Exploring the Credit Union Experience with Remittances in The

Exploring the Credit Union Experience with Remittances in the

Latin American Market

David C. Grace

Financial & Regulatory Affairs Manager

World Council of Credit Unions, Inc. (WOCCU)

5710 Mineral Point Road

Madison, WI 53705 USA

608-231-8494 –

Mr. Grace is responsible for WOCCU’s regulatory monitoring and financial services including the development of the International Remittance Network (IRnet) service – a mechanism for credit unions to send money transfers to 41 countries. He oversees development of the IRnet money transfers service in both developed and developing countries and has led program activities with credit unions in the United States, Latin America, Caribbean, Asia and Africa. Mr. Grace has been deeply involved in remittances briefing members of U. S. Congress, Mexican President, Vicente Fox, advising on legislation in the U.S., writings and been broadly interviewed as an expert on the topic by national and international media. From 1992 to 1998, he was with the Federal Reserve Bank of St. Louis managing its financial services and information technology units. In those capacities he worked directly with the President of the St. Louis Federal Reserve in his role as Chair of the Financial Services Policy Committee. Mr. Grace holds a M.A. in International Affairs from Washington University in St. Louis and graduated honorsfrom St. Louis University with a B.S. in Economics and International Business. He has lived and studied in Italy and Spain and is fluent in English and Spanish.

He would like to thank Ms. Anna Cora Evans Ms. Janette Klaehn of WOCCU for their helpful comments. Any errors or omissions are the authors’.

ABSTRACT:

This paper seeks to provide resources to practitioners and offer a clear description of how the market works to researchers and donors. A description of how and why credit unions have begun offering remittances, an analysis of their current and potential impact on the market in both the originating and distributing markets and lessons learned for other financial institutions and development finance practitioners is presented. If there is to be a sustainable and long-term impact from the provision of remittances, both originators and distributors should have the capacity to and the practice of encouraging senders and receivers to open depository accounts and where possible capture savings.

KEY WORDS FOR INEXING:

Remittance, Credit Unions, Latin America, Money Transfer, Development Finance

Exploring the Credit Union Experience with Remittances in the

Latin American Market

David C. Grace[1]

Credit unions have traditionally been founded to correct a market failure -- the lack of access to financial services for individuals of modest means. Today, developed countries have well developed and broadly accessible financial systems for most individuals with the exception being newly arrived immigrants. Conversely in many developing countries, market failures still exit for financial services and therefore are the source of growth for newly formed credit unions. By providing remittance services, credit unions in developing countries are presented the opportunity to interact with potential members and capture savings from their communities.

In the late 1990s, the World Council of Credit Union’s (WOCCU) member credit unions in Central America encouraged it to explore how to facilitate the transfer of funds from credit unions in the United States to Latin America. In July 1999, the project became formalized and WOCCU’s International Remittance Network (IRnet) service was launched to facilitate credit union entrance into the remittance business on both the sending and distributing side of the transactions with the end goal of utilizing the provision of the service as a mechanism to increase membership in credit unions. As of September 2003, 190 credit unions in 36 states with 850 points of service in the United States are using the service to send money to 42 countries on five continents. On the distributing end of transactions, WOCCU works with two commercial money transfer companies and credit union national associations in El Salvador, Guatemala, Honduras, Nicaragua, Mexico and Jamaica to provide remittance services.

As financial intermediaries offering a range of savings, credit and related financial products to their members, credit unions are well positioned to influence the remittance market. On a global scale, a physical infrastructure of over 40,000 credit unions and their 90,000 points of service broadly disbursed in 85 countries provides the international credit union system one of the largest physical infrastructures of any financial network in the world to handle such payments.

This paper seeks to provide resources to practitioners and donors offering a clear description of how the remittance market works based on experience gained from current remittance operations. A description of how and why credit unions have begun offering remittances, an analysis of their current and potential impact on the market in both the originating and distributing markets and lessons learned for other financial institutions and development finance practitioners is presented.

I. Motivation And Method For Offering Remittances

A . Motivation

Credit unions are not-for-profit financial cooperatives that have been operating for over 150 years. They can be found in nearly all parts of the world and serve 118 million members worldwide. (WOCCU 2003 Statistical Report) In general, when safe, sound and efficient credit unions enter a market and are able to offer lower-cost services, competition increases and prices fall (Emmons and Schmid 2001). Although credit unions are well positioned for the market, motivation for pursuing the market has been a combination of the following three factors:

1. Relationship Building

-For sending institutions, the product serves as a tool to reach new and growing immigrant markets while deepening relationships with existing immigrant members. Community demographics have changed so dramatically that in some cases not seeking to serve new immigrants is simply not an option if the institutions are to remain relevant. For distributing institutions, the act of distributing transactions brings individuals that are not already members into the organization on a repeated (often monthly) basis and presents the opportunity to attract these receivers as members and turn at least part of their remittances into savings.

