Remittances are the money or goods sent back home by migrant workers living in a foreign country. It is a fast-growing channel of payment that affects a country in various ways. Remittance flows are important to maintain economic stability and generate foreign exchange. However, the method of getting the money to family and friends is a hassle. Customers need to jump through hoops to make a transfer. The poor customer service in traditional remittance payment services left a gap for upcoming financial startups to grow and expand their business.
Although the startups have newer technology providing ease of transaction for customers, they are finding it difficult to establish themselves without proper funding from investors. Thus, leaving the customers with only the option of traditional payment systems. It is hard to tell who will come on top in this tug-of-war between traditional and new-edge remittance payment services. Let us consider the different factors that play a role in remittance disruption.
Traditional Versus Modern Remittance Models
Remittances are a high-volume low-margin form of income source for many developing countries. It is an evenly distributed source of income for developing countries as opposed to other sources of capital flows such as foreign direct investment. In low-income countries, remittances contribute to the gross domestic product of the country (GDP) constituting almost 6% of their GDP. However, much of this flow comes from informal channels making it difficult to calculate the total remittances acquired by a country.
The reason why customers are deterred from using formal channels for remittance payments is mainly because of poor customer service and greater inconvenience. But for many, remittances form the major source of household income and are indispensable. So, for those, remittances are continued to be paid through increasingly problematic formal channels.
Fintech entrepreneurs are jumping to the rescue by disrupting remittances and creating alternative systems for remittance payments. These options are more lucrative for customers as they offer better pricing, service, and experience. This is extremely beneficial for the global poor who can avail of these services at a cheaper rate thus increasing their overall income. Thus, remittances have greater implications for mobile financial services for financial inclusion in any developing country.
Migrant workers, international students, and others living in foreign countries send back money to family members and friends on a regular basis. These constitute the remittances of a country. However, sending remittances is not an easy process. Broadly, a typical remittance transaction is carried out following these steps:
- The migrant sender pays the sending agent the remittance in the form of cash, credit or debit card, money order, or check.
- The sending agency forwards instructions to its agents in the recipient’s country to deliver the remittance.
- The beneficiary receives payment through the paying agent.
The sender usually bears additional costs apart from the principal amount of remittance. This cost is borne by the migrant sender. Additional costs are incurred in the form of:
- The fee of the sending agent for providing this financial service.
- Currency-conversion fee to deliver local currency to the beneficiary.
- A fee may be charged to the beneficiary for collecting the remittance. This charge is in place to account for any unexpected change in exchange rates.
A remittance processing service provider thus generates profit from the rate charged for their services. Apart from this main source of income, they also earn an indirect source of income from interests by investing the amount of remittance before delivering it to the beneficiary.
Problems Faced by Traditional Remittance Systems
The traditional remittance systems which have been in place for so many years are glaringly problematic for customers. But in the absence of alternate options, these systems were able to continue their services. With the emergence of high-tech financial service providers, the problems with traditional remittance systems are becoming more evident.
The rates of sending agents are considerably higher which reduces the total amount received by the beneficiary. This is usually not a problem for large remittances where the transaction cost is only a fraction of the principal amount. Although for poor migrants sending money back home the transaction costs eat away at the principal amount. For smaller remittances (under $200), the remittance fee ranges between 10-20% of the principal.
Customers usually need to face a lot of hurdles before they are able to send back any remittance. They need to coordinate with receivers, locating branches in both countries that offer remittance services, paperwork, and red tape, and other factors that make the process of remittance payment long and unbearable.
What Can the Modern Remittance Systems Offer?
The environment of the remittance business is badly in need of disruption. As the full potential of remittances is not utilized due to poor customer management and improperly managed business models. The system is now being revolutionized with newer, faster fintech startups like mobile remittance startups. They have a lot of advantages over conventional systems. Some of them are as follows.
High-tech Financial Services
As technology advances, newer methods of financial services are introduced to the public such as mobile money and transactions over the Internet. These methods provide options for remote digital access to financial products. As opposed to traditional methods, these systems can transfer money remotely so that remittances can be paid from the comfort of your home.
Mobile money payments are becoming increasingly popular in developing countries. Following Africa’s 2015 smartphone record-breaking sales, the usage of mobile money increased rapidly thereby reducing the dependency on traditional financial service providers like banks, etc.
New Forms of Currency
Cash is now rapidly being replaced by new forms of currency which are digitally transferred. Cryptocurrency is one such example. It provides instant, point-to-point value transfer making highly intermediated correspondence channels obsolete. This novel form of currency offers an easier solution for both the customers as well as financial service providers who can reduce their cost of transactions using these methods.
