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Remittances and Financial Development in India




Dissertation
Submitted by
Ajay Kumar (75008)
for the award of the degree of
Bachelor of Financial and Investment Analysis






Shaheed Sukhdev College of Business Studies
Delhi University
April 2014



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Certificate

I hereby declare that the project work entitled Remittances and Financial Development
submitted to the SHAHEED SUKHDEV COLLEGE OF BUSINESS STUDIES, is a record
of an original work done by me under the guidance of Dr. Kumar Bijoy, Head of
Department, Department of Financial Studies, SSCBS, and this project work has not
performed the basis for the award of any other Degree or diploma/ associate ship/fellowship
and similar project if any other than this.

Date:
Place: Delhi








Ajay Kumar Dr. Kumar Bijoy Mrs. Poonam
Verma
(Student) (Supervisor) (Principal)






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Acknowledgments
In pursuit of the degree of Bachelor of Financial and Investment Analysis, the final project is
a critical component of the entire program course. As part of a student in Shaheed Sukhdev
College of Business Studies, University Of Delhi, I got an opportunity to gain invaluable
experience under the guidance of Dr. Kumar Bijoy for completion of my final graduation
project. His continuous support and valuable in hand experience provided me with the
conceptual understanding and practical approach needed to work efficiently for this project.
Sincere thanks to all the staff members and the entire praiseworthy faculty of CBS.
The present work is an effort to throw some light on Remittances and Financial
Development in India. The work would not have possibly come to the present shape without
the able guidance, supervision and help of a number of people. I convey my heartfelt
affection to all those people who supported during the course, for contributing tremendously
in completing my Research Report. I hope this report, reflecting my learning in the past
thirteen weeks, is as beneficial to the readers as it has been to me.
Sincerely thanking you all.

Ajay Kumar (75008)
Bachelor of Financial and Investment Analysis
Shaheed Sukhdev College of Business Studies

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1 CONTENTS
2 Abstract ........................................................................................................................................... 5
3 Research Objective ......................................................................................................................... 6
4 Review of Literature ....................................................................................................................... 7
5 Analysis and Observations .............................................................................................................. 9
5.1 Introduction ............................................................................................................................. 9
5.2 History................................................................................................................................... 11
5.2.1 Overview ....................................................................................................................... 11
5.3 By region ............................................................................................................................... 11
5.3.1 Asia ............................................................................................................................... 11
5.3.2 Latin America and the Caribbean ................................................................................. 11
5.3.3 Africa ............................................................................................................................ 13
5.4 Economic benefits ................................................................................................................. 15
5.5 Remittances to India ............................................................................................................. 15
5.5.1 Remittance by fiscal year .............................................................................................. 17
5.6 Financial sector development ................................................................................................ 19
5.6.1 Importance of Financial Sector Development ............................................................... 20
5.6.2 Measurement of Financial Development ...................................................................... 20
5.7 India Financial Development Fund ....................................................................................... 21
6 Data and Methodology .................................................................................................................. 22
6.1 Ratios .................................................................................................................................... 23
6.1.1 Bank deposits to GDP Ratio ......................................................................................... 23
6.1.2 Share of bank credit to GDP Ratio ................................................................................ 25
6.1.3 M2 to GDP ratio ............................................................................................................ 26
6.1.4 Gross value added of the financial sector to GDP ........................................................ 27
6.1.5 Private Sector Credit to GDP ........................................................................................ 28
6.1.6 Financial Institutions asset to GDP .............................................................................. 29
6.1.7 Accounts per Thousand Adults ..................................................................................... 30
7 Results ........................................................................................................................................... 33
8 Conclusion .................................................................................................................................... 35
9 Bibliography ................................................................................................................................. 38


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2 ABSTRACT
This Study Focus the impact of Remittances on financial Development in India . And, it
investigates the impact of remittances received by India From developed countries. This is an
important issue given recent studies showing that financial development can have significant
beneficial effects on households. Using household-level survey data, the impact of
remittances on households use of savings and credit instruments from formal financial
institutions. We find that although remittances have a positive impact on financial
Development by promoting the use of deposit accounts, they do not have a significant and
robust effect on the demand for and use of credit from formal institutions. If anything, by
relaxing credit constraints, remittances might reduce the need for external financing from
financial institutions, while at the same time increasing the demand for savings instruments.
For example in Sub-Saharan Africa only 24% of adults have a bank account even
though Africa's formal financial sector has grown in recent years. It is argued that as banking
services are in the nature of public good; the availability of banking and payment services to
the entire population without discrimination is the prime objective of financial Development
public policy.If anything, by relaxing credit constraints, remittances might reduce the need
for external financing from financial institutions, while at the same time increasing the
demand for savings instruments.

















