the transfer mechanisms. II.2 Informal System (IMTS) Informal Money Transfer Systems (IMTS) are remittances system that exist and operate outside of (or parallel to) conventional regulated banking and financial channels. Many IMTS have operated in various communities over time but they have evolved from two or three original types, namely, hawala, called Hundi in Pakistan, developed in South Asia (Bangladesh, India and Pakistan) Fei ch ien which started in China Colombia System 8

9 Others include Hui kuan (Hong Kong) Padala (Philippines); and Phei kwan (Thailand) II.2.1 Hawala/hundi System This system was developed more than a century ago within the immigrant India population in Africa and South East Asia as a means of settling accounts. Other Schoolars place its origin many centuries ago when traders sought a secure system to transfer money. Still, other experts claim that the hawala system has been around for thousands of years, having been part of the ancient Egyptian System based on credits called giro. Regardless of its time age, the system remains widely in use in the world today, especially in Africa. Asia and Middle East. How the hawala System works The operation of hawala essentially involves a hawaladar (or broker ) delivering money from his cash reserve or account at the request of a counterpart hawaladar in another country who is serving a client. In country A, a client hands over a sum of money to the hawaladar and requests that the equivalent amount (usually in the currency of the receiving country) be sent to a designated recipient in country B. The sending hawaladar relays all the necessary information concerning the transactions to a counterpart through telephone, Facsimile or . At this stage of the process, a collection code is agreed between the two hawaladars. 9

10 The hawaladar in country A will then communicated this code to the client, who in turn, will relay it to the designated recipient in country B. The hawaladar in country B will give the money to the recipient upon presentation of the collection code. If the sending client is also the recipient, he would have to present the code to the counterpart hawaladar, upon arriving in country B before the money could be released to him. In many cases, the payment will be made by the counterpart hawaladar to the designated recipient countries hours after the request to remit money was placed by the client in country A. The income of the hawaladar from the transaction comes from charging a commission ranging from 0.25 percent to 1.25 percent of the amount involved and is paid either in local currency or foreign exchange. Too often hawaladars charge lower operating costs to use their services by offering exchange rates that are more attractive than the official rate available through conventional banking institutions. II.2.2 Fei ch ien System The fei ch ien (means flying money or coin) system of money remittance evolved during the later half of the T ang Dynasty ( AD) as a result of the growing commodity trade within China. The fei ch ien system was a convenient means of exchange, sparing the merchants and couriers of the provincial governments the inconvenience and risk involved in transporting money physically over long distances between the capital and the provinces. 10

11 In addition, as the Chinese began to migrate to many parts of the world, a split family system developed and was sustained by the flow of remittances from the expatriate unit in support of the family that stayed in China. Thus with the advent of Chinese emigration in the 19 th century, the fei ch ien system became internationalized. The within the family structure of the remittance process offered the added advantage of privacy in the transactions and many clients would use the system to shield their income from the heavy tax burdens imposed by some governments on the ethnic Chinese. Other Remittances Systems II.2.3 Chit System A variant of the hawala and the fei ch ien systems is the chit system, which was introduced by the British colonialists in China during the 19 th century. Chit is a diminutive of the Hindi word, chitti, and means a note, pass or certificate given to a servant. In the chit system, the salaries of British workers were deposited to an escrow account managed by a Chinese comprador. These foreign workers would write chits to pay for food and other essentials that they purchased from local merchants. In turn, the merchant would present these chits for collection (payment) to the comprador, who would then deduct the corresponding amounts from the accounts of the foreign workers. The chit system offers not only safety from robbery as people needed to hold less 11

12 cash than otherwise, but it is also convenient since foreign workers did not have to carry around with them cash, silver ingots or even bulky commodities, such as silk, to use as payment for their purchases. II.2.4 The Chop System This works the same way as the hawala system and is still in use today. A client in country A wishing to remit money to a recipient in country B would come to a broker at store or outlet who will take the cash, make an entry into a ledger book for the amount received and communicate the relevant information about the transaction (amount to be remitted, name and location of recipient, etc) The broker will also create a chop (in this situation, possibly a train ticket or play card), tear it into two pieces, give one piece to the client and send the other piece to his counterpart broker in country B. The client sends his half of the chop to the recipient, A match of the two halves will be made before the broker releases the money to the recipient. Transactions involving the transfer of goods usually entail the use of seals (which would be broken in two pieces) and generally follow the procedures described above in the remittance of money. A commission fee is charged the client for the service. II.2.5 The Colombian black Market Peso exchange System This has been developed more recently in the 1970s as a vehicle for the movement of money across borders, by Colombian importers. Against the prevailing exchange control regulations which slammed limits on how much foreign exchange importers were entitled to, the Colombian black market system enable importers to buy hard currencies through it, without limit, 12

