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Formal versus Informal Remittance Channels: An Overview

January 23rd, 2020

Apart from being a source of external finance in developing economies, inward remittances from expats account for a significant part of their household’s disposable income. With heavy dependence on money transfers, increasing attention is being paid to the size and impact of different channels. 

This raises the question – how did expats remit before they had access to formal remittance channels? They relied on travellers – often complete strangers – to take money home to their families. Today with the digital age influencing lifestyle decisions, governments are encouraging the use of formal money transfer services. However, informal remittance channels (such as the hawala system) continue to prevail due to multiple factors. 

What are the differences between the two? 

Here is a brief overview of how they operate along with the socio-economic factors that influence expats to choose one over the other.

What are the informal remittance channels?

In a nutshell, informal remittances are typically generated privately; through unrecorded channels. Initially, when legal money transfer services were unavailable or scarce expats had to rely on friends, travellers, or ‘hawala’ agents to do the job. There may be no empirical data to account for the amount of informal remittances that takes place globally, but this does not negate the fact that it continues to be an option for a plethora of reasons.

Informal remittances vary from region to region. Areas like Eastern Europe and sub-Saharan Africa see a much higher prevalence of informal remittance channels when compared to East Asia or the Pacific region. This is primarily driven by the lack of knowledge and trust in legal money transfer services.

  • The socio-economic background of the expat plays a pivotal role, along with the educational status of the recipient’s household. When remitting to rural areas, expats tend to think: ‘Why use legal remittance channels?’
  •  Laws and migration policies prevalent in the host country have a significant impact on the expat’s decision to send money back home.
  • When it comes to remittance channels, the financial background of the expat and his/her family back home plays a prominent role in influencing the expat’s decision. Factors such as having a bank account, cost, speed, convenience and security define whether an expat will prefer to use formal or informal remittance channels.

In the first quarter of 2019, the fee for sending US$200 as remittance to an LMIC (low- and middle-income country) was 7%. That is 4% higher than the targeted cost specified by the UN’s Sustainable Development Goals (SDGs). 

It is important to note, one of the most critical factors that lead expats to opt for informal remittance channels is the high cost of transferring funds through formal channels. But despite the cost involved, expats need to be aware of the drawbacks that come with using informal remittance channels. Yes, informal agents could do the job even for free, but there’s no denying how much is at stake. 

For an expat whose family back home lives on the remittance sent each month, there is no guarantee that the funds will be delivered on time. There is also the risk of the money being pilfered along the way. Informal channels are risky, time-consuming, and often more inconvenient than not.

So what benefits do formal remittance channels bring to the table?

According to the World Bank, remittance flows to LMICs were projected to touch US$551 billion in 2019, a 4.7% growth over 2018. The increasing volume of cross-border remittances has made way for institutions to speed up the process of delivery. Exceeding official external aid, since the 1990s, remittance inflows augment the GDP of developing nations. 

Technological advances and innovations within the industry significantly contribute to the enhancement of formal remittance transfers. However, an expat’s general payment behaviour and personal characteristics typically influence their choice of channel. Here’s how:

  • Financially literate expats are more likely to use formal remittance channels such as banks, mobile wallets, and money transfer services to send money home. 
  • Traditional financial institutions usually involve a higher cost and are preferred in the case of large amounts. 
  • The availability of ample money transfer services is essential. Xpress Money has 200,000 cash pickup locations worldwide, and allows money transfer to more than 170 countries. 

Remittance inflows provide income support to families, while also facilitating opportunities for education and healthcare. Government policies that permit nationals to open a favourable non-resident foreign currency (NRFC) account facilitate expats to use formal channels for money transfers. 

Also Read: How the remittance market fared in 2019 and what to expect in 2020

Some possible solutions

The global money transfer industry is working towards increasing the use of formal remittance channels. In spite of this, it is difficult to implement in the case of illegal immigrants who may not wish to identify themselves in the host country. 

However, some solutions at the macro level are working towards creating a more transparent and customer-driven market for expats. Money transfer operators such as Xpress Money have helped boost the efficiency of transfers at competitive costs. 

On a micro level, initiatives taken by formal financial institutions to speed up deliveries at a lower cost could help drive expats towards legal remittance channels. An excellent money transfer service will ensure that the money reaches the recipient within minutes, at a competitive cost. 

Encouraging expats with better options for money transfer is one of the most important ways to curb informal remittance channels. Formal channels offer the following benefits: