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International remittances

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This Knowledge Paper makes an effort to elucidate the concept of remittances in the international context and is focused on the remittances sent by emigrants to their families back home, for domestic consumption and investment. The paper highlights the significance of International Remittances... to the global economy, details existing business models, and examines emerging trends as well as challenges faced by an industry which is to poised to play a bigger role in the globalization process.

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International remittances

  1. 1. International RemittancesUniversal Banking Solution System Integration Consulting Business Process Outsourcing
  2. 2. “Remittance is the act of transmitting money to a Migrant-receiving country:distant location to fulfill an obligation” • Availability of employmentThis Knowledge Paper makes an effort toelucidate the concept of remittances in the • Friendly migration policiesinternational context and is focused on the • Shortage of skilled resourcesremittances sent by emigrants to their families • Financial liberalizationback home, for domestic consumption andinvestment. The paper highlights the significance • Abundance of natural resourcesof International Remittances to the global A few examples of such corridors (sendereconomy, details existing business models, and country-receiving country) are Mexico-US,examines emerging trends as well as challenges South Asia-UAE and India-US.faced by an industry which is to poised to play abigger role in the globalization process. Impact on Global EconomyRemittances Overview This section highlights the magnitude and impactIn this globalizing world, migration of people of increased migration on the world economy.from one country to another for employmentopportunities has become a common The World Bank estimates that remittancesphenomenon. Dominant migration corridors have in 2009 totaled $420 billion - out of whichbeen formed between various countries/regions. $317 billion went to developing countries - andThis is primarily due to the socio-economic involved some 192 million migrants or 3.0% ofconditions prevailing in the migrants’ countries the world population.of origin and destination. A few examples: Figures 1 and 2 respectively depict the remittancesMigrant-sending country: of top remittance sending and receiving countries• Lack of job opportunity for 3 consecutive years.• Lower wage rates Figure 3 expresses the quantum of this incoming• Social insecurity money as a percentage of GDP thereby indicating• Political instability its significance to the destination country’s overall• Extreme geographical conditions development. (Source: World Bank website)Figure 1 Top Remittance-Sending Countries (figures in US $ million) International Remittances
  3. 3. Figure 2 Top Remittance-Receiving Countries (figures in US $ million)Figure 3 Remittances as a Percentage of GDPOperating Models in the Remittance Business banks globally, through which remittance transactions are routedAn International Remittance business may followthe conventional banking model or any of the Figure 4 illustrates the Nostro-based setup,non-banking models. wherein the Beneficiary Bank has an account with the Correspondent Bank, while Figure 5Conventional Banking Model shows the generic process involved in a remittanceIn this model, an end-to-end remittance transaction transaction based on a Nostro account model.involves the following parties:• Remitter’s Bank - the bank where the remitter has an account that is debited for transferring money to the beneficiary• Beneficiary’s Bank - the bank where the beneficiary of the remittance has an account that is credited for the remittance money received• Correspondent Bank (only in cases where the above-mentioned entities do not have a direct business tie-up) - an intermediary bank which has associated with various Figure 4 Nostro-based setup International Remittances
  4. 4. Non-Banking Channels Non-banking players play a vital role in the remittance space and have a larger share in the Global Remittance business than conventional banks. These entities operate in various forms: Money Transfer Operators MTOs (Money transfer Operators) like Western Union and Money Gram have a network of agents across the globe and serve as non-bank remittance channels. The remitter can visit an MTO outlet and pay cashFigure 5 Remittance Transaction Process in a in foreign currency to send money to any part ofNostro-based Setup the globe where the MTO’s agent is present. TheModes of Remittance receiver can visit the MTO agent at his location and collect the money in local currency.There are various Origination Modes, which are Figure 6 depicts the process for an Internationalused by the remitter to transfer money. Remittance transaction effected through an MTO.The remitter can issue a remittance request tohis bank eithera. by visiting the branch and furnishing a Remittance Instruction Form prescribed by the Remitting Bank, bearing all details necessary for effecting the remittance along with an account debit mandate orb. by dropping a cheque from an account with the Remitting Bank along with the Remittance Instruction FormBased on the details in the form, the Remitter’sBank debits his bank account and sends aSWIFT message to transfer the money to theBeneficiary’s Bank. Figure 6Listed below are the various DisbursementModes of remittance using which the moneycan be tendered to the beneficiary. The settlement between the MTOs in the two countries