Remittances and financial development in Latin America and the Caribbean countries: A dynamic approach

• Author: Vincent Fromentin
• Published date: 01 May 2018
• Date: 01 May 2018
• DOI: http://doi.org/10.1111/rode.12368

REGULAR ARTICLE

Remittances and financial development in Latin

America and the Caribbean countries: A dynamic

approach

Vincent Fromentin

University of Lorraine, Nancy, France

Correspondence

Vincent Fromentin, Centre Europ

een de

Recherche en 

Economie Financi

ere et

Gestion des Entreprises (CEREFIGE),

University of Lorraine, Nancy, France.

Email: vfromentin@gmail.com

Abstract

Despite the importance of remittances in total interna-

tional flows, the conclusion of the studies on the relation-

ship between remittances and financial development, is

still not completely unanimous, particularly in Latin

America and the Caribbean. However, financial develop-

ment matters for growth and poverty alleviation and

financial inclusion have many beneficial effects for

households. We examine the relationship between remit-

tances and financial sector development with several

dynamic panel data methods. We find a positive, signifi-

cant, and robust bidirectional link between remittances

and financial development for the panel of 32 countries.

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INTRODUCTION

In 2014, international migrants from developing countries were expected to have sent U.S.$436

billion in remittances to their home countries. Global remittances, including those to high-income

countries, were estimated at U.S.$581 billion for this same year, from U.S.$542 billion in 2013

(World Bank, 2014). In 2013, remittance flows were generally robust in all regions except in Latin

America and the Caribbean (LAC), which saw a decline in remittance inflows, partly because of

removals and deportations from the United States. The LAC region receives approximately three-

quarters of its total remittances from the United States. Remittance flows to countries in the LAC

region grew slightly by 1.9 percent in 2013 to reach U.S.$61 billion.

This trend shows that remittances are more stable than other international financial flows

(Ratha, 2004). During the 2008/2009 global financial crisis, remittances declined only 6.1 percent

and by 2010, they had almost recovered to their 2008 peak level (Ratha, Mohapatra, & Silwal,

2010; World Bank, 2011). They have become the second largest source of external finance for

DOI: 10.1111/rode.12368

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©2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2018;22:808–826.

developing countries after foreign direct investment (FDI) and represent about twice the amount of

official aid received (Aggarwal, Demirg€

ucß-Kunt, & Mart

ınez Per

ıa, 2011). For many remittance-

receiving developing economies, remittance flows exceed foreign direct investment, portfolio flows

from financial markets, and official development assistance. Some countries’total remittance

receipts amount to a substantial portion of their imports and a nontrivial fraction of GDP (Chami

et al., 2008). Officially recorded remittances are not completely full of remittances—they are gen-

erally underestimated (Reinke, 2007). Balance of payments data on remittances tend to record

remittances sent via banks more accurately and, in some cases, ignore those sent via nonbank insti-

tutions (e.g., money transfer operators) and informal channels (e.g., family and friends). In some

countries, migrants have tended to rely heavily on informal transfer channels rather than bank

transfers, owing to the lack of financial sector development in the remittance-receiving communi-

ties and the lower transaction costs and greater efficiency of informal transfer methods such as

transfers by hand (Brown, Carmignani, & Fayad, 2013).

Despite this precision, some studies analyze the link between remittances and financial sector

development. However, little attention has been paid to the question of whether remittances pro-

mote financial development across remittance-recipient countries and vice versa. This issue is very

important because financial development has been shown to foster growth and reduce poverty

(Beck, Demirg€

ucß-Kunt, & Levine, 2007). Furthermore, the link between remittances and the bank-

ing sector is important because intermediating remittances through the banking sector may magnify

the developmental impact of remittance flows (see World Bank, 2006). The receipt of remittances

increasingly exposes households to the formal financial sector, which in turn induces households

to make more use of formal bank services for their transfers and other financial transactions

(Gupta, Pattillo, & Wagh, 2009; Demirg€

ucß-Kunt, Cordova, Mart

ınez Per

ıa, & Woodruff, 2011;

Aggarwal et al., 2011). This might potentially increase their demands for deposit accounts, since

financial institutions offer households a safe place to store this temporary excess cash.

Financial systems perform the key functions of mobilizing and intermediating savings (Levine,

2005). By sending remittances, migrants play the role of financial intermediaries, enabli ng house-

holds and small-scale entrepreneurs to overcome credit constraints and imperfections in financial

markets. In such cases, remittances may potentially contribute to raising the country’s long- run

growth through higher rates of capital accumulation (Mundaca, 2009). Moreover, remittances

might increase a household’s likelihood of obtaining a loan. Processing remittances flows provides

financial institutions with information on the income of recipient households. This information

might make financial institutions better willing and able to extend loans to otherwise borrowers

(Anzoategui, Demirg€

ucß-Kunt, & Mart

ınez Per

ıa, 2011).

While remittances may lead to an expansion of the banking sector, the causation may also go

in the opposite direction (Demirg€

ucß-Kunt et al., 2011). This interrelationship results in a reverse

causality. Greater financial development might lead to larger measured remittances either because

financial development enables remittance flows or because a larger percentage of remittances are

measured when those remittances are channeled through formal financial institution s. In addition,

financial development might lower the cost of transmitting remittances, leading to an increase in

such flows (Aggarwal et al., 2011).

Despite the different considerations and the number of studies, there is still no consensus about

the general or typical effects of remittances on financial development and vice versa. The differ-

ences in the empirical studies can be explained by the methodologies that are used, the diversity of

the countries that are studied, and the data that are used. This paper contributes to the exiting liter-

ature on remittances by examining the relationship between remittances and financial development

in LAC.

FROMENTIN

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