2. New Source of Fee Income

-As a result of originating or distributing transactions, the credit union involved generates income on each transaction. Credit unions are considering the size of the international remittance industry at an estimated $105 - $150 billion dollars globally (Inter-American Development Bank 2002) and the estimated $12 billion that will likely be sent from the United States to Mexico in 2003 in their decisions. (Lugo 2003) Similar to most financial intermediaries worldwide, income from fees is increasingly becoming a growing share of total income for credit unions. Credit unions, as not for profits, charge lower fees for comparable services in a given banking sector. (American Banker 2002)

3. Demonstrates Commitment to Communities

-The two motivations listed above for offering remittances are essentially the same rationale for both originating and distributing credit unions on the opposite side of the transaction. Additionally, in many developed countries, credit unions offer remittances as a way to reconnect to their founding missions of serving groups that otherwise would not have service to depository banking services.

The demographics of Latino immigrants in the U.S. that are most likely to send money to their home countries is well correlated to the demographics of those Latino immigrants which are most likely to be unbanked. Approximately 69 percent of all Latino immigrants send money home to families – usually through non-bank providers charging exorbitant rates. Approximately 73 percent of Latino immigrants between the ages of 18-34 and earning less than $20,000 per year are sending money home; 68 percent of Latino immigrants ages 18-24 earning less than $20,000 per year are unbanked. (Bendixen 2001) The primary reasons these individuals do not have accounts are: they do not feel they need an account (38 percent); they do not have the documentation that they believe is required to open an account (25 percent); or the process appears (is) too complicated (9 percent). (Bendixen 2001) This data clearly demonstrates that reaching the core Latino money transmission sector in the U.S. equates to serving the underserved.

In contrast, in many developing countries 65-80 percent of the population does not have access to depository financial services many of the existing members of credit unions may not have access to depository services if it were not for their credit unions. (Westly and Branch 2000) As receivers of remittances in Latin America are often low to moderate-income groups, many banks are not actively seeking to open savings accounts or provide credit to these clients. (Personal Interviews 2000 and 2002) Yet, this clientele is already the core of credit union membership in these countries and may not require new strategies by credit unions to connect to this type of potential member.

B. Method of Remittance Service

When WOCCU began investigating the methods for offering remittances on a global basis a range of options were evaluated based on efficiency, likelihood of adoption by users and credit unions and technical fit with current operations. The four broad categories of options included: card-based systems, account-based electronic transfers, international shared branching and cash-based electronic transfers. To date, the growth area for credit unions working with WOCCU has been concentrated on the cash-based model of electronic transfers. As the majority of this section will address this methodology, a brief review of the alternative methods considered is presented below.

1. Card-Based Systems

As technology has evolved, credit unions continue to monitor their remittance strategies. While they encourage the using of ATM cards for remittances for some migrants, it remains a secondary strategy compared to cash payment at the point of sale for the following reasons:

ATMs receipt of money does not facilitate savings and banking the unbanked as effectively as well-trained tellers that cross-sell the credit union services;
Immigrants in the originating country must have a depository account and ATM card associated with an international network. Approximately 66% of Central American immigrants in the U.S. do not have a banking relationship (Bendixen 2001);
Limited availability of international ATM networks in rural destination areas and withdrawal size limitations; and
While ATMs c can be cost effective for remitters, programs from large U.S. banks to-date have been more costly than cash payments. (Orozco 2002)

2. Account-Based Electronic Transfers

Nearly all 10,000 credit unions and 4,000 commercial banks operating in the United States have the capability to offer traditional account-based international wire transfers. Although financial intermediaries have been offering such services for decades this method has very little penetration in family based remittance transfers primarily because of the requirement for both the sender and receiver to maintain an account with a depository financial institution that has international correspondent relationships. In addition, these account-to-account based transfers occur through traditional or established bank wire systems that were created for, and cater to, large value commercial payments that originate through the Federal Reserve System’s Fedwire and are carried across the SWIFT messaging system. Because these systems are extremely flexible and ubiquitous in their ability to deliver payment to a vast number of banks worldwide, limited information is available to the originator of the transfer regarding the exchange rate at which the transaction will occur or the time by which payments will be received. These limitations have also created an environment where many banks or credit unions in developed countries no longer actively promote such services because of previous negative experiences.

3. International Share Branching

International shared branching refers to an integrated environment where institutions or a single institution allows individuals full access to their account in person and perform related banking services at a facility in another country other than his/her “home” branch. For example, a person that is a credit union member in Mexico could deposit/withdrawal funds, apply for or make loan payments and utilize associated services at a participating and distinct credit union in the United States. These services have not previously been implemented due to challenges in quantifying the potential return on investment for credit unions, but there does seem to be some market these services.

4. Cash-Based Electronic Transfers

This category of transfers represents the most common, and a continually growing, method for transmitting money domestically and internationally. These transfers allow an individual to present cash or have an account debited at a sending institution and either cash is delivered to the recipient or in some cases an account can be credited at a distributing institution abroad. WOCCU chose this as the most optimal way to offer the service because of the popularity of this method by immigrants, the ease of implementation among a technologically diverse set of institutions and the personal contact required for initiating/distributing transactions presents opportunities for gaining new members.