takes place through their partner1. Direct Credit to the beneficiary’s account banks. On receiving the remittance amount in with the Beneficiary Bank cash from the remitter, MTOs deposit those2. Disbursement of Cash to the beneficiary on funds in their local bank accounts. MTOs furnishing appropriate photo - identification/ request their bank to transfer the consolidated address proof in the event of his not having amount to the bank account of the MTO agent a bank account in the receiving country. In order to minimize3. Transfer of Money by the Beneficiary costs, only the net amount (total amount to be Bank to the beneficiary’s account with sent to the recipient country minus total amount some other local bank using the local to be received from that country) is sent. payment mechanism Please note that the beneficiary receives the money much4. DD issuance in the name of the beneficiary before the settlement between the MTOs International Remittances
  5. 5. Figure 7 Fund Movement for an MTOCosts have started spending on advertising and brand building.The fixed costs incurred by an MTO arelisted below: 4. Compliance and Regulatory Costs Various mandatory compliance/regulatory1. Origination and Disbursement Agent procedures in the remittance business are Network Costs listed below. Expenses involved in following Setting up agency networks/outlets in the them form a sizeable part of the total cost. country of origination and disbursement • KYC of Remitter / Beneficiary forms a significant portion of an MTO’s To prevent practices like transfer of costs. Though traditionally, MTOs have had money between anti-social elements, proprietary agents, of late, third party agents the “Know Your Customer” checks are have also been appointed by Western done by the Remitter’s and the Union and Money Gram. While these agents Beneficiary’s Bank. KYC would typically receive a fixed minimum compensation, involve obtaining documents such as major incentives are linked to the number photo-ID, address proof, passport and value of transactions. The MTOs thus details, driving license details etc. share the risk of expanding their network with these partners. • Regular Reporting of Transaction Details to the Central Bank2. Processing and Money Transfer Costs Central Banks place limits on the value of an individual’s remittances within a These are the fees to be paid to the certain time frame. local bank which buys and sells various Additionally, institutions are also international currencies, on behalf of the supposed to comply with Anti-Money remittance service provider. These costs are Laundering requirements and report linked to the aggregate transaction value any suspicious/fraudulent transactions and MTOs with large volume transactions to the Central Bank. could negotiate lower fees. 5. Administrative and IT costs3. Marketing Costs The MTO will also have to bear office This simple transaction processing business maintenance expenses as well as system has now become commoditized and players development and maintenance costs. International Remittances
  6. 6. Risks Exchange Houses Exchange Houses are extensively used forCurrency Hedging remittances from the Middle East. Unlike theWhen there is an International Remittance banking channel, this channel is based ontransaction through an MTO, there is a time lag Vostro accounts i.e. the accounts maintainedbetween fund availability to the recipients by exchange houses with various banks in(money is generally received the same day) the beneficiary countries. These accounts areand actual international transfer by the MTO’s pre-funded by the exchange houses.partner bank through its Correspondent Bank The Remittance Transaction Process(generally takes 3 business days). This impliesa currency rate risk which is borne by the MTO. Step 1 The remitter deposits the remittance money in the overseas currency in cashSalient Features of the MTO model at the Exchange House counter.1. It is the fastest mode of transfer since the Step 2 The exchange rate and the transaction beneficiary can receive the money within fee are communicated and confirmed seconds after it is sent. over the counter.2. People without bank accounts can also Step 3 The beneficiary account details are transact in this model. provided by the remitter.3. The cost per transaction is lower compared Step 4 The exchange house instructs the to other models. Beneficiary Bank with whom it has a4. MTOs have the biggest market share in the tie-up for transferring the requisite remittance business. amount in the beneficiary country’s5. Setup costs are high, acting as a barrier for local currency using one of the new entrants. following modes:Figure 8 depicts the Vostro-based setup wherein the Correspondent Bank has an account with the Beneficiary Bank a. E-mail: The exchange house sends Costs: The costs involved are similar to that of e-mail to the Beneficiary Bank the MTO channel. instructing it to transfer the amount to the furnished beneficiary account. Salient Features of the Exchange House Channel b. Integration of exchange house and Beneficiary Bank systems 1. Since the Vostro accounts are pre-funded, the beneficiary amount is paid based c. Beneficiary Bank’s proprietary on the funding in this account. Hence, remittance platform on receiving the Exchange House’s International Remittances