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3 RESEARCH OBJECTIVE
First, it is to analyze the impact of remittances on financial Development directly.
While previous studies have looked at the link between remittances and aggregate deposits and
credit amounts, this is the study to examine whether remittances foster the use of deposit accounts
and credit by households. This is important given the literature that has identified beneficial
effects from financial Development
Second, by looking at whether households apply for loans, this study is able to examine
the impact of remittances on the demand for credit and not purely on credit outcomes. This is
useful because it can allow us to begin to assess to what extent remittances might relax credit
constraints.
Third, by using household-level panel data, this study can circumvent some of the
limitations of the previous studies.




















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4 REVIEW OF LITERATURE

King and Levine, Beck and Loayza and Demirgu-Kunt, (1993-2004)
The purpose of this study argues that by intermediating societys savings and allocating them
to their best uses, financial systems have a critical function for economies growth. However,
financial sectors can also be a source of fragility. Critically, recent policy approaches towards
the financial sector have focused more on the size of the sector rather than its intermediating
function, which might have led to short-run growth at the expense of high volatility.
Reducing the financial safety net subsidy and adjusting the regulatory framework
strengthening incentives towards intermediation will not only make the financial system safer
but also increase the growth benefits of finance for the real economy.

Banerjee et al. (2010)
This paper reports on the first randomized evaluation of the impact of introducing the
standard microcredit group-based lending product in a new market. In 2005, half of 104
slums in Hyderabad, India were randomly selected for opening of a branch of a particular
microfinance institution while the remainder were not, although other MFIs were free to enter
those slums. Fifteen to 18 months after Spandana began lending in treated areas, households
were 8.8 percentage points more likely to have a microcredit loan. They were no more likely
to start any new business, although they were more likely to start several at once, and they
invested more in their existing businesses.
There was no effect on average monthly expenditure per capita. Expenditure on durable
goods
increased in treated areas, while expenditures on temptation goods declined. Three to four
years after the initial expansion (after many of the control slums had started getting credit
from Spandana and other MFIs ), the probability of borrowing from an MFI in treatment and
comparison slums was the same, but on average households in treatment slums had been
borrowing for longer and in larger amounts. Consumption was still no different in treatment
areas, and the average business was still no more profitable, although we find an increase in
profits at the top end. We found no changes in any of the development outcomes that are
often believed to be affected by microfinance, including health, education, and womens
empowerment.

Aggarwal, Demirg-Kunt, and Martnez Pera (2011)
The Purpose of this study show the impact of remittances on the financial sector using
balance of payments data on remittances and aggregate data on bank credit and deposit
amounts for 109 developing countries over the period 1975-2007.
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Lopez-Cordova, Martnez Pera, and Woodruff (2011)
The Purpose of this study shows the importance of remittances to developing countries, their
impact on banking sector breadth and depth in recipient countries has been largely
unexplored. We examine this topic using municipality-level data on the fraction of
households receiving remittances and on measures of banking breadth and depth for Mexico.
We find that remittances are strongly associated with greater banking breadth and depth,
increasing the number of branches and accounts per capita and the amount of deposits to
GDP. These effects are significant both statistically and economically, and are robust to the
potential endogeneity of remittances, Development of a wide range of controls and even
municipal fixed effects specifications using an alternative panel data set from a sample of
municipalities.

