13 thereby removing a constraint on how much they could import. However, it was used as a vehicle to launder drug money and other illegally acquired wealth. II.2.6 Unlicensed Remittance Centres (URCs) These operate in Hong Kong and their services mainly involve the transfer of money from Hong Kong to other parts of the People s Republic of China, where currency controls are enforced. URCs exist in various forms. Many are located in shop or office premises offering remittance service exclusively or along with some other services such as money exchange or international facsimile services. They are situated in residential premises, operated by a member of the occupying family as a part-time job. If a client wishes to send money from Hong Kong to other part of China, say Shanghai, he must find a URC that is able to remit money there. The client deposits money into the bank account of the Hong Kong URC and relays to the Hong Kong URC all pertinent information regarding the intended recipient. The Hong Kong URC contacts its counterpart URC with instructions to remit money to the designated recipient. Thai (poey kuan) and Vietnainese Systems The operations of these types of informal money transfer systems are similar to those of either the South Asian hawala/ hundi or Chinese chop system. 13

14 II.3 The Building Blocks of a Money Transfer System In the light of the foregoing discussion on the formal and informal money transfer mechanisms it is possible to articulate three broad main elements of monetary transfer systems: the institutions that provide the transfer the mechanism that carries a transfer from point A to point B; and the customer interface thorough which cash is collected from senders and / or disbursed to recipients. However, possible combinations of these three elements are virtually limitless, and as the money transfer market evolves, new combinations are constantly being invented. Fig 2 Building Blocks of a Money Transfer System Transfer Providers Transmission Mechanisms Delivery Approaches Bank Checks /banks drafts Retail/store Front pos Pc kiosks Credit union ACH/SWIFT ATMs Postal bank MTC Money Order/giro Fixed and mobile phones Other micro-finance providers Proprietary networks internet 14

15 III Advantages and Disadvantages of Informal and Formal Money Transfer System III.1 Informal System III. I.I Advantages Informal money transfer systems (IMTS) provide immigrants and small firms a much less expensive, faster and more secure way to remit funds than that provided by traditional banks and non-bank institutions such as Western Union. In many parts of the world, especially in the rural areas of the developing countries, IMTS are the only possible means of receiving money from within the country or abroad. There are places where conventional banking services do not exist, are terribly inefficient, slow or expensive. For instance, the lack of banking linkages between Australia and several African countries was the reason behind the establishment of an IMTS in Austrialia to serve the needs of African expatriates there IMTS are also the only channel of sending money from the United States to some African countries including Somaila. The operations of IMTS are free of bureaucracy and are reliable because they are streamlined, involving a minimum number of parties. The duration of a hawala transaction could be as short as a matter of hours. Being a relatively document-free transaction, IMTS also offer discretion, secrecy and anonymity to the sending and receiving parties of the remittance. The discretion that the hawala system provides to its clients makes the element of trust an essential feature of the system. 15

16 With trust and the strong influence of social connections such as family or regional relationships, hawaladars are almost universally honest in their dealings with clients and each other. The hawala system is selfregulating. It is rare for hawaladars to defraud one another or their clients. A typical IMTS transaction is less formal and less adversarial in tone. Consequently there is less need to prepare documents spelling out in detail the responsibilities of all parties. Such a business culture anchored on trust prevents widespread use of formal financial systems. In the modern financial world, there is so much distrust that every letter has to be documented. IMTS are efficient international consumer oriented payment mechanisms capabale of handling a very large number of small transactions that simply do not exist in the formal economy. In sum the above advantages of IMTS include, speed, lower transaction costs, cultural conveniences, versatility and potential anonymity. These have contributed to the underspread use of IMTS. III.1.2 Disadvantage of IMTS The qualities of simplicity and anonymity of the operations of the hawala system have also attracted individuals and groups engaged in criminal activities such as money laundering, gambling, smuggling or the financing of terrorism. IMTS reduce the reliability of statistical information available to policymakers. This effectively limits the significance of economic data 16

