metadata: authors: 0: author: Beck, Thorsten
1: author: Martinez Peria, Maria Soledad
count: World
docna: 0: docna: What explains the cost of remittances ? an
            examination across 119 country corridors
docty: Policy Research Working Paper
theme: Other financial and private sector development
subtopic: Private Sector Economics,Reproductive Health,Early Child and Children's Health,Educational Sciences,Private Sector Development Law,Marketing,Inequality,Financial Literacy
teratopic: Macroeconomics and Economic Growth,Health, Nutrition and Population,Finance and Financial Sector Development
abstracts: cdata!: Remittances are a sizeable source of
            external financing for developing countries. In the LAquila
            2009 G8 Summit, leaders pledged to reduce the cost of
            remittances by half in 5 years (from 10 to 5 percent). Yet,
            empirically, little is known about what drives the cost of
            remittances. Using newly gathered data across 119 country
            corridors, this paper explores the factors that determine
            the cost of remittances. Considering average costs across
            all types of institutions, the authors find that corridors
            with larger numbers of migrants and more competition among
            remittances service providers exhibit lower costs. By
            contrast, remittance costs are higher in richer corridors
            and in corridors with greater bank participation in the
            remittances market. Comparing results across all banks and
            all money transfer operators separately, the analysis finds
            few significant differences. However, estimations for
            Western Union, a leading player in the remittances business,
            suggest that this firms prices are insensitive to competition.
repnme: repnme: What explains the cost of remittances ? an
            examination across 119 country corridors
display_title: What explains the cost of
            remittances an examination across 119 country corridors
listing_relative_url: /research/2009/10/11202109/explains-cost-remittances-examination-across-119-country-corridors
topicv3: Private Sector Development m1326060 1921,Infant and Child Mortality m1326544 1446,Poverty m1326687 695,Education m1327048 470,Financial Literacy m1504979 3391
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Macroeconomics and Economic Growth,Health, Nutrition and Population,Finance and Financial Sector Development
no_of_pages: 31
model_extractions: WPS5072 Policy Research Working Paper 5072 What Explains the Cost of Remittances? An Examination across 119 Country Corridors _Thorsten Beck María Soledad Martínez Pería_ The World Bank Development Research Group Finance and Private Sector Team October 2009
Policy Research Working Paper 5072

# **Abstract**

Remittances are a sizeable source of external financing for developing countries. In the L’Aquila 2009 G8 Summit, leaders pledged to reduce the cost of remittances by half in 5 years (from 10 to 5 percent). Yet, empirically, little is known about what drives the cost of remittances. Using newly gathered data across 119 country corridors, this paper explores the factors that determine the cost of remittances. Considering average costs across all types of institutions, the authors find that corridors with larger numbers of migrants and more competition among remittances service providers exhibit lower costs. By contrast, remittance costs are higher in richer corridors and in corridors with greater bank participation in the remittances market. Comparing results across all banks and all money transfer operators separately, the analysis finds few significant differences. However, estimations for Western Union, a leading player in the remittances business, suggest that this firm’s prices are insensitive to competition.

This paper—a product of the Finance and Private Sector Team, Development Research Group—is part of a larger effort in the department to understand the factors that drive the cost of remittances across corridors. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted atmmartinezperia@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **What Explains the Cost of Remittances? An Examination across 119 Country Corridors**<sup></sup>

Thorsten Beck Tilburg University and CEPR María Soledad Martínez Pería The World Bank

>  We thank Subika Farazi and Diego Anzoategui for excellent research assistance. We are grateful to Harald Anderson and Ziya Gorpe for help obtaining data. We received helpful comments from participants at the Second International Conference on Migration and Development, at the World Bank International Conference on Diaspora for Development and from World Bank colleagues in the Finance and Private Sector Development Research Group and in the Payment Systems Unit. This paper’s findings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.
# **I. Introduction**

In 2008, remittances to developing countries reached $328 billion dollars, more than twice the amount of official aid and over half of foreign direct investment flows (World Bank, 2009).<sup>1</sup> Numerous studies have shown that remittances can have a positive and significant impact on economic development along a number of dimensions including: poverty alleviation, education, entrepreneurship, infant mortality, and financial development to mention a few.<sup>2</sup> But remittance transactions are known to be expensive, with estimates averaging 10 percent of the amount sent (World Bank, 2008).<sup>3</sup> At the same time, there is a wide dispersion in these costs across corridors, ranging from 2.5 percent to 26 percent of the amount sent. Furthermore, case studies have shown that remittances flows are very sensitive to costs and are likely to increase significantly as costs go down (see Gibson, McKenzie and Rohorua, 2006).

