A recent debate in the literature is the extent to which remittances can promote access to financial services and financial development. This is an important question considering the extensive literature that has documented the growth-enhancing and poverty-reducing effects of financial development. However, how remittances impact financial development is complex issue. Early work on the link between remittances and financial development was mainly descriptive in nature and suggested that remittances may be a potential catalyst for financial development by providing migrants’ families with increased demand for credit and other financial services. In addition, remittances can also affect banks willingness to loan money to households in remittance receiving areas. Risk can play a central role in low-income environments. A high default rate may reduce the willingness of banks to lend to poor households, and may also reduce the demand for credit among poor households who do not want to lose their collateral.
In recent work, scholars have attempted to directly measure the link between remittance flows and financial development using existing data sources. Aggrawal, Demirguc-Kunt and Peria (2006) find that remittances promote financial development in a large sample of developing countries. Their study also highlights several potential channels through which remittances can affect financial development. Remittances may increase financial development by paving the way for recipients to demand and gain access to financial services. For example, remittance receipts are often lumpy, and may lead to a higher demand for formal financial services such as savings products. An additional possibility is that remittances can provide financial institutions with information about remittance-receiving households, previously excluded from the formal banking sector, leading to the expansion of credit for small business start-up capital and other investments. Transaction fees associated with remittance flows may also spur the expansion of financial institutions into previously underserved areas.
A key question raised in the literature is whether there are limitations to the financial deepening impact of remittances in countries with less-developed financial systems. In particular, where trust in financial institutions is low, recipients may prefer to save outside the formal banking sector. In addition, where financial systems are less-developed, migrants and their families tend to rely mainly on informal channels to transfer and save resources. However, Gupta, Pattillo, and Wagh (2007) find that remittances have a positive impact on financial development in sub-Saharan Africa, a region where a large share of financial transactions takes place outside the formal sector. Their study documents that remittances promote financial deepening in this region, and their results hold even after accounting for the possibility that reported remittances are likely to be higher in better-developed financial markets.
Finally, one possibility is that remittances may relax credit constraints among recipients lowering the demand for credit and insurance services. In an important contribution, Guiliano and Ruiz (2005) find that in countries with less-developed financial systems, remittances can act as a de facto substitute for financial services, providing households with credit and insurance and increasing investment opportunities, leading to higher growth. Due to data limitations, there are very few studies that allow researchers to study the impact of remittances on financial development by creating counterfactuals with and without remittances.