Who’s to blame for high fees?
Posted on Mar 19, 2015 by Iñigo Rumayor
Remittances have emerged as an indispensable source of money for developing countries; in some countries they generate more than entire sectors of the economy. In 2013, remittance money totaled three times the total global aid budget - and that’s a conservative figure! Remittances have more influence than international aid in determining global growth.
That’s why The World Bank and the G8 want to bring the world’s average remittance fee down to 5%. In Africa alone, this would save migrants and their families who rely on remittances for survival more than $4 billion USD.
Everyone seems to be in agreement that the fees in the remittance industry are too high and they price gauge poor people. While this may or may not be the case, few have discussed why the cost to send money is so high. In this post, I’m going to break this down and offer a few suggestions about new innovations which may allow us to hit the 5% goal.
Right now, the industry is monopolized by companies that use an agent-based model. The money has to go through a chain of ‘agents’ before it gets to the recipient. And, obviously, the more players involved in fulfilling a transaction, the higher the cost to the business.
Traditional remittances, also known as cash to cash transfers, were pioneered more than 144 years ago by Western Union and surprisingly still account for the majority of remittances sent every year. A sender takes his or her cash to a store, the store sends it over to the processing company (eg. Western Union or MoneyGram), and the company then sends it to their store or a participating location in the receiving country where the immigrant’s family picks it up.
The average amount sent abroad by immigrants in the US is $300 every month. In the agent model, the total fee to send those $300 to Mexico is close to $25 USD- that’s a $7 transaction fee and a currency spread of 6%.
Remittance companies make money in two ways - by charging the customer a fee to send money and by converting one currency to another.
In the agent model, Western Union or Moneygram don’t pocket the total fee paid by the customer. They have to pay the agent, and they also need to pay the payout location for allowing the recipient to pick up the money. The agent needs to get paid since the physical location must be staffed and has to pay rent.
Wire transfers cut out the payout locations on each side, but at an average cost of $35 USD per transfer they are even more expensive than Western Union or MoneyGram. Wires were designed to send large funds between institutions and corporations across borders. They’re simply not an option for immigrants, who send relatively small amounts of money per month. Additionally, many immigrants lack access to formal financial services in the first place.
Wells Fargo now offers competitive rates for family remittance services, but most banks have opted to disregard the remittance industry altogether. They have no incentive to provide these services, really, since remittances have higher compliance costs and lower margins compared to the other financial services they already offer.
The spread of the internet brought some much needed innovation to the remittance industry. Xoom, founded in 2001, pioneered online transfers.
Companies such as Xoom use the ACH system, allowing them to obtain funds from the sender’s bank account for less than $0.20 cents and effectively cutting out the costs associated with the agent on the sender side of the remittance equation.
Customers pay an average of only $18 USD per online transaction. Unfortunately, the receiving end usually lacks ACH infrastructure so agent locations are still needed to pay out cash to recipients. Therefore, this change has not impacted the bottom line for users as much as previously projected.
And, although they eliminate costs, online services are susceptible to fraud in a way traditional remittances are not. In the last quarter of 2014, Xoom was the victim of fraud and lost $30.8 million. One of the major challenges for everyone in the online remittance industry is to figure out a way to prevent fraud so that the cost savings of eliminating an agent in the model can be translated into even lower transaction fees for the customers.
Thankfully, new breakthroughs have succeeded in removing one more link from the money transfer chain: they have eliminated the need for payout locations abroad. By removing agents from the equation on both ends, companies are now able to reduce fees even further.
Transferwise, for example, found a way to bypass costly currency conversions and the international transfer fees that governments charge payout locations. Let’s say someone in the US (Sender 1) wants to send $300 to Mexico. Transferwise finds someone in Mexico (Sender 2) that wants to send the equivalent amount of pesos ($4652) to the US and reroutes the transactions, sending the pesos to Person 1’s family in Mexico and the dollars to Person 2’s recipient in the US. (Think of it as carpooling for remittances.)
Because of this system, Transferwise can process transactions at an average of 1% per transaction, which translates to a fee of about $3 USD.
Ezetop and Regalii are other companies that focus on international top-ups and cross-border bill payment, respectively. These companies do not only eliminate payout locations from the equation but also introduce revenue opportunities. By charging the Telcos and the bill payment providers for the payments collected in the US, these companies are able to charge the lowest commissions in the market.
So, who’s to blame for high fees? Generally, the long chain of agents involved in processing transfers. While the majority of remittances still happen offline, thankfully online transfer companies are becoming more sophisticated and are lowering fees by shortening the supply chain. It looks like the global goal of 5% fees is finally in sight.
Much thanks to Naysawn (the currently the ping pong champ) and Manuela for providing many edits to this piece.