Technology and age old business practices

The great Indian dream for several families, particularly those that are low income, is to send a family member abroad. Migration from India, particularly for short term employment for low skilled labour occurs to two predominant corridors: the Middle East and Gulf, and of course, Singapore, Malaysia/South East Asia. With the IT boom in the late nineties, higher skilled migration has also started to countries like Australia, UK, US and increasingly, the EU.

The straight forward reason for sending a family member abroad, even for low skilled jobs is remittance of funds. For low income families, remittances are an important income stream that help in sending siblings to college, purchasing assets and providing a cushion against emergencies. India is one of the highest inward remittance destinations in the world, overtaking Mexico, with remittances contributing to 3-4% of the GDP since 1999-2000. This number is a function of the large Indian diaspora in the world, and the IT boom, which facilitated large scale labour mobility from India.

Given that remittances can provide low income households with a path out of poverty, countries should be moving towards greater labour mobility. Indeed, I have to agree with the Centre for Global Development and their analysis of what should form the next set of development goals in their recent blog post. Hopefully, this will form an important part of policy dialogue and labour mobility will act as a catalyst for poverty reduction.

Remitting money back home is by no means a new practice. In India and South Asia, it is popularly referred to as hawala (from the Arabic word hewala meaning transfer). Hawala is widely used in the present day to refer to the parallel, informal network of brokers that helps transfer money across borders, by low skilled migrants who do not have access to the formal financial system.

Due to the high dependence of several low income families on income through remittances,  and the more important role it can play in increasing a country’s foreign reserves, it is important that international remittances are reliable, safe and efficient. Despite the age old practice of remitting money, formal policy guidance on the topic only began emerging in 2007 with the assistance of the World Bank and the Bank for International Settlements (BIS). The IMF in a report suggested that remittance transfers to India can be expensive relative to a) the low incomes of remitters and b) the small amounts involved. This leads people to use informal channels like the hawala brokers or hawaledars. The actual cost of remitting funds from one country to another is a function of (i) the sending country and the payment infrastructure available therein (ii) the remittance sending scheme used and (iii) the type of remittance service provider and the foreign exchange rate used.

Commonly used formal channels are bank account transfers or global payment service providers like Money Gram or Western Union. International bank transfers are through a mechanism called SWIFT. Most large banks belong to a bank network in Belgium called SWIFT (Society for Worldwide Interbank Financial Telecommunications), which verifies and processes financial messages. Banks usually charge a fee that is payable to SWIFT while initiating a SWIFT transfer. In addition, banks may have a tie up with correspondent banks who will forward the message in a specific country. It is possible that the correspondent banks may deduct their own fee resulting in a lower amount being remitted to the end receiver. If the speed of remittance is not an issue, then slower and cheaper modes are often used, such as cheques and demand drafts. Despite the higher cost involved, an RBI report shows that remittance to India through SWIFT accounts for 63% of formal channels used. However, this should also be seen in the light of the ‘corridor of remittance’ and  value transferred. For instance, remittance from the Middle East region is largely through Private Exchange Houses (PEH) due to limited presence of banks that can remit to India.

There are two parts to the cost of remitting money: a) the fees that is charged: this is usually hard coded and can be easily obtained, while it varies from one service provider to another and b) the exchange rate used. The exchange rate is slightly harder to code since it is important to know the exchange rate that is used at the end of the remitter, or while effecting payment in India, or both (if two conversions are involved). The rate that is used depends on the competitiveness of the market at the remitter’s end or whether the remitter gets a competitive quote. The agency then adds a margin to the exchange rate which is a function of the interbank rates available to the remitting agency. The cost can be as high as 1% of the transaction value. The fee that is charged by various banks varies quite significantly, with the lowest being 0.2% of the fund value, going up to as high as 5% of the fund value, according to the RBI bulletin (table 5). With service providers like Money Gram, the cost can be slightly higher to compensate for their extensive network of agents across the country, which is a boon for several low income households in India.

While I have to lay my hands and do any analysis on remittance data, I would hypothesise that the dependence on informal channels like hawala is usually when the remitted amounts are low and the frequency is high. The biggest risk that the informal hawala channel poses to nations is the threat of money laundering and financing of terrorist activities. For the remitter, there is the risk that the hawala agent may not actually deliver funds to the beneficiary at the other end. Given the larger risk of money laundering, I would imagine that financial institutions and definitely the RBI should be looking at ways to reduce costs in formal channels.

Transferwise is a great example of taking the age old practice of hawala and using technology to reduce costs for remitters. This is an example of creative destruction at its best! Sure, there are limitations to the model. However, it does show a way in which small remitters can remit money without the high costs that they normally have to bear.

How does Transferwise work?

Transferwise takes the real exchange rate, which is the mid market rate that is found on or Then they apply a fee of 0.5%. Transferwise requires both the recipient and the beneficiary to have a bank account though.

The following are the features that make Transferwise pretty remarkable according to me:

1) You can set up a Transferwise account using even your gmail account

2) Transferwise does a transfer between people and not countries: what does that mean? This means that when I login and want to convert from say dollars to rupees, the system begins to search for someone who wants to convert from rupees to dollars. The conversion rate that is used is the one that exists when a match is found for my conversion.

3) You use Transferwise’s bank account to transfer funds to your recepient

4) Since Transferwise uses multiple currencies, you can use different routes to arrive at the required rate. This is almost like the search that a Kayak does to get you the best rates on an airline

5) Transferwise uses bank accounts at both ends, thereby riding on the the KYC and AML done by banks.

This is a great Youtube video on Transferwise

At a time when banks are being asked to ensure that everyone in the country has a bank account, will Transferwise be the next solution to bringing down remittance costs for low income households? Remains to be seen