The world’s most lucrative money trail

Unconfirmed US reports suggested that sums had been wired from Pakistan to allow alleged terrorist bomb plotters in London last month to buy airline tickets. The alleged bomb plot on August 10 was discovered, but how funds are being transferred across borders and how payment remittances, in general, are changing is of increasing interest to not only the security forces but also to a growing range of financial institutions and others that see huge opportunities in the expanding market for legitimate global person-to-person payments.

The past few years have witnessed a radical restructuring of the traditional remittance industry where the entire process of money transfer is being redefined and reinvented by a host of banks, non-banks and new technologies. Dan Schatt, in a key industry report last year by Celent, noted: “The combination of new technology, innovative partnerships, changing remitter demographics and new legislation has created an unprecedented opportunity for new players to disrupt the existing remittance landscape.”

The landscape that was once viewed as the rather uninteresting transfer of low-value payments by migrant workers is now being seen very differently. One aspect of globalisation is that more migrant workers are sending more and more funds back home and more institutions are now competing for this growth business.

The remittance pie is already large and growing steadily. The World Bank estimated that in 2005 the total value of remittances worldwide was more than $230bn, involving some 175 million migrants, with $167bn flowing to developing countries. The International Monetary Fund (IMF) added in a December report: “This amount, however, reflects only transfers recorded in the balance of payments; unrecorded flows through informal channels are believed to be at least 50% higher than recorded flows.”

Reflecting on the importance of remittances, the IMF notes: “In 2004, recorded remittances were the second largest source of external financing in developing countries, after foreign direct investment, and amounted to more than twice the size of official aid. Remittances are less volatile than most other sources of foreign exchange earnings for developing countries.”

An enormous market

While estimates of recorded flows vary, they also show no sign of slowing, and estimates from the 2005 Celent report (see chart on page 199) suggest that the market will grow at a 10.1% cumulative average growth rate through 2008, by then hitting a total of $345bn. If the unrecorded flows are estimated and included, this could mean total remittances, official and unofficial, could well exceed $800bn, a large market.

The top three recipients of remittances (in dollar terms) in 2004 were India, China and Mexico, with India receiving about $22bn. But smaller countries, such as Tonga, Moldova and Lesotho, top the list in relation to their share of GDP, with Tonga’s remittances accounting for more than 30% of GDP. Unsurprisingly, the US is the largest source of remittances, with an official outward flow in 2004 of $39bn, followed by Saudi Arabia with $17bn and then by Switzerland and Germany.

Falling fees

But just as transfer flows have been rising, the cost of sending money home has been declining, particularly for Latin American and Caribbean immigrants. Manuel Orozco, asenior associate at the Washington-based Inter-American Dialogue, notes in a report: “Four of the most relevant changes in the remittance industry over the past five years include a decline in transaction costs among remittance intermediaries; an increase in competition among formally licensed businesses, including the consolidation of firms which in turn reduces levels of informality; a growing interest on the part of banking institutions in the US and Latin America in providing financial services, including remittances, to immigrants; and tightened government regulations.”

Mr Orozco explains that in 2000 the cost of sending money to Latin America and the Caribbean was above 10% of the amount sent, this included the fee, which could be above 10% by itself, plus variable exchange markups above 5%. By December 2005, the cost to send $200 to these areas had dropped to 5.6%. Moreover, when considering amounts that are over $300, the average cost for senders is lower than 5%, saving immigrants an estimated $5bn in fees on their remittances of $52bn in 2005. In effect, the fee to send $200 has dropped from $30 to nearly $10, or a reduction of almost two-thirds.

Remittance fees, however, can still exceed 10%, as the costs chart shows in a variety of links, such as sending from Belgium to Nigeria for a cost of 12%. The IMF recommends that such fees should be a low fixed amount, not a percentage of the principal, since the cost of remittance services does not really depend on the amount of the principal.

