With ever more expats and migrant workers around the world, remittance continues to be big business. In fact, the World Bank’s statistics show the amount of money being sent overseas just to developing countries increasing considerably each year, jumping from $633 billion in 2017 to $689 billion in 2018 and an estimated $715 billion in 2019. Of course, with the COVID crisis seriously impacting finance around the world, the number is expected to drop sharply in 2020, but is still expected to total at least $445 billion.
Potentially, even these staggering numbers are only part of the story. There are several viable methods of sending money from one country to another - some formal, official and recordable, others less so. Studies estimate that between 35 and 75 per cent of money moving into developing countries from overseas could be doing so via informal remittance channels, making it effectively impossible to guess the total amount of money movement.
Given that such huge sums are moving by informal remittance channels each year, it begs the question of what exactly these channels are and whether they are preferable to the formal channels.
What are the informal remittance channels?
We all know what the formal remittance channels are, right? Bank transfers are the obvious option, though often the least practical. Much cheaper and quicker are dedicated remittance services like DeeMoney, TransferWise, Western Union and MoneyGram (among others). However, even these still charge a fee to get your money to where it is going. It might not be much, but “not much” is an extremely relative amount and even a couple of hundred baht can be a lot of money for low- and middle-income households. This is why informal channels are so popular with such households.
Informal remittance channels are those that developed before formal channels were widely available, and which persist to this day for the reasons explained above. At their most basic, it can consist of handing an envelope full of cash to a trusted friend who happens to be going back to your shared home country, on the understanding that they will pass it to your family there. Naturally, this needs to be a very good friend - someone who is extremely trustworthy. The somewhat safer alternative is to just bring large sums of cash home when you travel back yourself, though even this comes with some risks.
Hundis and Hawala
Of course, this approach only works if you happen to be travelling home yourself or have a trusted friend who is doing so. This is naturally going to be very infrequent and inconsistent and, worse still, is functionally impossible during situations like the COVID-19 lockdowns, which is when the money is likely to be needed at home the most. For this reason, somewhat more organised systems of informal remittance developed, such as the Hundi or hawala.
Hundis first appeared in India as far back as the 12th century and, staggeringly, are still in use today. Around the same time, the Knights Templar were developing their ‘letters of credit’ system to help pilgrims get their money to the Holy Land without risking being robbed along the way and, despite the dissolution of the order and execution of its members, this system also continues to exists. While letters of credit went on to become documentary credit, Hundis still work basically the same way they did 900 years ago.
But how does a Hundi work? Functionally, it’s the same as the letters of credit issued by the Templars. You approach a merchant in one location and present the sum that you wish to be transferred, for which you receive a Hundi. If you present this to a merchant in another location, you will be given the same value of money. It is basically a fancy IOU or traveller’s cheque, enabling you to carry large amounts of money as a single document instead of heavy bundles of cash and coins, thereby reducing your risk of being robbed. Just as with formal remittance services, there’s a certain amount of trust in the system, particularly between the two merchants who must trust that the balance will be settled between them.
It is worth noting that, even though Hundis are still widely used, they are also illegal, with operators risking arrest. Naturally, the parties involved in the process cannot honour their part of the agreement from prison, with their assets frozen by the authorities. Therefore, relying on this approach is not without its risks.
Hawala, which originated in the Middle East, works subtly differently from a Hundi. As above, the back-end part of the process is reliant on trust between brokers in separate locations. However, hawala works without a document. Instead, you tell the broker your chosen password when you give them the sum to be transferred. They inform their broker in your target destination and that broker will then give out the agreed sum when given the same password by, for example, your family back home. Of course, this system is also illegal in many countries and brokers risk being arrested. And it is very hard to give your password to a person who is facing a five-year prison sentence.
Why informal remittance channels are impractical
While they go by different names in different places, all of these informal remittance systems share certain traits in common: they all depend on trust and good will between the merchants/brokers who enable them and they are mostly illegal. This is often because they are not officially tracked, making them an ideal option for those seeking to launder or move ill-gotten funds, dodging taxation in the process. They are also commonly employed in scams, for much the same reason. The process leaves no paper trail for investigators to follow the money back to its source.
The principle advantage of using informal remittance channels is the fact that it is considerably cheaper. The fees for international bank transfers are staggering and even the cost of using remittance services can be quite hefty, in some cases, especially when the amount being transferred is relatively small, in which case even a fee of just a couple of hundred baht can represent a considerable proportion of the total sum.
However, that saving is inevitably a gamble. While it may be possible to save a little on each transaction, it’s also entirely possible to lose the whole amount if the worst should happen. What if your Hundi merchant or hawala broker gets arrested before you can reclaim your funds? What happens if your trusted friend runs off with your envelope full of cash? What happens if, when carrying your own money back home, you are mugged? If it’s a considerable amount you are carrying (which is likely, given that most expats visit home fairly infrequently, especially if they are from low- or middle-income households), what happens if you are stopped at customs? Many countries require you to declare large sums of cash and you may lose a substantial chunk of it to taxation or confiscation, not to mention fines if you make a false declaration. You could end up losing significantly more of your money this way than you would have by simply using formal remittance channels.
What are the benefits of formal remittance channels?
What formal channels bring to the table is security - an extremely important factor, when it comes to moving money around. Since they use legal methods, you are first and foremost guaranteed to be able to get at your funds at their destination without having to make a prison visit in the process. Additionally, a lot of effort goes into ensuring that the transfer is secure. A Hundi can be damaged or lost or your password could be overheard and used to draw your funds from a hawaladar before you have the chance to do so, but formal channels employ the latest technology to make the process as safe and secure as possible.
Technology also helps to make the process much more convenient. Informal channels are anything but convenient. As stated above, the chances of you going back home or having a trustworthy friend do so at consistent intervals are pretty remote. Using Hundis and hawala may allow more frequent transfers, but finding merchants isn’t easy, given that their activities are illegal. It’s not like you can google for “Hundi merchants near me” and expect to get reliable results! Using formal channels, you can increasingly send money through a mobile app and confidently expect the sum to arrive in your home country virtually instantaneously. No informal process can match this level of speed and simplicity and most require substantially time and effort to complete the transaction.
A study in Ghana in 2007 showed that, while only 1 per cent of domestic migrants use formal channels to send money home, 43 per cent of international migrants remit using formal channels. Admittedly, this shows that more than half of international remittance into Ghana came through informal channels (mostly money carried by friends and family, in this case), but it also shows that the added security and practicality of using formal channels when sending money across international borders makes them substantially more practical and preferable.
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