The World Bank projects that $572 billion will be sent from migrant workers to their families abroad in 2020.
These payments affect the day-to-day lives of nearly one out of every three humans globally, as the world’s estimated 1 billion migrants each provide for other individuals in their home countries.
One might expect that an everyday process that affects so many would have been simplified and streamlined over the years, but sending or receiving remittances continues to be challenging. Slow payment times, excessive fees and regulatory requirements that complicate sending and receiving processes are just some of the struggles that individuals must deal with every time they attempt to make payments across borders, and any delayed or lost payments could devastate recipients who need them to survive.
The following Deep Dive examines how cross-border remittances are typically conducted via a correspondent banking model and details how these payments’ slow processing times and high fees are exacerbated by complex and overlapping government regulations.
How Correspondent Banking Works
Everyday payments made within the same country typically take a straightforward course. When an individual transfers money to another individual via a payment app, the money is transferred directly from one bank account to another. Such P2P transactions are fairly simple, and any fee associated with making such transactions is small.
Making payments across borders, as when a migrant worker sends funds to family abroad, is significantly more complicated. For an individual to send their money directly requires a direct link between one bank in the sending country and another bank in the receiving country. These links are usually created on a bilateral basis, meaning that money has to be transferred in a daisy chain from one bank to the next until it crosses the international border and reaches its final destination in a system known as correspondent banking. The typical cross-border payment will generally flow through at least four different banks before the remittance is complete.
This complicated process brings with it a whole host of issues, including high costs and slow payments. Overlapping and conflicting government regulations can further exacerbate both of these problems, but fortunately, correspondent banking is on the decline.
Obstacles To Smooth Remittances
The first and biggest obstacle to processing remittances is the sheer cost involved in routing the money through all of these different channels. Each bank in the chain covers transactional costs by charging a percentage of the money routing through its system, and these costs can add up quickly. The average cost of remittances varies by channel and can range from 5.7 percent for payments made through post offices to 10.3 percent for payments made through banks. The World Bank estimates that the average remittance fee amounts to approximately 6.8 percent of total payment, however, which can be exorbitantly expensive for migrant workers in countries with low average wages. Farm workers in the U.S. on average earn as little as $10,000 per year, which is already below the federal poverty line before remittance fees are taken.
The speed of sending and receiving remittances is yet another factor that can result in frustration. Wire transfers between two banks located in the U.S. are typically completed in less than 24 hours, for example, while transfers abroad can take up to five days. This long period is often a result of the involved financial institutions (FIs) needing to meet regulations and resolve any disputes every time the funds move from one bank to another. Families of migrant workers are often living paycheck to paycheck and can ill afford a missed or delayed payment, making any delay in these remittances potentially ruinous.
Remittances also face the labyrinth of laws and regulations concerning the movement of money in the sending country, the receiving country, and the home countries of any bank involved in the correspondent banking chain. Every bank has to ensure that payments are not involved in money laundering, terrorist financing or other wrongdoing, and this process has to be repeated every time money changes hands. The payment data needed to clear compliance regulations in one country may not be enough for other involved countries, forcing banks to subject the payment to additional scrutiny rather than rely on their automated systems and further increasing the time and cost of processing these payments.
The good news is that correspondent banking — as well as the challenges associated with it — is on the decline. Nearly 100 percent of cross-border payments, including remittances, were conducted via correspondent banking in 2012, but that figure has dropped by 20 percent as of 2019. Banks are instead turning to more advanced payment models that connect participating banks in a given country to a single transfer point where funds flow directly to another country’s transfer point and then go directly to the receiving country’s bank network.
Remittance-as-a-service solutions have also shown promise, taking the burden off of banks and other companies to process these payments and instead allowing a dedicated provider to handle the sending and receiving of remittances in a real-time, closed loop fashion. All of the solutions are contributing to the decline of correspondent banking and easing these remittance roadblocks substantially, reducing the stress on the billions of migrant workers and family members spread throughout the globe.