Although the trend is a decline in cost, the growth of migrant flows in recent years, combined with improved education standards and changing economic growth rates, raises many other issues. Francesco Burelli, a consultant with London-based consultants Capco, explains: “While price compression continues, increased economic migration means remittances is a growing business with estimates suggesting a 9% annual growth on a base currently valued at a range of up to $250bn worldwide.

“With high percentages of this flow passing through unofficial networks the macro-challenge is two-fold: how to regulate this business and how can banks commercialise it?”

Room for further growth

According to Western Union (WU), which has at present 270,000 agent locations in more than 200 countries and territories and has a leading share estimated at 15% of the global cross-border remittance market, there is plenty of room for growth. WU says there are 191 million people living outside their country and this is expected to growto more than 280 million – about the population of the US – by 2050.

With more than half a million Indians migrating every year and with the six states of the Gulf Cooperation Council (GCC) host to foreign workers that number roughly 13 million and account for 70% of the work force, WU believes the remittance market is expanding dynamically.

The question is whether the new entrants, such as the banks, will eat away at the share already taken by established players, such as WU and Moneygram, and the traditional informal transfer routes described as hawala or hundi.

Mr Burelli says: “For a bank, as a stand-alone product, the commercial viability of remittances is questionable. Remittances are, however, central to developing account-based relationships with emerging and increasingly attractive customer segments. For example, US bank Wachovia’s ‘Dinero Directo’ product targets the Hispanic community with an account-pairing current account that facilitates remittances.”

Given the cost of delivery of money to the recipient by courier and the risks associated with the transport of cash, any bank or player with a significant distribution network in both countries has an advantage in attracting remittance business because of ease of access. While the internet and pre-paid cards represent two quick and cheaper channels for remittances, there is a limitation in countries where internet access or the automated teller machine (ATM) network are less developed.

Sherry Johnson, a spokeswoman for WU, says: “WU and its agents have a unique understanding of its customers. With more than 270,000 agent locations, we are where they work, shop and live, we are part of their communities. Our agents operate in large urban centres and small rural communities.”

Can banks significantly break into this market? Julian Wakeham, partner at Capco, says: “Banks have a significant cost disadvantage compared with the informal networks for the provision of remittances and it is difficult for them to compete on a pure cost basis.

“While a bank requires a significant investment [compliance, automated clearing house money transfer, transaction initiation, accounting, statementing] to set-up or maintain remittance services to its clients, an informal network does not require more than a established trust relationship between two or more parties located in different geographies connected by business transactions of any kind to act as the underlying channel for clearing and settlement.” A hawala trust relationship provides a low-cost vehicle that can take the time of just an international phone call, but with little legal back-up.

Big players wade in

But while some banks may be at a disadvantage, many large banks, such as Citibank, HSBC, Bank of America and Wachovia, to name a few, and specialists, such as India’s ICICI Bank, are attacking the market and see opportunities.

Wachovia’s Dinero Directo is a prepaid card that offers a secure and inexpensive way to send money to Mexico, Latin America, the Caribbean and Spain. As the sender, the value of the card can be determined (up to $1000) and the

recipient can use the card to withdraw money immediately from Visa ATMs around the world. Wachovia’s remittance product is part of a new package of deposit products through which it hopes to attract more Spanish-speaking customers.

In addition, according to the IMF’s Dilip Ratha, some commercial banks have recently started providing remittance services for free, hoping that would attract customers for their deposit and loan products. And in some countries, new remittance tools – based on mobile phones, smart cards or the internet – have emerged.

In June last year, HSBC Bank USA introduced a free global money transfer service called Easy-Send aimed initially at the Latin American markets. And in April this year, HSBC offered free money transfers to India for non-resident Indians (NRIs) in the UK. “Today there are 22 million NRIs around the world who expect global banking expertise and a high level of service,” says Manasije Mishra, head of HSBC’s NRI services in India. Citibank also offers free transfers to India. Bank of America offers three transfers for free to Mexico per month via its SafeSend offering.