In the L’Aquila 2009 G8 Summit, leaders pledged to reduce the cost of remittances by half (from 10 to 5 percent) in 5 years.<sup>4</sup> Yet, empirically, little is known about what drives the cost of remittances.<sup>5</sup> Is the problem of high costs mostly due to sending country or recipient country factors? Are high costs related to socio-economic factors, industry market structure, or government policies and regulations? Are there significant differences between banks and money transfer operators (MTO)? Given the importance of remittances for many developing countries, explaining the variation in costs is of interest for academics and policy makers alike.

1http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/0,,contentMDK:21122856~pa gePK:64165401~piPK:64165026~theSitePK:476883,00.html 2 For example, see Adams and Page (2003), Adams (2005), IMF (2005), Lopez-Córdova (2005), Maimbo and Ratha (2005), and Taylor, Mora, and Adams (2005) for studies on the impact of remittances on poverty. Studies such as Cox-Edwards and Ureta (2003), Hanson and Woodruff (2003), López-Córdova (2005), and Yang (2005) find that by helping to relax household constraints, remittances are associated with improved schooling outcomes for children. Remittances have also been shown to promote entrepreneurship (see Massey and Parrado, 1998; Maimbo and Ratha, 2005, Yang, 2005; Woodruff and Zenteno, 2006). Furthermore, a number of studies on infant mortality and birth weight have documented that, at least in the Mexican case, migration and remittances help lower infant mortality and are associated with higher birth weight among children in households that receive remittances (see Kanaiaupuni and Donato, 1999; Hildebrandt and McKenzie, 2005; Duryea et al., 2005; and López-Córdova, 2005). Aggarwal, Demirguc-Kunt, and Martinez Peria (2006) show that remittances can have a positive impact on financial development.

> 3 See the World Bank Remittance Prices website at www.remittanceprices.org.

4 See paragraph 134, page 49 of the L’Aquila 2009 G8 Summit.

http://www.g8italia2009.it/static/G8_Allegato/G8_Declaration_08_07_09_final,0.pdf 5 Orozco (2006) and Freund and Spatafora (2008) are the exception, but their data is limited to few countries or few providers. While Orozco’s work focuses exclusively on Latin America, the second study analyzes only the costs of remittances sent from the US and the UK exclusively via MoneyGram or Western Union to 66 countries.

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Using a new dataset assembled by the World Bank Payment Systems Group on the cost of remittances across 119 country corridors, this paper explores the factors that drive remittance costs.<sup>6</sup> The corridors studied include 13 major remittance sending countries and 60 receiving countries, representing approximately 60 percent of total remittances to developing countries. Because our data are by corridor, we are able to conduct a bilateral analysis of costs, as opposed to simply looking at costs aggregated at the receiving or sending country level. Furthermore, contrary to previous studies that have only focused on a certain type of remittance service providers (in particular the largest international money transfer operators), the data used here pertain to the largest providers in each corridor, be they money transfer operators, banks, post offices, etc.<sup>7</sup> At the same time, we are able to conduct our analysis both averaging across all types of providers and separately for banks and money transfer operators, thus allowing us to compare the determinants of the costs of remittances across different institutions. Finally, by analyzing the costs charged by Western Union across 98 corridors (80 percent of the sample), we are able to abstract from concerns of bias due to differences across firms (since we are looking at the same provider across corridors) and we are able to shed light on what drives the costs charged by a leading remittance service provider with worldwide operations.

We distinguish between three groups of factors as potential drivers of the cost of remittances. First, we consider the role of socio-economic characteristics of sending and receiving countries that might influence fees through their impact on costs incurred by remittance service providers, including the number (stock) of migrants, the level of economic and financial development, and the share of rural population within each corridor. Second, we examine the role of factors that might affect the ability of remittance service providers to set prices like the extent of competition, the market structure, and the level of education of the migrant population. Third, we assess the impact of government policies in different areas including exchange rate policies, capital controls, and regulation of remittance service providers.