Innovative Distribution Methods
Technology has not only eased the process of sending money, but now the receiver can also track payments through their mobile phones without having to physically go to banks or other financial service providers to collect remittance payments. Customers can even use their remittances directly from their online accounts to pay for merchants locally or pay any kind of bills.
The emergence of alternative financial service providers in the market results in greater options for customers to choose from. Companies like Xoom, Transferwise, WorldRemit, Azimo, etc. are giving tough competition to earlier remittance giants such as Western Union and Moneygram. The prevalence of multiple remittance service providers causes them to provide affordable rates and better services for any individual company to set afloat.
Improved Customer Service
The fintechs use newer, advanced technology to improve the customer experience at every step of the transactions. They use AI to solve various problems with the operations of many financial services. But one of its most visible outcomes is using AI to improve customer service. AI to improve customer engagement for BBVA Bancomer and Bancolombia is the first of its kind to be implemented and it has shown glorious results. The up-and-coming remittance service providers use these technologies to stand out and provide better services to customers.
Why are Investors Backing Away From Newer Remittance Services?
Although there is a gap to be filled in the remittance business, it is hard to set up a shop without strong investors. But investors are wary of betting their money on fintech startups without a strong cause. The new businesses are failing to attract the eye of investors because they cannot invoke the confidence of the investors because of the following reasons.
Branding Costs Money
The present remittance companies run on their brand image. They have already established their brand through many years of experience. It is not impossible to disrupt the remittance system but startups without enough capital cannot establish their own brand effectively. And without a brand, it is hard to invoke trust among customers.
A remittance company with customers naturally has an edge over other companies. But having a loyal and large enough customer base requires time and money, both of which are unavailable to startups and businesses in the seed stage. Investors are unable to judge the power and quality of customer acquisition of infantile companies with very few customers.
Customer acquisition is not enough to determine whether a company can handle a larger customer base.
Lower Prices are No Longer an Advantage
Many new companies who have based their business models around providing cheaper rates for their services are now finding themselves in a bind. Lower prices are not sustainable in the long run and with all companies using better technologies to provide cheaper rates, the lower prices of any one company do not provide a competitive edge anymore.
Lower prices for the same service are great for the customers but not so much for the remittance companies. This gave startups an edge against more established companies, but when the more experienced companies like Western Union reduce their prices, the newer companies will find themselves at a disadvantage. A better customer experience, convenience, and brand, along with proper pricing, will help remittance companies sustain themselves.
Established Challengers Using Cryptocurrency to Stay Ahead
The use of cryptocurrency has cost and speed advantages when it is used as part of the customer experience, but it is also a great tool to be used for back-end functioning. The use of cryptocurrency at the back end is most effectively done by the more established of new-tech companies.
The advantages of cryptocurrencies at the back end cannot be fully utilized by either the more conventional companies due to legal issues or remittance companies at the nascent stage of their business. Remittance service providers such as Transferwise, Xoom, and Azimo can incorporate the advantages of cryptocurrency without directly making them a part of the customer experience.
User Experience and Design
The newer companies are coming up with easier and better user experiences and designs but investors are still skeptical whether that is enough to acquire and retain customers in the long run. They argue that without proper brand and distribution, user experience and design alone will fail to sustain the company in the future.
Lack of Scaling in Most Remittance Strategies
Many of the remittance strategies prevalent in the market today have too narrow a corridor for a profitable business to grow out of it. For example, “directed remittances” depend heavily on the assistance of local vendors and utility and product distributor partnerships. Without the proper cooperation from these sources, it is impossible for a remittance service provider to grow.
Directed remittances refer to the direct payment of utility or necessary products from a foreign country. This includes health services, remote bill pay, etc. Although the scaling of directed remittances is slow due to dependence on external sources, some have been quite successful. For example, bundling mHealth info and microinsurance to improve health outcomes in Kenya has been triumphant. But this may not be the case for other services.
Scaling issues also arise when remittances are made strictly through a single method such as mobile money accounts. In order for this to succeed, people in the country receiving the remittances should all have access to mobile accounts. This will never succeed in a country where the majority are unbanked or still using traditional financial service systems.
Impacts of Remittances on the Economy
Where calculating the total amount of remittance worldwide is a challenge, calculating the impacts of remittances is even more complicated. Related issues of emigration, household characteristics, and specific needs based on composition are all interconnected making it difficult to judge the impact of remittances. Researchers used instrumental variable methods conducting natural and/or randomized experiments to accurately gauge the consequences of remittances.