Can banks make good on free transfers? The cost disadvantage for banks is clear when compared with other means, but other factors are becoming increasingly significant. On the receiving side in Mexico, for example, some agent networks have had a monopoly. But Bancomer, a Mexican bank owned by Spain’s BBVA, saw a large revenue opportunity. Now Bancomer works with 75 money transfer companies and functions as a switch to multiple money services businesses. Celent estimates that Bancomer accounts for 65% of all remittance transactions received in Mexico.

Nevertheless, in last year’s report, Celent argued that the “traditional agents” group (WU, Moneygram) still make up 80% of the US/Latin money transfer market. And Celent estimates that traditional banks and credit unions have a 5% stake, adding that banks offering pure card-based remittance services represent less than 0.2% of total US outbound remittances. Half of the overall market consists of households that find it easier to send $1000 through a WU than through a bank’s limited remittance offerings.

Loss leader

Given that half of the Mexican remittance community have bank accounts, the reluctance to use them appears surprising and bears testament to the tenacity of the non-bank providers. But banks look keen to continue their ‘loss leader’ strategy with ‘free’ transfers in the hope they will eventually make inroads into other financial areas.

Elsewhere, particularly in the NRI market, the banks or select banks are showing the way. Sanjay Chatterjee, chief executive of the London office of India’s ICICI Bank, explains that in addition to huge unofficial remittances to India, official formal flows reached $25bn in 2005 and are growing at 15% due to the banks’ distribution capability.

He also stresses ICICI’s alliances with banks such as Wells Fargo in the US, Lloyds in the UK, DBS in Singapore and BBVA in Spain in helping to make remittances his bank’s “most profitable non-asset based product”.

Mr Chatterjee believes the market is changing with the trend towards the formal bank routes, including online, and a decline in the informal or “agent” channels. He adds: “Total formal remittances from the UK to India have reached $3bn, and we are doing $1.2bn, more than a third of the market.”

For ICICI, Mr Chatterjee is pleased by his bank’s low cost base, which he claims is 10% that of big banks. And he intends to offer his bank’s remittance platform in Sri Lanka and Bangladesh to further leverage its capabilities. Also, with high education standards, the NRI group is closely associated with the high-tech approach and the usage of online and new technologies; Celent estimates that 20% of global India-bound remittances are done online.

Shape of things to come

Looking to the future, some argue that the WU model is in decline, with the 270,000 agent locations likely to come into essential conflict with new technologies such as mobile phones and the internet.

WU’s Ms Johnson counters this charge, emphasising WU’s ability to change gear: “WU’s dot.com business, available in the US and select countries, is seeing consistent double-digit growth year over year, increasing transactions by 37% year on year and revenues by 43% in the second quarter of 2006.”

However, she adds: “While WU offers consumers in many countries the ability to send money via the internet or by telephone, we still find that the vast majority of our traditional consumers prefer the face-to-face interaction they get with bricks and mortar WU agent locations.”

Although WU may have been around for more than 150 years, new technologies, such as mobile phones, pose a distinct threat. And with five million new users each month in India alone there is no shortage of threats. While a mobile still needs a bank at both ends of the transaction to be effective, the remittance model is changing, the decline of the exclusive distribution relationships among traditional transmitters is coming and new remittance models are highly likely. Also, greater convenience through decreasing physical collection of remittances (which would also reduce transaction costs) could be achieved through the use of bank accounts and card-based monetary instruments. In addition, innovations such as PayPal may allow cross-border transfers to develop even faster.

“The challenge for a commercially viable remittance solution,” says Kathleen Tyson-Quah, chief executive of specialist payment and settlement systems consultancy Granularity, “is deploying on a global scale a cross-currency, multi-bank, multi-channel solution that meets all FATF [Financial Action Task Force] money-laundering requirements within a cost margin comparable to credit card processing costs. Given the small payment values and wide diversity and dispersion of the target clientele, that challenge doesn’t appeal much to established players, so any solution is likely to depend on a disruptive technology.”

In short, the remittance industry is in the midst of wholesale change, and in such a diverse and fragmented market the likely winners are those with fresh models and fresh technology that are able to genuinely bring high-tech and high-touch together.