Estimations of the cost of remittances across all types of remittance service providers show that corridors with a larger number of migrants and more competition exhibit consistently

> 6 The original World Bank database contains information on 134 corridors. We lose 13 corridors - those where Russia is the sending country- due to missing exchange rate spread data,  plus 2 other corridors where there is missing information for some explanatory variables.

> 7 On average, in each corridor between 8 and 10 providers are included. In some corridors, primarily those including the US and Spain as sending countries, the number of providers surveyed exceeds 10.

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lower costs. On the other hand, remittance costs are higher in richer corridors and in corridors with a higher share of banks among providers. Bank and MTO costs are associated with similar factors. In particular, across both types of institutions costs are higher in corridors with a smaller number of migrants, higher levels of incomes, and a larger participation of banks. As before, competition lowers costs charged by banks and MTOs at large. On the other hand, in the case of Western Union, costs appear to be insensitive to competition, perhaps a symptom of this firm’s role as a leader in the remittances market.

This paper is a first exploration of corridor variation in the cost of remittances and, therefore, is subject to certain caveats. First, this is a pure cross-sectional analysis, and we can only make limited, if any, inference on causality. Second, our analysis is also limited in scope since it includes only data from formal providers of remittance services. According to some estimates, at least a third of remittances are sent through informal channels (Freund and Spatafora, 2008). Notwithstanding these limitations, we believe the paper offers some interesting evidence that we hope will stimulate further data collection efforts and analysis.

The rest of the paper is organized as follows. Section II describes the data on the cost of remittances. Section III explains the empirical approach. Section IV presents the results, and Section V concludes.

# **II. Data on the cost of remittances**

The data we use on the cost of remittances come from a recent survey of remittance service providers conducted by the Payment System Unit of the World Bank. The cost of remittances is made up by a fee component and by an exchange rate spread component. The original World Bank data cover 14 sending and 72 receiving countries. However, because spread information is missing for remittances sent from Russia and due to missing data for some explanatory variables, we focus on 119 corridors, including 13 sending countries and 60 receiving countries (see Table 1).<sup>8</sup> In most cases, data cover the costs from the main sending location/area for the corridor in question to the capital city or most populous city in the receiving market. Data were collected by

> 8 The full data is available at <u>www.remittanceprices.org. Data on exchange rate spreads is also missing for some</u> institutions in Germany, France, and Japan. These institutions are excluded from the calculations of the average remittances costs from those countries.

4
interviewers posing as customers and by contacting individual firms. Within each corridor, the data were gathered on the same day to control for exchange rate fluctuations and other changes in fee structures. In general, cost data were collected for 8 to 10 major service providers in each corridor, including both the main money transfer operators (MTO) and banks active in the market.<sup>9</sup> Companies surveyed within each segment were selected to cover the maximum remittance market share possible.<sup>10</sup> Costs based on two amounts were surveyed per corridor: the local equivalent of US$200, and the local equivalent of US$500. Because previous studies have found that a typical remittance transaction involves sending close to US$200, we conduct our analysis based on the costs associated with this amount.<sup>11</sup> Furthermore, the costs of sending US$200 and US$500 (expressed as a percentage of the amount sent) are highly correlated (the correlation is 0.91), so we do not expect results to vary significantly if we use costs based on the higher amount.

Table 1 shows the average and median costs (based on transferring US$200) in each of the 119 corridors, calculated across surveyed remittance service providers in each corridor.<sup>12</sup> Average and median costs are highly correlated (96 percent). The average remittance costs are lowest in the Saudi Arabia-Pakistan corridor (2.5 percent) and highest in the Germany-Croatia (25.8 percent) corridor. Across all corridors the average mean cost is 10.2 percent. The median costs are lowest in the Singapore-Bangladesh corridor (2.3 percent), highest in the GermanyCroatia corridor (25.9 percent), and average 9.8 percent across all countries. Averaging costs for each sending country, we observe that costs are lowest for transfers initiated from Saudi Arabia (3.9 percent) and highest for transactions originating in Japan (17.8 percent).

There is significant heterogeneity in costs even when we consider the same sending or the same remittance-receiving country. For example, Figure 1 shows the costs associated with sending remittances from the US to 22 receiving countries, while Figure 2 shows the costs associated with remittances received by India from 8 sending countries. Figure 1 shows that the

> 9 The actual number of respondents by corridors varies depending on the number of firms active in the corridor. In some cases (like the Spain-China corridor) only 2 firms are included, while in others, like the US-Mexico corridor, the number of respondents climbs to 18.

