The remittances market is too big to ignore, but with more providers entering the market and with banks struggling to respond to new regulations, how can banks stay relevant?

Social media users may have noticed messages popping up on their screens advertising a 'cheapest, safer and easier' way to transfer money abroad. This ‘best in class’ transaction is now possible thanks to a new online app developed by UK-based start-up company Azimo. The app can be used from Facebook to deliver funds to any bank account or to one of more than 150,000 cash payout locations around the world, allowing the user to see exactly how much the recipient will get.

Intriguingly, Azimo claims to be up to 85% cheaper than other established providers. Michael Kent, founder of the company, says that because competition is weak, there are great business opportunities in the remittance space.

Cause for concern?

Banks, as well as existing money transfer companies Western Union and its smaller competitor Moneygram, should be concerned. Others have entered this market with success. San Francisco-based Xoom, for example, has a similar business model to Azimo and has recently gained a Nasdaq listing.

What if established providers end up being priced out of this crucial market, which has until now provided healthy margins as well as access to new customers? Banks in the US, in particular, will have to adapt to new regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act, which demands full transparency on the cost of remittances transactions. This will also apply to their correspondent banks around the world. While banks will struggle to comply with these regulations, the remittance market is too big to ignore.

According to the World Bank’s estimates, the total value of workers’ remittances reached $406bn in 2012, almost 7% higher than the previous year. Forecasts between now and 2015 see growth accelerating further. Other estimates are even higher, and bring last year’s total to well over $500bn. Even at the lower end of the scale, this represents more than three times the size of official aid to the developing world, points out Dilip Ratha, who manages the World Bank’s migration and remittances unit, as well as its Global Knowledge Partnership on Migration and Development initiative.

The World Bank also estimates that the global cost for emigrants’ money transfers is about 9% per transaction, with a peak of 12.4% in sub-Saharan Africa, the most expensive region in the world to send money. When it comes to sending money out of a country, the poorest record belongs to Tanzania, with a rate of 22.38%. Both the G-8 and G-20 countries have established 5% as the target average remittance cost to be reached by 2014. Those percentage prices take into consideration any typical flat fee and percentage fee on foreign currency services, and vary according to the size of the transaction too.

Western Union and Moneygram say their efforts to reduce prices have lowered fees to about 5% or 6% in most cases, depending on the transaction. In a bank transaction, an international transfer through financial transactions network Swift comes with a fee that can range between $25 and $35, or even higher, say bankers. On top of this there is a foreign exchange (FX) percentage fee. This makes smaller bank transfers particularly costly.

Azimo’s Mr Kent believes that banks are reluctant to change because of the loss of income. “Speaking to [market operators], they say banks share a vested interest in keeping costs high. On an average transaction of £400 [$611] or £500 from the UK to Poland, for example, [a bank] would charge £25 on [a wire system] plus a 3.5% FX retail fee. Azimo charges £5 plus 0.25% FX fee,” he says.

Azimo offers a flat fee of £5 to transfer up to £500 and 1% commission up to a maximum of £15 for any larger sums. The company either links to a bank network to deliver the funds in a bank account or relies on its network of ‘payers’, which can be small shops in remote areas. Azimo reaches payers either through its proprietary network or by linking to networks of similar operators, such as Small World Financial Services or The Currency Cloud.

Remittance flows to developing countries ($bn)

No place for banks?

But banks say transaction prices are higher to cover the cost of their systems. So, if they are unable to compete on price, should banks persist on being present in the remittance market?

Jan Hillered, head of Western Union’s business in Europe and Commonwealth of Independent States, says that despite the challenges, attracting migrant consumers is crucial for all financial sector players, including banks. “What you’ll find when you talk to chief executives of many banks, not only in Europe but around the world, is that attracting a migrant consumer is becoming extremely important for them. If they want to drive growth in the future, they want to attract that consumer,” he says.

The remittances market has indeed shown incredible resilience and has offered stable growth even during the economic downturn. The World Bank’s Mr Ratha says that remittances fell in 2009, but only by 5%, and they quickly recovered by 2010, continuing to go up afterwards. “Remittances act as insurance during crises, whether in source or recipient countries,” he says.

There is another phenomenon that makes remittances particularly appealing in regions badly affected by the global economic downturn. According to recent data, some of the world’s flows of cross-border payments are reversing direction, signalling the changing fortunes of some developed markets. While until recently Portugal provided a greater flow of remittances to Brazil than from Brazil to Portugal, the direction has now switched. As of 2011, according to the World Bank, $353m was sent from Brazil to Portugal, against $236m in the opposite direction. Portugal has now become a net recipient of remittances from all sources. In 2011, money coming in totalled $3.7bn against the $2.8bn that left the country.