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5 ANALYSIS AND OBSERVATIONS

5.1 INTRODUCTION
Remittances have become a significant source of external financing for developing
countries. They reached US$307 billion in 2009 and In 2012, according to the World Bank Report,
$401 billion went to developing countries (a new record) with overall global remittances at $514
billion more than double the amount of official development assistance and over two-thirds of the
private capital flows received by developing countries in that year. Remittances are especially
significant for small developing countries neighbouring large rich economies. For example,
remittances account for approximately 17 percent of GDP and they represent the second most
important source of external flows after exports.
There is an extensive literature on the effects of remittances on growth, investment
in microenterprises, poverty, inequality, health, and education. However, there are not many
studies that address the effects of international remittances on the domestic financial system. This
question is important because the literature has shown that financial development can have a
significant impact on economic growth and poverty reduction.
Furthermore, there is evidence that promoting financial Development facilitating households
access to and use of financial services can also have significant beneficial effects. Based on a
randomized evaluation of a microcredit program in India, find that access to microcredit leads to
greater investment in business durables, increases the number of businesses started, and improves
the profitability of existing ones. It conducted in a field experiment in which a finance company
randomly liberalized screening criteria on consumer loans in South Africa and find significant
positive effects of access to credit on consumption, economic self-sufficiency (measured by
employment status and income), and some aspects of mental health and outlook. Studies on the
impact of accessing and using savings products also find positive effects. In particular, the
literature has found that providing individuals access to savings instruments increases savings.




Using household-level survey data for the period 2001-2011, this study investigates the impact of
remittances on financial Development. In particular, we focus on whether remittances promote
the use of deposit accounts and credit by examining the impact of remittances on the likelihood
that households have a deposit account, apply for loans, and receive loans from formal financial
institutions.

There are several ways in which remittances could affect financial Development.
First, remittances might increase the demand for savings instruments. The fixed
costs of sending remittances make the flows lumpy, providing households with excess cash for
some period of time. This might potentially increase their demands for deposit accounts, since
financial institutions offer households a safe place to store this temporary excess cash.
Second, remittances might increase households 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 opaque borrowers. On the other hand, since remittances might help
relax households financing constraints, the demand for credit might fall as remittances increase.
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To the best of our knowledge, there are only three papers that examine the direct link between
remittances and the domestic financial system. They find strong evidence indicating that
remittances promote financial development, measured by the ratio bank deposits to GDP, and the
share of bank credit to GDP. Focusing exclusively on Mexico and using municipality-level data,
find that municipalities where a higher proportion of households receive remittances have a
higher number of bank branches and accounts per capita, and larger shares of deposits to GDP.
Our paper contributes to the study of the impact of remittances on the financial sector in several
ways.
In particular, the survey data used in this study has the potential to capture remittances flows
received through formal and informal channels, minimizing concerns about measurement error in
remittances. Also, because we use household-level panel data we are able to control for
unobserved household characteristics that can affect both remittances and financial Development,
something that was not possible in the earlier studies. Finally, this study will offer evidence on
the impact of remittances on financial Development for a new country - for which remittances
represent a very significant share of GDP. We conduct probit estimations of the likelihood of
using deposit and credit services, allowing for department-, municipality-, or household-level
fixed effects to control for factors other than remittances that might affect financial Development
at the household level. Also, to deal with the potential endogeneity of remittances, we conduct
instrumental variables regressions. Our main instruments are economic conditions in developing
countries.

Our estimations show that households that receive remittances are more likely to have
a deposit account at a financial institution. Our most conservative estimates indicate that
receiving remittances increases the likelihood of having an account by at least 11 percent and an
additional colon per capita in remittances raises this probability by 5 percent. These effects are
sizeable given that on average only 19 percent of households have an account. However,
remittance-recipient households are not more prone to request or receive a loan. In fact, some
estimations show the opposite. This suggests that though remittances might have the potential to
encourage the use of savings instruments, they do not necessarily foster the demand for and use
of credit, perhaps because they help to relax credit constraints.
A majority of the remittances from the US have been directed to Asian countries like India
(approx. 66 billion USD in 2011), China (approx. $57 billion USD), the Philippines (approx. 23
billion USD), Pakistan (apporx . 16 billion) and Bangladesh (approx. 14.5 billion USD). In Latin
America and the Caribbean, remittances play an important role in the economy of the region, totaling
over 66.5 billion USD in 2007, with about 75% originating in the United States. This total represents
more than the sum of Foreign direct investment and official development aid combined. In seven
Latin American and Caribbean countries, remittances even account for more than 10% of GDP and
exceed the dollar flows of the largest export product in almost every country in the region.
Percentages ranged from 2% in Mexico, to 18% in El Salvador, 21% in Honduras, and up to 30% in
Haiti.

What is Remittance?
A remittance is a transfer of money by a foreign worker to an individual in his or her home country.
Money sent home by migrants competes with international aid as some of the largest financial inflows
to developing countries. In 2012, according to the World Bank Report, $401 billion went to
developing countries (a new record) with overall global remittances at $514 billion. The economic
impact remains contested among researchers, however, remittance transfers do draw people towards
the financial services that are available to them.