> 10 Unfortunately, information on the market share covered by each provider is not available.

> 11 Freund and Spatafora (2008) use the same amount in their study.

> 12 Note that the averages reported are not weighed. That is, the costs from each remittance provider are averaged without taking into account their relative market shares, which we do have not available.

5
costs of remittances sent from the US vary between 3.7 percent to Ecuador and 14.1 percent to Thailand. Figure 2 shows that remittances’ costs to India vary between 3.1 percent from Saudi Arabia and 13.3 percent from Germany. This variation underlines the importance of conducting the analysis of cost of sending remittances at the corridor rather than at the sending or recipient country-level.

There is also variation in remittance costs across different types of providers. Table 1 shows the average costs across corridors separately limiting the sample to all banks, all money transfer operators (MTOs), and Western Union, respectively. On average, we find that banks charge significantly higher fees than MTOs (12.4% vs. 8.8%). This, however, does not control for the fact that banks and MTOs are not active in all corridors and that different banks and different MTOs are active in different corridors. When we focus on the corridors where both types of institutions are present, we find that in 43 out of these 63 corridors, average costs for banks exceed those for MTOs. Furthermore, when we regress costs at the provider level on a set of corridor dummies and a bank dummy, we find that bank costs are, on average, three percentage points higher than MTO fees. At the same time, relative to the average costs charged by other MTOs, Western Union exhibits slightly higher costs. The average cost for this institution is 10.8 percent, relative to 8.8 percent for all MTOs.

# **III. Empirical Methodology**

To examine the determinants of remittance costs, we regress the average cost of sending remittances on a set of sending and receiving country characteristics, as well as on some corridor-specific variables captured by the matrix X in equation (1) below: _C_ ij =  0 +  1 _Sending country factors_ i +  2 _Receiving country factors_ j +  3Xij+ uij (1) where _C_ ij is the cost of sending $200 US dollars from country i to country j (expressed as a percentage of the amount sent). Table 2A provides the summary statistics and data sources for each of the variables included in the estimations, while Table 2B reports correlations across all variables.

In estimating equation (1), we try to capture an array of factors that might influence remittance costs. First, we include several socio-economic variables that might influence 6
remittance prices through their impact on transaction costs incurred by remittance service providers. In particular, we include a proxy for the volume of remittance transactions within corridors: the number (bilateral stock) of migrants residing in country i originally from country j. This data comes from the World Bank.<sup>13</sup> Unlike the flow of actual remittances sent, this variable is less likely to be endogenous to the cost variable. We conjecture a negative relationship between migration and the cost of remittances, as a higher volume might imply scale economies and more competition among service providers. The number of migrants is negligible in the South Africa-Zambia corridor and exceeds 10 million people in the case of the US-Mexico corridor. The average for this variable is 379,199 migrants.

We also include GDP per capita, proxying for the level of economic development and standard of living in a country. This variable comes from the World Bank’s World Development Indicators Database. In countries with higher standards of living the cost of goods and services will be higher, so we expect remittance costs to be higher as a result. On the other hand, economic development may be associated with greater efficiencies and lower cost of financial intermediation (Harrison, Sussman and Zeira, 1999) and, hence, lower remittance costs. In our sample, GDP per capita for receiving countries varies from US$148 in Malawi to close to US$14,000 in Korea. Among remittance sending countries, GDP per capita varies between US$3,640 for South Africa and US$40,200 in Japan. In some estimations, we separately control for the level of financial development by including a measure of liquid liabilities to GDP. This variable comes from the World Bank Financial Structure Database (see Beck, Demirguc-Kunt, Levine 2009). A priori it is unclear whether financial development should have a positive or negative impact on costs. On the one hand, more financially developed systems are likely to be more sophisticated and to offer better services, which might be more expensive. On the other hand, more financially developed systems may be more efficient and might be able to deliver services at lower prices to consumers. The ratio of liquid liabilities to GDP in receiving countries varies from 15 percent for Algeria to 126 percent for Jordan and the average is 48 percent. Among sending countries, the ratio of liquid liabilities to GDP varies from 44 percent in South

> 13 See Ratha and Shaw (2007).

