Experts Meeting Latin American Economic Outlook 2010

1. Remittances and Financial Development Experts Meeting Latin American Economic Outlook 2010 Rolando Avendaño Sebastian Nieto Parra OECD Development Centre  19 May 2009 – Paris 

2. Core sections: Remittances and Access to Banking Remittances and Capital Markets Conclusions and Policy Implications Outline: Remittances and Financial Development

3. 1 Remittances and Access to Banking - Costs (transaction costs, currency costs,…). Latin America vs other regions -Money sending institutions (banking and other sending platforms): empirical facts and strategies - New instruments: Mobile banking (Distribution networks and Transactions costs) - Remittances and banking development - Box: Historical comparison for banking development (Latin European countries 1870-1913) Outline: Remittances and Financial Development

4. Remittances and capitalmarkets - International experience: Securitizations/ Diaspora bonds - Remittances and capital markets: the case of ratings (risk indicators : debt over exports and volatility of external flows) Current economic crisis and remittances - Box: external capital market shocks and remittances (historical experience: Baring crises and remittances) Outline: Remittances and Financial Development

5. Remittances and Access to Banking 1 2 Remittances and Capital Markets

6. Differences in bank concentration across the region Source: World Bank 2008.

7. Significant differences in bank concentration across the region Source: Thorsten Beck, Asli Demirgüç-Kunt and Ross Levine, (2000), "A New Database on Financial Development and Structure," World Bank Economic Review 14, 597-605. Updated November 2008. Note: Bank concentration defiined as a measure of the degree of concentration in the banking industry, calculated as the fraction of assets held by the three largest commercial banks in each country, averaged over the period 1995-99.

8. Remittances and Banking Access • A broader range of services: • Repatriation insurance • Free money-sending • Residence Certificates • Low cost travel plans • Legal advice • Home Loans • Strategies: • Bancarización inducida: encouraging bank account creation in receiving country. • Remesas cuenta a cuenta: From 4% to more than 20% in the last four years. • Remesas finalistas: Specific destination for remittances (housing, education, etc.) • Two main obstacles: Distribution / Costs

9. Why mobile technology for remittances? Distribution and Coverage across regions Geographic bank branch Demographic bank branch Geographic cash machines Mobile Phone Mobile technology has a potential in regions with low density of banks and cash machines. Source: Wireless Intelligence (2008), Beck, Demirguc-Kunt and Martinez Peria (2005)

10. Costs and actors in the remittances business model Transaction Costs in Banks and Money Transfer Operators Fee for sending USD 200 (%) Mobile technology is more likely in countries with a weak presence of Money Transfer Operators; under any banking market structure Source: OECD Development Centre (2009), based on World Bank (2008)

11. Different corridors, different mechanisms: The role of the sending country Most promising corridors - Japan, France, Canada, The Netherlands Latin America and Caribbean Source: World Bank (2008)

12. From mobile payments to mobile banking In LAC mobile banking is more about households than firm access • While 9 / 10 people in LAC have a mobile • phone line, 70-80 % have no banking access. • Mobile banking is feasible with a large • amount of small deposits • Mobile phones are enabling to trace a • history to access loans when no collateral • In credit decisions face-to-face contact • remains essential Source: Beck, Demirguc-Kunt and Martinez Peria (2005) Mobile banking operations are largely available in LAC as an additional distribution channel

13. Policy recommendations for mobile payments Outlook: Will LAC’s bank-lead model fully integrate mobile advantages? • 1. International remittances through mobile technology are lead by.. • ..banks with cash out through branches: Spain Ecuador, US  Colombia • ..mobile operators for population without bank access: US  El Salvador • 2. While mobile remittances are estimated to grow, LAC will only benefit • if banks and money transfer operators (financially compliant) make full use of mobile operators (distributional networks) or • if mobile operators are subject to adequate financial regulation and liquidity is available at telcos agents’ shops

14. Remittances and Access to Banking 1 2 Remittances and Capital Markets

15. Total Yield (bp) at Launch Future Flow Securitization (Diversified Payment Rights) Payments on the receivables do not enter before obligations are met Rating at Launch(Sovereign vs DPRs) Source: OECD Development Centre (2009), based on Dealogic

16. Diaspora Bonds: A mechanism to tap the migrants’ wealth Households’ income matter but other factors are crucial (patriotism ,… ) Source: OECD Development Centre (2009), based on OECD stats

17. Are Remittances relevant for Rating Agencies? Remittances flows are an important source of financing for developing countries. They act as an instrument to reduce financial vulnerabilities  Lessen the probability of current account reversals and credit risk. World Bank: « Remittances can improve a country’s creditworthiness and enhance its access to international capital markets.» We study: (i) Role of workers’ remittances in the estimation of sovereign ratings, following the models Credit Rating Agencies (CRAs). Solvency ratio (debt/exports) Volatility of external flows (ii) Shadow ratings for unrated countries (some with high remittances levels) Motivation