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5.2 HISTORY
5.2.1 Overview
Remittances are not a new phenomenon in the world, being a normal concomitant to
migration which has always been a part of human history. Several European countries, for
example Spain, Italy and Ireland were heavily dependent on remittances received from their
emigrants during the 19th and 20th centuries. In the case of Spain, remittances amounted to
the 21% of all of its current account income in 1946. All of those countries created policies
on remittances developed after significant research efforts in the field. For instance, Italy was
the first country in the world to enact a law to protect remittances in 1901 while Spain was
the first country to sign an international treaty (with Argentina in 1960) to lower the cost of
the remittances received. Since 2000, remittances have increased sharply worldwide, having
almost tripled to $529 billion in 2012. In 2012, migrants from India and China alone sent
more than $130 billion to their home countries.
5.3 BY REGION
5.3.1 Asia
A majority of the remittances from the US have been directed to Asian countries like India
(approx. 66 billion USD in 2011), China (approx. $57 billion USD), the Philippines (approx.
23 billion USD),Bangladesh (approx. 21.5 billion USD) and Pakistan (apporx. 16 billion).
Most of the remittances happen by the conventional channel of agents, like Western Union,
Xpress Money, UAE Exchange and MoneyGram. However, with the increasing relevance
and reach of the Internet, online and mobile phone money transfers from companies such as
Remit2India, Azimo and Xoom.com have grown significantly.A common shop for remittance
in Angeles City, Philippines
According to a World Bank Study, the Philippines is the second largest recipient for
remittances in Asia. It was estimated in 1994 that migrants sent over US2.6 billion back to
the Philippines through formal banking systems. With the addition of money sent through
private finance companies and return migrants, the 1994 total was closer to US 6 billion
annually. Looking at current remittance flows, the total is estimated to have grown by 7.8 per
cent annually to reach US 21.3 billion in 2010. Remittances are a reliable source of revenue
for the Philippines, accounting for 8.9 per cent of the country's GDP.
The Estrada administration in 2000 declared it "The Year of Overseas Filipino Worker in the
Recognition of the Determination and Supreme Self-Sacrifice of Overseas Filipino Workers."
This declaration connects monetary remittances of overseas workers as the top foreign-
exchange earnings in the Philippines.
5.3.2 Latin America and the Caribbean
In Latin America and the Caribbean, remittances play an important role in the economy of the
region, totaling over 66.5 billion USD in 2007, with about 75% originating in the United
States. This total represents more than the sum of Foreign direct investment and official
development aid combined. In seven Latin American and Caribbean countries, remittances
even account for more than 10% of GDP and exceed the dollar flows of the largest export
product in almost every country in the region. Percentages ranged from 2% in Mexico, to
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18% in El Salvador, 21% in Honduras, and up to 30% in Haiti. The Inter American
Development Bank's Multilateral Investment Fund (IDB-MIF) has been the leading agency
on regional remittance research.
Through the providers listed on Send Money Home migrant workers can now view a price
comparison on remittances to Latin American and Caribbean countries.This research has
often been carried out in collaboration with Manuel Orozco of the Inter-American Dialogue,
his remittance research can be found at the Dialogue