17 by underestimating the factors that affect certain economic aggregates, including national accounts with concomittant loss of accuracy in compilation IMTS transactions can affect the composition of broad money and thus have indirect effects on monetary policy. IMTS transaction could be expansionary of money supply and destabilize targets set for monetary aggregates especially as IMTS transactions are difficult to capture by the monetary authorities, let alone being subject to sterilization. IMTS transactions may influence exchange rate operations because they can affect the supply and demand for foreign currency. IMTS systems have negative fiscal implications for both remitting and receiving countries. Since informal funds transfers are conducted outside of the formal banking system activity, they are not subject to taxes on income and services. Like any underground economic activity, IMTS systems also entail a loss of business for the formal financial sector and thereby of potential government revenue. III. 2 Formal System III.2.1 Advantages Formal system enhance the development of potential of remittances and promote increased transparency and accountability in the remittance market. This positively affects not only the government and the financial sector, but also the individual remitters and their families. Formal methods of transferring remittances are preferable to informal ones because of their increased ability to foster development. The development aim to encourage savings and investment, or more 17

18 specifically, the channeling of remittances into savings and investment mechanism can be best facilitated and streamlined through formal channels that offer these financial services in conjunction with remittance delivery. Formal systems permit the transmission of high-value remittances necessary for development of institutions, businesses, and infrastructure. Example the electronic system operated by the Society for Worldwide Interbank Financial Telecommunication (SWIFT) III.2. Disadvantages of Formal System Formal system are subject to the hosting country s macroeconomic environment and government policies and regulations, such as currency controls and over-valued currencies, high tariffs and taxes, slow and expensive licensing process for financial institutions and repressive financial policies. Formal systems are slow, involving considerable volume of documentation or paperwork, which are more adversarial in tone. Every letter has to be documented, given the distrust prevailing in the modern financial world; and Formal systems can also be used for money laundering and financing of terrorism. It has been reported that the suspected hijackers of the airplanes involved in the September 11 attacks received and sent fund through Western Union and conventional banking facilities (Business Week, November 26, 2001, p.40; New York Time s, January 4, 2002). 18

19 IV. CONCLUSION Informal money transfer systems (IMTs) were developed centuries ago to facilitate the movement of money over long distances. Today, they remain in use and operate alongside the formal, conventional financial sector. They attract customers because of their simplicity, efficiency and speed of operations, reliability and low cost relative to most other available options in the formal systems. The growth of international remittances has been dramatic and this has been the major reason for the spread of IMTS beyond initial boundaries to become a global phenomenon. This is a market response by economic agents to the failure of conventional financial infrastructure in both developed and developing countries to offer efficient services needed by migrant workers. In many developing countries IMTs are likely the most crisis-proof part of financial infrastructure. However, the lack of transparency and accountability as well as government supervision raises the possibility of abuse of these formal and Informal remittance systems. 19

20 References 1. Adams, Richard H. and John Page (2003), International Migration, Remittances and Poverty in Developing Countries, Policy Research Group Working Paper 3179, Poverty Reduction Group, Washington D. C. 2. DFID (2003), Migrant Remittances to Developing Countries: A scoping Study: Overview and Introduction to Issues for Pro-poor Financial Services, London. 3. Erik Lueth and Marta Ruiz Arranz (2006), A Gravity Model of Workers Remittances, IMF Working Paper WP/06/290, Washington D. C. 4. L. Buencamino and S. Gorbunor (2002), Informal Money Transfer Systems: Opportunities and Challenges for Development Finance ST/ESA/2002/DP/26, DESA Discussion Paper No. 26, United Nations, November 5. M. CL Qorchi, S. M. Marinbo et. Al (2003), Informal Funds Transfer System An Analysis of the Informal Hawala System, IMF, Washington D. C. August 6. Orozco, Manual (2003), Changes in the Atmosphere: Increase in Remittances, Price Decline and New Challenges Paper for the Inter-American Dialogue Remittance Project, Inter-American Development Bank, Washington D. C. 7. Ralph Chami, A. Barajas et. Al (2008) Macroeconomic Consequences of Remittances, IMF, Washington D. C. Occasional Paper

21 8. Ratha, D. (2003), Workers Remittances: An Important and Stable Source of External Development Finance. Chapter 7, Global Development Finance, Washington D. C., World Bank. 9. Richard H. Adams, Jr. (2007), International Remittances and the Household: An Analysis and Review of Global Evidence, World Bank, WPS 4116, Washington D. C. February 10. World Bank, Crafting A Money Transfer Strategy: Guidance for Pro-Poor Financial Service Providers, Occasional Paper. 21