> http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/0,,contentMDK:21154867~pag ePK:64165401~piPK:64165026~theSitePK:476883~isCURL:Y,00.html

7
Africa to 199 in Japan. The average ratio of liquid liabilities to GDP among sending countries is 99 percent.

The geographic distribution of the population in both sending and receiving countries might also be an important driver of the cost of sending remittances, as a more sparsely distributed population might be harder to reach and, therefore, imply higher transaction costs. We use the share of rural population in both sending and receiving countries to proxy for the disparity in geographic distribution.<sup>14</sup> These data come from the World Bank’s World Development Indicators. Among receiving countries, the percentage of rural population varies from 13 percent in Lebanon to 87 percent in Uganda. On average, 48 percent of the population in receiving countries lives in rural areas. In contrast, on average, only 21 percent of the population in the sending countries is considered rural. This variable ranges from 0 for Singapore to 40 percent for South Africa.

To measure access to financial services more directly, in some estimations, we also control for the number of bank branches per capita in sending and receiving countries<sup>15</sup> We expect that this variable will have a negative association with the costs of sending remittances, as higher branch penetration will reduce transaction costs and increase scale. Among receiving countries, the ratio of branches per capita averages close to 6 per 100,000 inhabitants, while it averages close to 34 per 100,000 inhabitants in sending countries.

Second, we include proxies for factors that might influence the degree to which remittance service providers can determine prices. We posit that providers will be better able to influence prices if there is little competition in the remittance market and if costumers are not well informed. Because we do not have a direct measure of competition among remittance service providers, we use two different indirect measures. For each corridor, we include the number of remittance service providers in the database. We speculate that since the World Bank survey tries to cover the most important providers in a corridor, corridors where more providers

> 14 We consider the share of rural population a better proxy to capture the effect of service delivery than population density, which is an average within a country and does not take into account, which share of the population actually lives in more remote areas.  However, we also tried the population density variable, with similar findings. 15 These data come from Beck, Demirguc-Kunt and Martinez Peria (2007) and can be found at ~ <u>http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEARCH/0,,contentMDK:20652043 pagePK: 64214825~piPK:64214943~theSitePK:469382,00.html. Because these data are available for a reduced number of</u> corridors, we do not include this variable in all estimations.

8
are included have more active firms and, hence, other things equal, we would expect these corridors to be more competitive. On average, across all corridors, the number of respondents is 8 and it varies between 2 in the Spain-China corridor and 18 in the US-Mexico corridor.

We also include a direct measure of competition among banks in both receiving and sending countries. The rationale for including this variable is that more competitive banking sectors are going to offer cheaper services, including remittances. This will create pressure for other providers to lower costs as well. Of course, this implicitly assumes that banks are significant players in the remittance business.

Following Panzar and Rosse (1982, 1987), we compute the _H-statistic_ , which measures the degree of competition by calculating the elasticity of the total interest revenue of banks with respect to input prices.<sup>16</sup> Under perfect competition, an increase in input prices raises both marginal costs and total revenues by the same amount and, hence, the H-statistic will equal 1. In a monopoly, an increase in input prices results in a rise in marginal costs, a fall in output, and a decline in revenues leading to an H-statistic less than or equal to 0. Panzar and Rosse (1987) show that when H is between 0 and 1 the system operates under monopolistic competition. We expect a negative relationship between the H-statistic in sending and receiving countries and the cost of sending remittances. We use data for the period 1994-2006 from Bankscope to compute the H-statistic. Among both remittance receiving and sending countries, the H-statistic averages close to 0.53. But as expected the standard deviation is larger for the latter.

As an alternative measure of market structure in the remittance industry, we include the share of bank respondents among all remittance service providers in the database. To the extent that, as some have argued, banks view remittances as a marginal product and are less likely to offer competitive prices for this product (Ratha and Riedberg, 2005), we expect to find a positive correlation between the share of bank respondents and the average cost of remittances. Across the 119 corridors the share of bank respondents varies from 0 in the Italy-Sri Lanka corridor to 100 in the South Africa-Swaziland corridor. On average, the ratio of bank respondents across corridors is 31 percent.

> 16 Other studies that use this methodology to estimate competition include: Bikker and Haaf (2002), Gelos and Roldos (2002), Claessens and Laeven, (2004), and Levy-Yeyati and Micco (2007).