Generally, migrants to oil-rich countries have continued to generate strong growth in remittance flows in 2012, as opposed to those working in developed economies, who were not able to generate such large flows, according to the World Bank. Western Europe is singled out as a particularly poor source of remittances.

Business priority

Albino Andrade, head of the remittances business at Millennium bcp, one of Portugal’s top banks, says that with the economic downturn in the domestic market, remittance inflows have become an important source of deposits for the bank, as well as helping to improve financial margins. “This business is one of Millennium bcp’s priorities. One example is Angola, which represents nearly 10% of the remittances received in Portugal – four times the amount in 2010,” he says.

Oil-rich Angola’s remittances to Portugal were $32m in 2011 according to World Bank data. Figures from Portugal's central bank for 2012, however, point to a much higher €219m ($285m).

Western Union’s Mr Hillered says: “Sitting in Europe, I feel quite comfortable because with the demographic dynamics we have here, migration has to be part of the solution to sustain [the region’s] economic growth. Our network in Europe alone has 150,000 points of service.” Western Union has also picked up business from migrants working in Russia, on the back of the country's oil-driven economic boom.

Changing demographic

Banks must follow these migration shifts to capture this new market. With growing numbers of new entrants, the remittance business will become more competitive. So far, migrant workers can choose between only a few providers, with similar prices and limited transparency on charges.

As the remittance market grows, so do consumers’ complaints about fees and transparency. In a 2012 report, Consumers International, the global organisation that groups consumer agencies around the world, expressed concerned over “opaque pricing” and “uncompetitive markets”, among other issues, in the remittance business.

The World Bank’s Mr Ratha agrees with these concerns. “Now [remittance providers] don’t disclose anything. And, what’s more worrisome, if the transaction doesn’t go properly, if there are delays or the money is stolen, typically there is no recourse,” he says.

The largest source country of worker’s remittances, the US, is trying to tackle these problems with comprehensive regulation under the Dodd-Frank Act. The $120bn-worth of remittances that left the US in 2011 went to more than 140 countries – the largest corridors being with Mexico ($23bn), followed by China ($13.4bn) and India ($10.8bn). If US banks want to do business with migrant workers, then the correspondent banks in migrants’ home countries will have to comply with Dodd-Frank. The new rules apply to money transfer companies too, although with a lesser impact as their closed-loop system can provide, in theory, all necessary information to the customer.

Section 1073 of the Dodd-Frank Act requires full disclosure on taxes, FX rates, delivery times and all potential fees – including those at correspondent banks – before payments are initiated. It also allocates error liability to the institution, rather than the consumer. Furthermore, it requires the service provider to issue a post-payment receipt stating the date the funds will be made available to the beneficiary, as well as cancellation and error resolution rights, and it allows 30 minutes for a consumer to recall a payment.

The newly created US Consumer Financial Protection Bureau (CFPB) has the task of defining the details of these rules. These came out in January in a draft that, following the industry’s extensive lobbying, is now being revised. At the time of going to press, the CFPB had not yet issued the second final ruling.

Regulation concern

Emerging-market specialist lender Standard Chartered is one bank that does not provide remittances services in the US but serves as a correspondent bank to US banks. As such, it is concerned about the new regulation, so much so that it formally expressed such concerns to the CFPB, along with many others in the 111 comments the CFPB received from the industry in the two-month consultation period for the first draft of the legislation, which was released at the end of December 2012.

“[Foreign banks] worry about their obligations if they are going to make a remittance on behalf of a US bank. If I’m in country X, I have to look at my agreement with US banks. If you’re going to do remittances with people in my country and I’m going to facilitate that for you, what’s my risk?” says one industry expert.

The FX disclosure element must be scrutinised, according to Donald Lamson, a partner at Shearman & Sterling and head of the law firm’s financial institutions advisory and financial regulatory group in the Washington, DC office. He says: “What I think the rule ignores is that the customer is going to have to pay for that risk one way or the other. [Most likely the customer] will pay for the risk in terms of a higher exchange rate than he or she would have otherwise obtained. If you are rational and you are in this business, you are going to place such a risk so that the other party will carry it.” This may also include placing the FX risk on the correspondent bank.

