Remittances: a window to the future?

Last year, foreign workers sent $401 billion in remittances to friends and relatives in developing countries. Remittance flows increased by 5.3% last year – and they are expected to do so again, rising 8.8% to reach $515 billion in 2015. In total, there are believed to be about 215 million international migrant workers out there, with a further 700 million internal migrants also remitting funds, according to estimates provided by the World Bank.

Over the past decade or more, the banking industry has made considerable strides in addressing this market, which it had hitherto left to the money transfer companies. As early as November 1999, HSBC announced a free international money transfer service for US customers sending funds to Latin America.

Since then, the main issue has been how to bring costs down and present a better deal to consumers. The main stumbling block has been the cost of FX, which has never been very transparent and which has been the subject of allegations of rampant overcharging. Today, two other forces are pushing change in the cross-border payments space. These are regulation, and the entry of new competitors to the market.

Competing visions

Traditionally, Western Union has played a major role in the international cross-border payments space. The firm has 510,000 agents worldwide and is active in 200 countries. Its strong presence on the ground has long been recognised as one of the company’s main advantages – a recipient in Romania for example can collect their international money transfer from 5,700 locations. However, it has long been criticised for being expensive and for being vulnerable to exploitation by money-launderers – complaints that have opened the door to competition from alternative providers.

Launched in December last year, Azimo is a UK-based money transfer tool that markets itself as the cheapest, safest and easiest way to send money to family members in the developing world. Instead of having agents on the ground in recipient countries, Azimo uses on digital technology such as smartphones and social media tools like Facebook as the means for cross-border money transfer to 125 countries. According to Michael Kent, chief executive at Azimo, the firm’s low-cost business model means that it can offer a service 85% cheaper than both Western Union and the main high street banks.

“The big firms are wedded to a cash-based, agent model,” he said. “But the problem is, that’s just not relevant to the way people live today. People are using Facebook and Skype to talk to their friends and family back home. We go direct to the customer. We have customer support, but we don’t have bums on seats. It’s a different value proposition.”

Azimo offers to send £500 to Poland for £6.25. For comparison, Western Union promises to send cash amounts up to £700 from the UK to Poland for £3.90 – but this figure does not include the cost of FX. The difference between the two firms highlights the debate over lack of transparency on FX, and the impact that has on pricing. According to Azimo, once the cost of FX is taken into account the true cost of making the transfer would actually be £32.64 via Western Union, and as much as £42.50 at a generic high street bank.

At Barclays, most international payments will incur a basic £25 fee – but further charges may be imposed to cover fees imposed by the foreign bank to process the payment. The value of these charges varies from country to country, bank to bank and sometimes even between different regions of the same country, meaning that the full cost may not be clear to the consumer at the outset. Meanwhile, HSBC provides international money transfers at an FX rate that refreshes every 90 seconds.

“There’s a perception that people don’t understand FX,” said Michael Kent, chief executive at Azimo. “That’s so outdated, paternalistic and it’s not true. Western Union reported a $1 billion profit last year to shareholders, in the teeth of a hideous recession. Firms such as Barclays pay a fraction of a basis point for FX, and then give it to their customers at 3.15%. That’s 3,500% mark up. The reality is it can be done so much cheaper. Bill Gates said last year if the cost could be brought down from 10% to 5%, it would free up $16 billion a year that can be used on poverty eradication in the developing world. It’s a straight transfer of value from Western Union to some of the poorest people on the planet, and that’s quite a nice thing to be involved in.”

In its defence, Western Union is moving towards a multi-channel approach (Banking Technology, February 2013). The company supports mobile transfer, in which customers in the UK can send money to recipients in 15 different countries, including Kenya. It is also moving away from cash towards account-to-account transfer, through partnerships with banks such as Unicredit in Italy and Banco Transylvania in Romania, both of which signed deals with Western Union last year. The company has also hired approximately 600 extra staff to handle compliance, and claims to have shut down parts of its business that didn’t have the structure necessary to handle the AML components necessary for compliance.

Robin Hood’s arrow

Regardless of the evolution of individual companies, the current average transaction cost worldwide is 7.8%, according to figures provided by Neil Burton, head of product strategy at cross-border payments company Earthport. That represents only moderate progress towards the target set by G8 development ministers in July 2009, which called for the commission charged on making remittances to be halved, from the 2009 average 10% to 5%, within five years. According to Burton, this represents a real missed opportunity to improve the flow of funds to the developing world.

“Since the average fee paid by a sender is up to 9%, for most of the 28 countries where remittances account for more than 5% of Gross National Income, fees amounting to around 0.5% of GDP are lost to intermediaries,” he said.