The limitation with this method is that to have significant presence or impact in the market a broad physical network is needed on the origination and distribution sides and a robust technological infrastructure to interconnect these participants. The importance of such a network is discussed further in the lessons learned section.

Upon selecting this method for transfers WOCCU began a process of identifying and selecting potential alliance partners. As with selecting any strategic partners, key criteria for selection included an institutional due diligence analysis including license evaluation, similar cultural orientation (in this case, commitment to low-moderate income immigrant communities as demonstrated through transparent operations and low prices) and complimentary business objective. The complimentary business objective was the need to combine a partner’s technological network, on both the originating and distributing sides of a transaction, with the vast physical infrastructure that credit unions offer.

WOCCU, as a broker for credit union participation in remittances, and its chosen global strategic partner (Vigo Remittance Corporation) deems it essential that sending and distributing institutions meet minimum financial and operational standards to participate.

Requirements for Participation

Given the technology and method chosen for facilitating remittances, there are differing operational requirements for credit unions on the originating versus distributing side of the transactions. The key difference is the ability to work with individual institutions on the originating side of transactions versus the need to work through networks of credit unions on the distributing side. By having broad networks on the distribution side, originating institutions can offer a convenient and consistent service in terms of price, exchange rates and service to senders. Operationally, originating institutions can send the transaction information to centralized servers maintained by a network provider and must settle the funds individually with the network provider. Conversely, a network of distributing organizations must identify a single centralized location within its network to receive information and funds for settlement from the centralized network provider on the origination side.

A description of potential requirements for distributing networks is described below:

A network of institutions that together offers a physical distribution system across a country. To a large extent, the key element of a strong distribution network rests solely on the points of service that it offers with particular emphasis on regions where the immigrants abroad have come from. A single entity in the network would contract with the centralized network provider and sub-contract with the distributing institutions if they were separate organizations.

The distributing institutions must have regulatory approval to offer money transmission services, if applicable, and must adhere to anti-money laundering guidelines. Some governments allow only certain types of institutions to be engaged in money transmission or may require specific licensing to enter the market. In increasing regulatory requirements include flowing the anti-money laundering principles of the Financial Action Task Force and/or the USA Patriot Act if transactions pass through the United States.

A Central Finance Facility (cash management desk) with technical and operational capacity to manage the disbursement of funds and information. Each institution offering remittances must have its own account with the Central Finance Facility through which funds will be distributed. All funds will be cleared through a Central Finance Facility (CFF) and settlement will occur between the CFF and each distributing institution. On behalf of the network, the CFF is also responsible for managing foreign exchange operations, if applicable. The management of foreign exchange includes informing the centralized network provider daily of the exchange rate that will apply for payments occurring and performing the exchange of currencies.

A reliable communications infrastructure through which information can securely and efficiently be distributed is necessary. There must be a reliable system in place for communication between the national-level entity and the participating institutions. While different technologies may be used, a formal system capable of securely moving information through the network efficiently needs to be in place. The level of automation and efficiency of the network will impact the network’s ability to growth the service.

A minimum level of financial performance, stability and capacity to capture savings is required. The cash-based methodology chosen for offering remittances requires distributing entities to make payment upon receipt of payment instructions; however, the settlement of funds between the originating and distributing institutions does not occur until the next business day. As a result, distributing institutions are providing overnight credit to originators (Herstatt risk) and need sufficient liquidity management capability to make payment immediately.

A strong customer service orientation that encourages recipients to continue using the service is needed. The bottom line accountability within the receiving country resides with the national entity. This entity must decide, within an acceptable range, the rigor with which it holds individual distributing entities/branches to standards. Distributing entities should be open at least five days per week, have an external audit completed annually, have telephone/fax communication capabilities and maintain a clearing account with the CFF.

II. Analysis of Current and Potential Impact

The most significant impact that the provision of remittance services by credit unions can have is the opening of depository transaction accounts and the integration of unbanked senders and receivers into the financial system. This impact does not diminish the interest to decrease costs in the money transfer market but rather recognize that lower costs in themselves are not sufficient. For example, if remittances were free but 50 percent of Mexican originators still relied on fringe banking services for savings in the mattress, paying 1-3 percent to cash paychecks, lack conventional credit histories and utilize predatory lenders, the individuals would not be better off economically. As discussed above, credit unions on both the sending and receiving sides of the transfers are offering the product for similar reasons. The service enables credit unions to leverage their existing infrastructures to offer money transfers and develop new relationships. Much like how checking accounts are offered at or below costs to build relationships for financial institutions, credit unions are able to offer remittance services as a relationship product with the expectation that income will be generated from such members on newly formed relationships that encompass savings, credit and/or insurance products. This positioning of the product and the non-profit status of credit unions, enable them to undercut prices of the for-profit money transfers companies as seen in Table 1 and generate revenue on the relationships that can be built. In contrast, the major money transfer companies are publicly traded firms that must maximize their profits from the fees and a narrow set of products.