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Another factor that can affect the extent to which providers can influence prices is the level of financial literacy of remittance senders. Since we cannot capture this directly, we include a measure of the level of education of migrants in each corridor. In particular, we include the ratio of migrants with a secondary and/or tertiary education over the total number of migrants from the receiving country, residing in the sending country. This variable comes from the OECD Database on Immigrants and Expatriates. We expect this variable to be correlated with financial literacy and, to the degree that financial literacy enables consumers to make better informed choices, costs should be lower. The ratio of secondary and tertiary educated migrants varies from 21 percent for Chinese migrants in Italy to 91 percent for Nigerians residing in the US. Because this variable is only available for 88 out of the 119 corridors for which we have cost data, we do not include it in the baseline regressions, but only show it as an additional variable.

Third, we control for different government policies relating to the exchange rate, the capital account and the regulation of the remittance market. We include a dummy variable for receiving countries with pegged exchanged rates (including cases of no separate legal tender, currency boards or _de-facto_ pegged regimes). Lower exchange rate volatility should reduce costs, by lowering the exchange rate spreads and we, therefore, expect this dummy to be negatively associated with the cost of sending remittances. At the same time, we expect the cost of sending remittances to be higher in countries that impose controls on remittance transactions, since these operate like a tax that is likely to be passed onto recipients. Both the dummy for pegged exchange rate regimes as well as the capital controls dummy come from the IMF Annual Report on Exchange Arrangement and Restrictions. In 39 corridors (close to 33 percent of the sample) there is no exchange rate variability (since the exchange rate is pegged or the economy is fully dollarized) and in 22 corridors (18 percent of the sample) there are controls on gifts from abroad.

Finally, we control for the breadth of regulation of remittance service providers in sending and in receiving countries by creating an index of regulation which can take values from 0 to 5 depending on whether providers must be: (a) registered, (b) licensed, (c) are subject to specific safety and efficiency requirements, (d) need to comply with AML regulations, and/or (e) need to comply with laws and regulations of general applicability. Data to create the indexes 10
come from Global Payment Systems Survey 2008, conducted by the World Bank.<sup>17</sup> While a broader regulatory framework might make the remittance market more transparent and more competitive, greater exposure to regulations can also increase the costs on the regulated institutions, so that the impact is a-priori ambiguous.<sup>18</sup> Among remittance receiving country the index averages 2.2, while it averages 2.3 among remittance sending countries.

The correlations in Table 2B indicate that the average costs are lower in corridors with a higher number of migrants, lower GDP per capita, smaller share of rural population, no exchange rate variability, and lower level of financial development. Also, costs are lower in corridors where there is a higher degree of competition and a lower share of bank participation in the remittance industry. Finally, costs are lower in corridors where sending countries have a broader regulatory framework for remittance service operators. We also note that some of the explanatory variables are highly correlated with each other. For instance, GDP per capita levels in receiving and sending countries are significantly correlated with the levels of financial development, competition among providers, the share of rural population, branch penetration and the breadth of regulations for remittance service providers.

# **IV. Empirical results**

Table 3 shows that, across all providers in 119 corridors, remittance costs are significantly associated with a number of factors, most notably: the number of migrants in the corridor, the level of income in remittance sending and receiving countries, the extent of competition among providers (measured either by the number of respondents or the H-statistic for the banking sector in receiving countries), and the extent of bank participation in the remittance market. Specifically, corridors with higher income levels in both sending and receiving country and a greater bank participation in the remittance market exhibit significantly higher average remittance costs, while corridors with a higher number of migrants, a higher number of market players, and greater bank competition in the receiving country exhibit significantly lower average costs. There is also some evidence that receiving countries with a higher share of rural

> 17 The report can  be found at:

> http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTFINANCIALSECTOR/EXTPAYMENTREMMITT ANCE/0,,contentMDK:21813290~noSURL:Y~pagePK:210058~piPK:210062~theSitePK:1943138,00.html

> 18 Note that the index does not measure the severity of regulations, but only the scope of the regulatory framework.

11
population (where presumably access to financial institutions is more limited) face higher costs. On the other hand, we find no robust association between costs and measures of exchange rate stability, the presence of capital controls on remittances or the breadth of regulation of remittance service providers. Finally our measure of migrants’ education level does not enter significantly, suggesting that the educational attainment of the principal clients does not affect the pricing behavior of remittance service providers.