  7. 7. instruction, the beneficiary receives the costs amount almost instantaneously. 1. Creating a network of banks in the countries of origination and disbursement would be2. The Exchange House has to fund its a major cost. account with the Beneficiary Bank; hence the latter enjoys the float. 2. The cost involved in creating and maintaining a robust and scalable IT platform would also3. The Exchange House can draw a DD on its be significant. Vostro account in favor of the beneficiary and hand it over to the remitter over the Salient Features of the Online Model counter, which can then be dispatched by 1. Transaction is effected from the convenience courier or even sent along with a friend of one’s home. travelling back home. Alternatively, the DD can also be drawn in favor of the 2. The transaction can be effectively tracked. remitter, who can then carry it back to his 3. TATs are on the higher side (3 to 5 home country on his return and get it working days). cleared there. This is a secure option for 4. The remitter has to undergo a one-time blue collar workers who would otherwise registration process which has a TAT of 4 to have to travel with hard cash. 5 working days.Emerging Non-Banking Channels White Label Platform ProvidersOnline Channels A White Label Platform provider is a variant of the online platform channel, wherein a thirdOnline Players, which provide platforms party enables banks and FIs operating in theencompassing the entire remittance process, remittance corridors to launch remittanceare a recent development. They have created services by providing the following:global networks with banks/FIs in origination • A gamut of innovative products basedand destination countries. From the comfort of on the latest demand, which could behis home, the remitter can initiate a remittance further customized to meet specificrequest by registering himself on the online requirements of banks and end customersentity’s website and furnishing his and the in various geographiesbeneficiary’s bank account details. • Best-in-class technology for new age businessThe Remittance Transaction Process • Marketing and sales support for promoting the product rangeStep 1: Select the recipient country and enter the amount to be remitted • 24*7 operations support in case the client proposes to outsource transaction processingStep 2: Choose the mode in which the recipient • Round the clock customer service through would receive funds toll-free numbers, email support and online • Cash pickup live chats • Direct deposit into bank account • Built-in international compliance and regulatory practices • Cash delivery to the recipients home • Adherence to the best practices in IT securityStep 3: Choose a payment method to confirm Costs: the money transfer 1. The major cost involved is in hosting and Through a card or by debiting his account maintaining the platform. with the local bank in the remitting country 2. Marketing expenses form a significant part ofStep 4: Notify the recipient about the transaction the total cost. International Remittances
  8. 8. Salient Features of a White Label Platform b. Offer high-level reach and scalabilityProvider c. Bring about efficiency in operations1. The provider need not be part of the d. Ensure more consistent and faster banking/financial domain. delivery of remittance services2. Without investing in technology and This system is currently being evaluated by operations, banks and FIs can use this leading banks and institutions, which provide plug-and-play offering to provide world-class remittance services. remittance services.3. It provides all the advantages of an online 6. Online offerings on the originating side are platform channel to the end customer. expected to increase in importance, in line with the growing education levels and4. The platform provider’s economies of scale computer proficiency of immigrants. reduce the per-transaction cost. 7. Increasing Role of Software and AnalyticalEmerging Trends in the Remittance Business Tools1. MTOs are leaders in the remittance space, In addition to SWIFT and the local payments but are being challenged by other channels. system in destination countries, which form the IT backbone for the remittance2. The following are turning out to be decisive business, in-house systems are also being factors while choosing a remittance provider: used to streamline various processing stages a. Transaction cost involved in a remittance transaction. Also, b. Exchange Rates several CRM and web analytics software c. User-friendly procedures are being used by the service providers d. TAT of the transaction to analyze the transaction data for the e. Transaction tracking mechanism following purposes: f. Reach in the destination country a. Understanding customer behavior b. Understanding business cycles3. Agent exclusivity, one of the strong competitive advantages of MTOs on both c. Segmenting customers the remitting and receiving side of money d. Launching products targeted at specific transfers, is eroding and agents are customer segments increasingly shifting away from the exclusivity e. Designing marketing campaigns and arrangement. incentive schemes for specific customer segments4. To increase their market share, conventional banks are leveraging their existing client f. Aligning sales force and customer support relationships and are coming up with channels for better customer service innovative offerings such as prepaid g. Effective customer due diligence through cards for the beneficiary. This enables them i. Transaction monitoring to provide account-to-cash and cash-to- cash offerings to the customer, allowing the ii. Customer screening against published beneficiary to withdraw cash in tranches. black lists iii. Identification of risks and suspicious5. SWIFT has come up with a Workers’ transactions Remittances solution for banks and FIs for settlement of cross-border person-to- 8. Role of Central Banks in Recipient person payments. It aims at providing a Countries standardized, off-the-shelf operational and technical framework to Central Banks in recipient countries are a. Connect new entities playing the role of facilitator and promoter International Remittances