Remittances currently account for a varying share of GDP in the recipient countries. In Tajikistan, remittances accounted for 47% of GDP in 2011, while other countries with the highest share of GDP from remittances include Liberia, Kyrgyz Republic, Lesotho and Moldova, according to figures provided by the World Bank. The largest flows overall went to India, China, the Philippines and Mexico, with $69 billion directed to India alone and a further $60 billion to China.

In recognition of the increasingly important role remittances play in modern society, governments such as the US have been keen to legislate better conditions for the consumer. However, many financial institutions have been gravely concerned about the upcoming US Dodd-Frank Remittance Regulation 1073, which states that payment service providers are required to disclose all the fees that would apply to a cross-border transaction, including fees at the beneficiary bank and any relevant taxes, to the customer in advance.

The rules are problematic for banks, partly because of the difficulty of working out some of the components in advance. For example, the rate of currency exchange can be virtually impossible to pin down in advance. The exchange could take place in the US, but if the currency denomination of the recipient account is unknown the transaction will be carried out in US dollars and therefore may still need to be converted. In addition, taxes may differ even between different provinces in the recipient country.

“For example, if a German customer is charged credit fees by their bank, that’s done in euros – but the payment service provider has to estimate the cost, and it may differ depending on the recipient bank and a whole host of other factors,” said Greg Murray, head of US dollar wire and clearing products, global transaction services at Bank of America Merrill Lynch. “Smaller banks may struggle to find the resources to deal with these requirements – and that’s where we can help.”

In April, Bank of America Merrill Lynch launched a new service designed to help smaller banks cope with the new Dodd-Frank rules. BAML’s solution was to create a database of fee and tax information, which it then extends to client banks through an API web service, BAML Information Exchange for Payments. BAML also operates a white label web application FXtransact White Label, which banks can use to enter the data relating to a cross-border transaction, and BAML will fill in the fee and tax details for them, and provide the disclosure form required by the Dodd-Frank regulation. The service is currently being implemented by clients. BAML will not charge a separate fee for the service; instead it will be included depending on which package its customers have chosen.

“By adopting our solutions, our clients have the ability to make payments within the new regulatory framework in more than 140 currencies, including the US dollar, across 200 countries and territories,” added Murray.

Lights red to green

Under amendments published at the beginning of this month by the US Consumer Financial Proection Bureau, remittance service providers would no longer be required to provide information on the foreign taxes imposed at the sub-national level. According to the World Bank study, this suggests that RSPs would effectively not be obliged to provide the exact amount to be collected by the recipient, thus removing one of the major objections to Dodd-Frank 1073.

In addition, a further provision – that if a consumer makes a mistake and submits the wrong details for a transfer to their bank, and the bank carries out the instruction as requested, the bank is liable for the mistake – has now been scrapped under the amendments, following strong opposition from financial market participants. Taking into account the proposed changes, the World Bank has voiced its support for the rule and recommended that it be implemented without delay. Yet some observers still have severe reservations about the likely impact of the new rules, and their wider implications outside the US.

“In the US, politicians imposed Dodd-Frank Section 1073, the unintended consequences of which resulted in amendment, delay and cost,” said Burton at Earthport. “We might see European regulators doing the same. The risk of regulatory intervention is arguably bigger, and might well be best headed off. It would be far better if, in Europe, a consensus solution could be found to the transparency and predictability need. I often use CLS as an example – a massive success which arose from collaboration not regulation and led by the late Mr Allsopp from the Bank of England.”

Given the size of global remittance flows and their distribution into small instalments, handling workers remittances reliably may present a challenge to some large financial institutions. Workers sending remittances typically make their payments 10-14 times per year, with the average amount transferred in the US typically around $300, according to Inter-American Development Bank. That has led some observers to claim that banks might be disintermediated if they do not update their technology to handle the expansion in remittance volumes.

“Bank systems are antiquated,” said Azimo’s Kent. “Teams of people manually input and check numbers multiple times as they are passed around various systems – all adding to the cost and the risk of human error. Western Union agents typing in bank codes while selling people cigarettes or newspapers and cannot be relied upon to carry out the task correctly either. If you want the money to get reliably to Ghana or Democratic Republic of the Congo 100% of the time, you have to do a lot of work to automate your systems.”

Azimo’s solution is to ping 25 databases to make sure it is capturing the right information; it is also moving away from batch processing of FTP files towards direct integration with customer APIs.

However, not everyone agrees that non-bank organisations are in a position to disintermediate the banks. Pointing out that non-banks must still operate within the compliance rules applicable to international payments, including standards on anti-money laundering and know your customer, Burton at Earthport suggests that the need for banks and the expertise they can provide is not likely to recede any time soon.

“Partnership and industry collaboration seems the most likely route going forward for serving the remittances segment, whether to share investment and operational costs, or for speed to market,” he said. “But in order to do this, Regulated Payments Service Providers need access to bank accounts. If the banks choose not to host accounts for these firms, then those organisations are in effect also financially excluded.”