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Migrants and diasporans, some doing numerous jobs, often send a substantial part of their hard-earned cash to their relatives and friends in their country of origin. Known as remittances, these transfers have not only grown in volume over the decades but, unlike foreign direct investment, remain a steady financial flow in both tough and stable times.

The World Bank estimates that global remittances sent through formal channels in 2015 were near US$600 billion, with developing economies estimated to have received more than $440 billion of this amount. Many economists furthermore assume that the amount of money sent through informal channels – cash taken back in the pockets of friends for example – at the very least equals this formal flow.

The sheer volume of money this represents, which is greater than official development aid and foreign direct investment flows to many countries, has put remittances at the centre of the global development agenda. Their flaws notwithstanding, which I’ll briefly discuss later on, they remain a vital source of funds for many families around the world. Yet their transaction costs remain high – one reason why so much of this money is transferred informally – and new, creative thinking is needed to reduce these costs and to better leverage these flows for the betterment of poor communities around the world.

Expensive aid

The reduction of remittance transfer costs is included in the UN’s sustainable development goals (SDGs), which aim to reduce transaction costs to 5% or below by 2030. The average price in June 2015 was above 7.6%, and the price varied considerably depending on the method of transfer. Remittances sent through banks were the most expensive, with costs averaging around 11% in early 2015. Post offices and money transfer operators like Western Union were less expensive, averaging 5.1% and 6.4% respectively, but both remain above the SDG goal.

Migrants, diasporans, and the poor are those most disadvantaged by high transaction fees.

The transaction cost of sending remittances varies by destination as well. For instance, a recent World Bank report states that South Asia is the cheapest region for receiving remittances, at an average cost of around 5.7%, while in some parts of Africa the overhead can reach as high as 20%. The costs are particularly high on remittances sent within the continent.

There are numerous reasons as to why costs vary to such an extent, including a lack of transparency in the remittances eco-system and the incapability of consumers to compare prices in real time, leaving them to the very limited expensive options. 

Those disadvantaged by these high transaction fees tend to be migrants and diasporans, who often hold low-paid jobs and work in poor conditions, together with their poor families and friends back home. Reducing transaction costs to 5%, for instance, could translate into US$4 billion in savings, annually, for low-paid migrants, diasporans, and their relatives abroad. This would not only provide more income for recipients or reduce the financial burden for senders, but it could also result in potential investment and opportunities for job and wealth creation.

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Importance of remittances

For countries with extremely poor economies, coupled with inadequate official development aid (ODA) and foreign direct investment (FDI), remittances are lifelines for the poor. This is the case for Somalia, devastated by years of conflict and economic hardship. Over $1 billion is remitted to the country annually from Somali diaspora. This money is often spent on basic consumptions such as food, education and healthcare.

Many other countries benefit from remittances, especially during politically or economically turbulent times. Indeed, the volume of remittances tends to grow during major disasters or economic hardship. For instance, according to the African Development Bank, remittances sent to Sierra Leone rose by 50% between 2013 and 2014 when the Ebola outbreak struck. Our recent AFFORD Business Centre study, assessing the impact of the Ebola outbreak on business in Sierra Leone, supports these findings. We found that more Sierra Leoneans in the UK (28% of the survey sample) remitted between £1,000 and £1,999 during the outbreak, compared to 16% prior to the outbreak.

Remittances aren't a silver bullet for addressing poverty, but with new thinking their challenges and flaws are solvable.

It’s important to remember that remittances do not provide the silver bullet to addressing poverty in developing countries. To some extent, remittances have the tendency to promote a dependency culture by recipients and curtail labour supply. For non-recipients, remittances have the propensity to encourage dysfunctional migration and social inequality. Take the example of someone who has no one abroad, but sees the difference remittances are making in the lives of their neighbours. This individual will likely be tempted to travel abroad to reap similar benefits. It is thus no surprise that thousands of young Africans have embarked on precarious journeys, including via the deadly and unforgiving Mediterranean Sea, in search of a better life.

That being said, the challenges and flaws relating to remittances are solvable. New thinking is required and innovative solutions are needed if the transformative impact of remittances is to be fully realised. Part of the solution lies in the implementation of policy to increase transparency and competition, as an enabler in the reduction in transaction costs.

More can be done though. In terms of the African corridor, with the high transaction fees and millions of people using mobile phones, an opportunity exists for cross-border remittances to be sent via use of mobile technology. Given that mobile money transfers are already happening in individual countries, there is clearly scope to expand this regionally. This will require global and local banks to improve their ability to collaborate in order to maximise the use of this new technology.

In addition, there is also an opportunity to develop platforms to support the transformative impact of remittances for specific charity giving from abroad. These would target programmes that are directly linked to the SDGs. Over a decade ago GK Partners and the African Foundation for Development (AFFORD) designed an innovative scheme called RemitAid, which aimed at addressing the imperfections of remittances while enhancing the positive effects. One aspect of these scheme was to create incentives to remit for certain types of expenditure. For example, if a remittance was aimed at improving access to education or health the sender would benefit from a gift-aid type scheme where 25% would be reclaimed.

RemitAid was never piloted, but schemes like these could go a long way toward encouraging remittances, enhancing their effects, and widening the pool of beneficiaries from individual households to entire communities. The volume of remittances has the power to change many lives and help alleviate poverty. But a cohesive global approach, backed with innovative solutions, is need to accelerate the transformative impact of remittances to support the SGDs.