Topic 4 – Formal vs. Informal Remittances

Recently an increasing amount of attention has come to focus on the size and impact of informal remittances. While formal remittances refer to those remittances which enter a country through official banking channels, informal remittances include those money transfers which occur through private, unrecorded channels. Such private transfers include remittances brought home by friends, relatives and even the migrant himself/herself. While formal remittances to developing countries now total over $167 billion (2005) a year, the level of informal remittances is virtually unknown because they tend to flow through unrecorded channels. Estimates of the size of informal remittances vary widely, ranging from 35 to 250 percent of formal remittances.

In one of the few empirical attempts to estimate the size of informal remittances Freund and Spatafora (2005) use insights from the literature on shadow economies to estimate informal remittances for more than 100 developing countries. Results suggest that informal remittances amount to 35 to 75 percent of formal remittances to developing countries. Findings also suggest that the size of informal remittances varies by region: informal remittances to Eastern Europe and Sub-Saharan Africa are high, while those to East Asia and the Pacific are relatively low.

Other preliminary work suggests that the level of informal remittances also varies by type of migrant, that is, internal or international migrant. For example, a recent household survey in Ghana (Adams, 2007) found that while only 1 percent of internal migrants remit through formal channels (banks, Western Union, post offices), 43 percent of international migrants remit through formal channels. These figures are interesting because they reveal that fully one-half of all international migrants in Ghana prefer to remit through informal channels, namely, through friends and relatives.

One important factor causing migrants to remit through informal channels is the high cost of transferring funds through banks and transfer agencies. In 2000 the average cost of remitting money to 8 Latin American countries was above 10 percent of the amount being sent (Orozco, 2006). By 2006 the transaction cost of remitting money to these Latin American countries had declined to 5.6 percent, but still this figure is much higher than that charged by informal channels.

From a policy perspective, it is important to reduce money transfer costs in order to increase the amount of remittances returning through formal channels. Remittances sent through official banking channels can facilitate financial sector development in developing countries in a number of ways: (1) as bank deposits from remittances increase, banks are able to make more loans; (2) remittance receivers who use banks can gain access to other financial products and services; and (3) banks that provide remittance transfer services are able to “reach out” to unbanked recipients and those with limited financial intermediation (Aggarwal et al, 2006). Also, in economies where the financial system is underdeveloped, remittances made through official channels can help alleviate credit constraints and promote growth (Giuliano and Ruiz-Arranz, 2006).

Title
Topic 4 – Formal vs. Informal Remittances
Published
Social Science Research Council, March 2009
Citation
Topic 4 – Formal vs. Informal Remittances (Brooklyn, NY: Social Science Research Council, March 2009).