On the micro-level, the effect of remittance on individuals and households is judged. At this level, remittances are quite useful in improving the living standards of single households by adding to their total income. This additional income results in better health and improved education. The money flow from remittance is helpful in stabilizing households during income shortfalls. As the extra income from remittance covers the cost of basics and essential goods, the savings are increased in households. The savings are then invested in better healthcare and higher education for children. Overall, the positive effects of remittance flow include higher savings, greater access to financial institutions, higher financial literacy, and larger investment opportunities.
However, the impacts are not all positive. Researchers are worried that remittance payments will breed a culture of dependency. When all needs of a household are met using the income generated from remittances, they are less likely to return to the workforce. As the budget constraints are eased through an income effect, members of the receiving household will be less likely to continue working. Remittances also have a substituting effect where household members have the incentive to reduce their working hours to continue receiving remittances.
The effect of remittance on the labor force is highly complicated as the reduction in labor participation depends on the type of work, gender, and age. It has been observed that in households receiving remittances, employment of children is likely to reduce, marginal types of employment also decline, whereas self-employment and employment of adults improve.
The changing pattern of consumption of receiving households is also a matter of concern for researchers and policymakers. It is observed that purchases of non-essential goods, exported goods, and products with high energy requirements are increasing among these households. This has a negative impact on the global environment.
On a macro-level, remittances have two major contributions: improving economic stability and the country’s creditworthiness. Remittances have proved to be an essential factor in maintaining the economic stability of the receiving country because of their resilience and countercyclical nature. This means that even at times of economic instability or when a country is hit with a natural disaster, the incoming flow of remittance does not fall as compared to other capital investments in a country. In fact, the remittances tend to increase in response to a crisis faced by the receiving country.
Due to the stable nature of remittances, even during periods of economic instability, the country’s credit rating is improved, providing a stronger base for future economic growth. Policies and incentives for emigration and, in turn, increasing remittance are how a country can tap this source of capital flow into the country. They have invested in improving institutional frameworks and educating potential migrants to increase the remittance inflow.
But the cons of higher incoming remittances at a micro-level also impact macro-level outputs. Reduced labor participation from individual households adds up when judged on a country level which might result in a drastically reduced labor supply. The development of problematic consumption patterns results in declining savings and ultimately affects future investments. At an aggregated level, remittances can reduce the competitive edge of a country in world markets. This happens because of its impact on exchange rates, increasing prices of locally produced goods, and overconsumption of non tradable goods. However, the negative impacts are more prominent for smaller economies rather than larger economies.
Frequently Asked Questions
Q1. How do remittances help a country?
Remittances bring foreign currency into the country. This constitutes a large and stable source of foreign exchange in a country which promotes economic stability, improves a country’s credit rating, and encourages the inflow of new investments. It improves the overall well-being of individuals, improves financial literacy, and greater capital accumulation in terms of savings and investments.
Q2. How do remittances affect the economy?
Remittances have both positive and negative impacts on the economy of a country. It leads to a reduced labor supply, unsustainable consumption patterns, and the development of a culture of dependency. Remittances have also been linked to reduced savings which could potentially have become investments in the future. As a source of foreign investment, remittances result in greater prices of domestic goods as their effect on exchange rates.
Q3. What are examples of remittances?
Remittances include any form of payment completed between the payer in one country and the payee in another country. Examples of remittances include:
- Sending money on a regular basis back to your home country while you are abroad.
- International students availing of money transfer services.
- Paying bills and invoices from abroad via cheques.
- Sending gifts and other one-off funds abroad.
When compared between traditional and modern remittance systems, the latter has proved to be more beneficial for customers and businesses alike. But establishing a remittance company with cutting-edge technology is extremely difficult in this competitive market especially with investors being skeptical about investing in new startups. Already, governments encourage workers to emigrate to increase the remittance inflow but the process is hampered if customers face a lot of difficulties while sending home money. Considering the benefits a country enjoys from migrant workers sending home money, the government should provide incentives and assistance for the blooming of new fintech companies.
However, if you want to know who the true winner is in this competition, it is the customers who benefit from having multiple options, reduced prices, and improved customer experience.
- Jonas Taylor is a financial expert and experienced writer with a focus on finance news, accounting software, and related topics. He has a talent for explaining complex financial concepts in an accessible way and has published high-quality content in various publications. He is dedicated to delivering valuable information to readers, staying up-to-date with financial news and trends, and sharing his expertise with others.