These results are not only statistically, but also economically significant. Take the example of the number of migrants, an increase from the corridor at the 25<sup>th</sup> percentile (United Kingdom-China with 56,774) to the corridor at the 75<sup>th</sup> percentile (Spain-Colombia with 384,621) results in a drop in average fees per transaction of approximately 1.8 percentage points. A similar change in the number of respondents (from 6, the 25<sup>th</sup> percentile to 10, the 75<sup>th</sup> percentile) leads to a drop in costs of close to 1 percentage point. Even stronger, an increase in the percentage of banks among survey respondents from the 25<sup>th</sup> (0 percent) to the 75<sup>th</sup> percentile (50 percent) can lead to an increase in costs of over 4 percentage points. Note that the average cost across corridors is close to 10 percent, so all these effects are considerable.

Table 4 shows results for median remittance costs, as opposed to average costs, across all types of providers. In general, the results found for average costs are confirmed when we focus on median costs. In particular, remittance costs are lower in corridors with larger number of migrants, lower levels of income, and greater competition. However, some results like the association between costs and receiving country GDP per capita weaken and others like the correlation between the share of rural population and costs disappear.

Next, we examine the factors that influence the cost of remittances across different types of providers. Tables 5 and 6 show separate estimations for the average costs among banks and MTOs, respectively. In Table 5, the dependent variable is the average cost across all bank respondents in a corridor. Since there are corridors where banks do not play a significant role in the remittance market (and, hence, were not included in the database), the sample size drops in Table 5 compared to Table 3. Most of the results discussed so far hold when we restrict our sample to banks only. In particular, we continue to find that a larger number of migrants and lower levels of income in sending and receiving country are associated with lower costs. Also, 12
as before a higher share of banks among respondents is positively correlated with costs. On the other hand, the measures of competition do not enter significantly anymore, a result that appears to be due to the lower number of observations.<sup>19</sup> We also find that broader regulation in the sending country is associated with lower remittance cost of banks.

Table 6 shows that most of our findings are confirmed when restricting the sample to money transfer operators exclusively. A larger number of migrants and greater competition is associated with lower costs, while corridors with higher levels of income and bank participation exhibit larger costs. Unlike the regressions of Table 5 for banks, limiting the sample to MTOs only confirms all the findings of our baseline regressions in Table 3.

Table 7 shows results for Western Union, one of the largest MTOs in the world, active in 98 corridors of our sample. Focusing on one specific financial institution allows us to control for any bias that might arise from having different institutions across different corridors (composition bias), even within the group of banks and MTOs. Considering the cost data from Western Union, we verify that a larger number of migrants and lower GDP per capita in the receiving and sending country seem to lead to lower costs. In addition, we find that no exchange rate variability (as a result of a peg or dollarization) is also correlated with lower costs. On the other hand, contrary to previous estimations, none of the competition related indicators enter significantly, which could be due to the fact that Western Union has a dominant position in the remittance business across most corridors.<sup>20</sup>

# **V. Conclusions**

This paper investigates the characteristics of sending and receiving countries that explain the large variation across corridors in the cost of remittance transactions. We find that remittance costs are associated with three main factors. First, the number of migrants is negatively and significantly associated with remittance costs across different samples and different providers. This seems to suggest an important volume effect that works either through scale economies and/or higher competition in a larger market. Second, corridors with higher income per capita in

> 19 We establish this by re-running the regression for the average fee across all providers for the same sample as used in Table 5.

> 20 This could be due to the fact that Western Union may have been in operation in some corridors for longer periods than other firms. Also, in some countries, Western Union could have a better network coverage than other providers.

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both the sending and receiving country exhibit, on average, higher costs, which could reflect higher costs of non-tradable goods, such as services, in general. Third, competition and market structure matter, except in the case of Western Union. Corridors with a larger number of providers and countries with more competitive banking sectors exhibit lower costs. On the other hand, costs are higher in corridors with a higher share of banks among providers.

It is also interesting to note which factors do not enter significantly. In particular, we did not find any evidence that regulation, exchange rate stability, capital controls or financial literacy seem to matter. Therefore, while it is feasible that some of this might be due to the fact that the variables we use to capture these policies are imperfect, the evidence so far indicates that efforts by policy-makers to reduce remittance costs should focus on improving competition in the remittance market.<sup>21</sup> While we think this paper offers some interesting findings regarding a very important topic, it is only a first exploration into what drives remittance costs. We hope that future research will be able to exploit panel variation to get deeper at the issues, while at the same time addressing some of the limitations of the existing analysis.

> 21 It is unlikely that policy-makers would try to lower income levels or increase the number of migrants in a corridor simply to lower remittance costs.

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