18. Why are we interested in ratings? Linked with financial markets (development, spreads) and ceiling rating Sub-Sovereign (% Sovereign and Ceiling) Source: OECD Development Centre based on Moody’s, 2009 Source: Authors based on World Bank and OECD data

19. Traditional Determinants of Sovereign Ratings Solvency Ratio (Debt/Exports) excluding remittances is a key variable in traditional models

20. Traditional channel: Solvency Ratio and remittances Solvency Ratio (Debt/Exports) including and excluding remittances

21. Remittances are less volatile than other flows: A source for financial stability Volatility of external flows 92-07 (% of GDP) Source: OECD Development Centre, based on IFS, 2009.

22. Capital flows volatility is reduced by remittances: an externality for sovereign ratings? Source: OECD Development Centre, based on IFS, 2009.

23. Our model and Counterfactual Analysis Predicted model: Counterfactual model: • Three estimations: • Observed • Predicted • Counterfactual

24. Our model and Counterfactual Analysis Results: Standard and Poor’s estimations Counterfactual – Predicted (Rating gain: 1=one notch) Observed, Predicted, Counterfactual Source: OECD Development Centre, based on Avendano, Gaillard and Nieto-Parra (2009)

25. Our model and Counterfactual Analysis Results: Moody’s estimations Counterfactual – Predicted (Rating gain: 1=one notch) Observed, Predicted, Counterfactual Source: OECD Development Centre, based on Avendano, Gaillard and Nieto-Parra (2009)

26. Rating agencies do not have an unique modelModel for High-Remittance Receptors: Defining a threshold Significance and sign of the key variables (remittances matter) S&P’s Moody’s Fitch Source: OECD Development Centre, based on Avendano, Gaillard and Nieto-Parra (2009)

27. Rating agencies do not have an unique modelModel for High-Remittance Receptors: Defining a threshold Indirect effect (premium): Reduce negative impact of volatility ext. flows Source: OECD Development Centre, based on Avendano, Gaillard and Nieto-Parra (2009)

28. Shadow ratings for Selected Countries Moody’s Fitch S&P Source: Authors calculation. OECD Development Centre 2009.

29. Conclusions and Policy Lessons • This paper also provides “shadow” ratings for countries which are not rated by the three main CRAs, in particular some Central American and Caribbean countries, where relative remittances flows are higher. Information and Portfolio Allocation. Public-Private Partnership • The impact of including remittances in the solvency ratio (debt over exports) and the volatility of external flows is relatively modest. • Remittance flows cannot, as a whole, enable low and medium income countries to improve their creditworthiness significantly. Remittances should be accompanied by policy measures related to the solvency of the country and the stability of external flows.

30. Conclusions and Policy Lessons • Specification for high-remittance receptors: The direct effect on ratings (the dummy variable remittances over GDP is not significant) is reduced. There may be an indirect, positive impact on ratings through a premium (captured with the interactive dummy and the variable volatility of external flows). Results consistent with previous research (e.g. Roubini and Manasse, 2005) showing that there is not a unique model to rate countries and not all variables have the same impact for a sovereign rating.

31. Role of remittances in rating agencies’ methodology • “ (…) Fitch will nonetheless take account of the volatility and potential vulnerability of such receipts – such as remittances – to domestic and external shocks. " Fitch Ratings, “Sovereign Rating Methodology", October 12, 2007 • “Remittances, equivalent to more than a tenth of domestic output and a major driver of consumption, are expected to drop 5 to 10 percent this year as a slowing global economy puts pressure on wages of Filipino workers abroad.” “Moody's: Slowing remittances hurt RP”, Manila Bulletin, February 14, 2009 • “The revision of the outlook on Mexico to negative reflects our assessment of the deterioration in its fiscal and external positions.....Our projections are for Mexico's external debt (net of liquid assets) to reach more than 40% of current account receipts by 2010 versus the 'BBB' median of 28%". Standard and Poor’s, 12 May 2009. • Standard and Poor's lowered El Salvador's credit rating to "BB" from "BB+": "The weak performance in 2009 is due to falling consumption, investments, and exports as a result of a significant pass-through from the global recession. Remittances from the United States fell by 8 percent in the first two months of the year..."

32. Do Remittances Prevent Financial Disturbances? Lessons from the Gold Standard Period Source: Based on data from Esteves and Khoudour-Castéras (2010). Financial crises and remittances before Word War I

33. Remittances and Financial Development Thank you! Rolando Avendaño Sebastian Nieto Parra OECD Development Centre  19 May 2009 – Paris 