The World Bank’s Mr Ratha believes this argument should be put in perspective as most transactions are completed in a relatively short period of time. “Transfers usually take three days and no longer than a week, even in the worse places. I think that these days you can even send money from Washington to Mount Everest’s base camp in Nepal in a couple of days. That problem of uncertainty of exchange rate is blown out of proportion,” he says.

Mr Lamson disagrees: “In the FX market you can figure out what forwards are, but the problem is that with forwards, and anything else, you have event risk. Remember when the Russian FX crisis [hit]? Nobody anticipated that – lots of money was lost. All sorts of events lead to FX shifts. The question is, who bears the risk of those changes? Should it be the person who wants to transfer cash from one place to another or should it be the [institution] that provides the service for a fee?”

Furthermore, new rules on errors are putting the responsibility on the bank that initiated the transfer. Under the regulation, the bank that initiates the transfer would be responsible for carrying out an investigation if the money was held up at any point in the transmission chain. If there is a complaint and the matter is not resolved in a reasonable period of time, that institution would have to refund the money, even if this is being held at a correspondent bank.

Just as contentious is the requested disclosure of fees and foreign taxes. Western Union and Moneygram move funds around the globe using their proprietary network so there are no privacy issues related to counterparties’ fees, something that would need to be disclosed under Dodd-Frank. Banks, on the other hand, would need to access that information from their correspondent banks. “Banks overseas have their own privacy requirements, which can prevent the flow of information,” says Roy DeCicco, JPMorgan’s industry issues executive with the corporate and investment bank. “Trying to get 100% certainty from this open-loop system is very problematic.”

Cost of compliance

Nonetheless, banks are already at work creating and selling solutions. The largest complaint they have been making to regulators is that preparing a disclosure system that meets lawmakers’ requests is costly, both in terms of new platforms and in terms of gathering of data.

Greg Murray, Bank of America’s head of US dollar wire and clearing products in the global transaction service division, explains that the solution its division has created can be used by banks with a limited branch network, as well as larger ones. The product will provide all the necessary information – as well as a compliance form, if needed. If the consumer is happy with the payment terms, the transaction will then be executed through Bank of America. There are still concerns, of course, with the complete accuracy of any solution, such as changes in a correspondent bank’s fees based on the profile of the consumer or bank client.

According to one banker: “Part of what we’ve been struggling with is that the law is asking us for complete and accurate transparency. But because the banks regulated by this law do not have complete transparency on this, our ability to be absolutely accurate and complete is flawed. This is why so many banks have struggled to figure out how to comply with this law.” 

While large banks are struggling with the law’s requirements, Western Union has created an account-based product that links banks’ ATMs to the money transfer company’s proprietary network to allow timely payments. By wiring funds through Western Union’s systems, banks can still offer a remittance service to their customers – at a cheaper price for small transactions – and leave the money transfer company dealing with disclosure requirements. By the end of last year, the company says it had 61 live account-based money transfer bank partners globally, with clients including Regions Bank in the US, Scotiabank and Bank of Montreal in Canada, Postbank in Germany and Garanti in Turkey, as well as China’s PSBC, Thanachart Bank in Thailand, Absa in South Africa and Banco do Brasil.

In another kind of partnership, Moneygram has teamed up with Qatari telecom company Qtel to allow customers to use a mobile wallet and transfer money through its network, merging the ease of mobile technology with Moneygram’s international payout locations.

Opportunities abound for other providers too. Cross-border payment company Earthport offers direct access to clearing houses in more than 50 countries, which allows payments to be settled in local currency and can be a viable alternative to correspondent banking relationships.

What now?

If nimbler outfits such as Azimo, Earthport and the more flexible structures of Western Union and Moneygram can provide a cost-effective and easy-to-use remittance service, even with the impositions of new rules, will banks end up limiting their own remittances divisions to large transactions and partner with non-bank providers for small payments, or will they simply exit the business?

Western Union’s Mr Hillered thinks that regulation will eventually push banks out of this space. “Banks already have [moved away]," he says. "[There will also be] a lot of regulation in the EU, and no doubt that will make a lot of banks around the world think very carefully about how they are going to deal with [this business]. They will outsource some of these services.”

For another banker, the answer is negative: “Forget about the revenue for a minute. This is what customers want," he says. "Big banks have a lot of consumer clients and a portion of them, not an insignificant portion of them, look to send money overseas. No bank that is a full-service provider for their consumer client base wants to pull out of a business their customers want. I haven’t heard of any large bank that is exiting the business. In fact, they have worked hard with their correspondent banks to build models that will help them meet regulation.”

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