  9. 9. to extract maximum benefit from the • The number of migrants is inversely opportunities provided by International proportional to the remittance costs across Remittances. They are: different regions and service providers. This seems to suggest an important volume a. Allowing migrant workers to open foreign effect that works either through scale currency accounts so that economies and/or higher competition in a large market. - their earnings could be retained in foreign currency and can be exempted from • Corridors with higher income per capita in foreign exchange regulations both the sending and receiving countries, exhibit on an average, higher costs, which - better interest rates could be offered and could reflect higher prices of non-tradable the interest income could be made tax free. goods, such as services, in general. b. Facilitating securitization of the future • Competition and market structure matter. flow of remittances, which will result Corridors with a larger number of providers in a better sovereign rating enabling and countries with more competitive local banks to raise cheaper and banking sectors exhibit lower costs. On the long term finance needed for the other hand, costs are greater in corridors country’s development. where banks have a higher share in the remittance business.Challenges Faced by the Industry b. Grey Channela. Transaction Cost The Grey Channel eats into a significant The cost that the remitter has to bear varies share of the remittance business. Apart from 2% of the remittance amount and from the threat it presents to the established may go as high as 10%, depending on the players, it also poses a security threat following factors: since the money remitted could be used for anti-social purposes. Since this channel 1. Exchange rate margin of the service does not have to comply with any regulatory provider procedures, it offers lower transaction costs 2. Fixed fee being charged by the service and faster TATs to the remitter. provider 3. Tax incurred c. Reconciliation of Remittance Transactions 4. Origination mode (Online, branch etc.) Since a remittance transaction flow involves chosen by the remitter processing by multiple parties, a significant 5. Disbursement mode (Cash, DD, other percentage of transactions are non-STP banks’ account etc.) chosen by the remitter due to various reasons such as incorrect 6. Revenue sharing arrangement between submission of details, account closure by the Correspondent Bank and the beneficiary, system errors, manual errors by Beneficiary Bank operations staff and communication gaps between the parties involved- such as failureCentral Banks have constantly endeavored to to convey information regarding changedbring down the costs. procedures -resulting in breach of TATs and customer dissatisfaction.In October 2009, The World Bank DevelopmentResearch Group published a paper on factors d. Revenue Sharing Arrangementinfluencing remittance costs based on datagathered across 119 country corridors. This report In the absence of a globally adoptedreveals the following trends which could help standard model, the revenue-sharingaddress the issue. arrangement between the Remitter’s Bank, International Remittances
  10. 10. Correspondent Bank and Beneficiary Bank Vostro - Local currency account maintained by is ad hoc, resulting in disputes and at times, a local bank for a foreign (correspondent) bank. disengagements between the parties. For the foreign bank, it is a Nostro account.Moving Ahead…. SWIFT - Society for Worldwide Interbank Financial Telecommunication supplies secure messagingThough the International Remittance industry services and interface software to wholesaleis out of its infancy, it is still evolving and financial entitiescatching up with the globalization process. TAT - Turn Around TimeRoadblocks and unaddressed issues continueto exist. The pace of reform is slow and the GDP - Gross Domestic Productbusiness is still commoditized. Several political, FI - Financial Institutionsocial and economic factors defining thebusiness will have to be gradually tackled through DD - Demand Draftvarious initiatives like CRM - Customer Relationship ManagementüPromoting liberal movement of labor KYC - Know Your Customerü progressive regulatory changesBringing Central Bank - The body which regulates theüDelivering services efficiently banking industry within a countryüIncreasing market penetration STP - Straight through Processingü products appropriatelyPricingüManaging customer relationship ReferencesüDeveloping innovations in technology Web-based research on many sites including theü up a cost-effective operationalSetting following:infrastructure 1. www.worldbank.orgPlanned and focused efforts in the above areas 2. www.swift.comcombined with political will and business 3. www.westernunion.comacumen would help this industry leap forward and 4. www.moneygram.comcontribute significantly to the globalization process. 5. www.m2inet.icicibank.co.inGlossary and Abbreviations 6. www.remit2home.comRemitter - Person working abroad who intends 7. www.xoom.comto send money across the border to his familymembers back homeBeneficiary - Person who receives money from Authorthe remitter Akhil NikamNostro - A banking term to describe an account Senior Consultant - Finacleone bank holds with a bank in a foreign country, Infosys Limitedusually in the currency of that foreign country International Remittances