and at the IDB. In this region, Mexico,
one of the best documented examples of migration and remittances, received remittance
inflows of almost 24 Billion US$ in 2007, 95% of which originated in the US.
A significant study conducted by the Inter-American Development Bank (IDB) in 2004
provides useful insight into remittance and related migration patterns between Latin America
and the United States. The study reveals that over 60% of the 16.5 million Latin American-
born adults who resided in the United States at the time of the survey regularly sent money
home. The remittances sent by these 10 million immigrants were transmitted via more than
100 million individual transactions per year and amounted to an estimated $30 billion during
2004. Each transaction averaged about $150$250, and, because these migrants tended to
send smaller amounts more frequently than others, their remittances had a higher percentage
of costs due to transfer fees.
Migrants sent approximately 10% of their household incomes; these remittances made up a
corresponding 5080% of the household incomes for the recipients. Significant amounts of
remittances were sent from 37 U.S. states, but six states were identified as the "traditional
sending" states: New York (which led the group with 81% of its immigrants making regular
remittances), California, Texas, Florida, Illinois, and New Jersey. The high growth rate of
remittances to Mexico (not the total amount) is unlikely to continue. In fact, according the
Mexican central bank, remittances grew just 0.6 during the first six months of 2007, as
compared to 23% during the same period in 2006. Experts attribute the slowdown to a
contraction in the U.S. construction industry, tighter border controls, and a crackdown in the
U.S. on illegal immigration.
As the foregoing statistics illustrate, increased migration from Latin America to the United
States has resulted in a very significant amount of remittance activity. The numbers also help
us understand the dependence between a developed country and developing countries: The
United States needs Latin Americans to supply its labor marketsthe migration improves
business profitability and reduces the costs of production, while Latin American countries
depend on the flows of remittances that result from the migration of labor. This dependence
has also resulted in what experts call "micro-geographies," tightly knit networks that integrate
U.S. communities with communities throughout Latin America, such as migrants from
Oaxaca, Mexico who have settled in Venice Beach, California. Oaxacans not only send
money back to their communities, but they also travel back and forth extensively.
As of recently, remittances from the U.S. to Latin America have been on the decline. While
there were USD 69.2 billion worth of remittances sent in 2008, that figure has fallen to USD
58.9 billion for 2011. This trend is a result of many factors including the global recession,
more economic opportunity in Latin American countries, and rising fees charged by coyotes
to smuggle immigrants across the border. The pattern of migration has changed from a
circular flow, in which immigrants work in the U.S. for a few years before returning to their
families in their home countries, to a one-way stream whereby migrants find themselves
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stuck in the United States. As a result, the new wave of migrants are both less likely to leave
and more likely to stay in the U.S. for longer periods of time. Overall, this trend has
contributed to falling levels of remittances sent to Latin American countries from the United
States.
5.3.3 Africa
Remittances to Africa play an important role to national economies, but little data exists as
many rely on informal channels to send money home. Today's African Diaspora consists of
approximately 20 to 30 million adults, who send about USD 40 billion annually to their
families and local communities back home. For the region as a whole, this represents 50
percent more than net official development assistance (ODA) from all sources, and, for most
countries, the amount also exceeds foreign direct investment (FDI). In several fragile states,
remittances are estimated to exceed 50 percent of GDP. Most African countries restrict the
payment of remittances to banks, which in turn, typically enter into exclusive arrangements
with large money transfer companies, like Western Union or Money Gram, to operate on
their behalf. This results in limited competition and limited access for consumers, although
there are a number of new players aiming to disrupt this established MTO (Money Transfer
Operator) model, such as Xoom and Willstream , which leverage increasing mobile phone
penetration in the region and provide different rate structures to Diaspora customers.
According to a World Bank study, Nigeria is by far the top remittance recipient in Africa,
accounting for $10 billion in 2010, a slight increase over the previous year ($9.6 billion).
Other top recipients include Sudan ($3.2 billion), Kenya ($1.8 billion), Senegal($1.2 billion),
South Africa ($1.0 billion), Uganda ($0.8 billion), Lesotho ($0.5 billion), Ethiopia ($387
million), Mali ($385 million), and Togo ($302 million). As a share of Gross Domestic
Product, the top recipients in 2009 were: Lesotho (25%), Togo (10%), Cape Verde (9%),
Guinea-Bissau (9%), Senegal (9%), Gambia (8%), Liberia (6%), Sudan (6%), Nigeria (6%),
and Kenya (5%).










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Top recipient countries



Top recipient countries of remittances (in billions of US Dollar)
Country
Remittances
2008
Remittances
2009
Remittances
2010
Remittances 2011

India
49.98 49.2 53.48 63.82

China

22.69 22.9 33.44 40.48

Mexico

26.04 22.08 22.08 23.59

Philippines

18.63 19.73 21.37 22.97

Nigeria

19.21 18.37 19.82 20.62

France

16.28 16.06 16.71 19.31

Egypt

8.69 7.15 12.45 14.32

Germany

10.97 11.3 11.73 13.16

Bangladesh

9.01 10.72 11 12.87

Pakistan

7.04 8.72 9.69 12.26

Belgium

10.42 10.44 10.3 10.91

Sri Lanka

6.78 5.94 6.54 9.92

Spain

10.15 8.95 9.11 9.91

Vietnam

6.81 6.02 8.26 8.6

South Korea

9.07 7.28 7.06 8.49

Ukraine

6.78 5.94 6.54 7.82



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5.4 ECONOMIC BENEFITS
As remittance receivers often have a higher propensity to own a bank account, remittances
promote access to financial services for the sender and recipient, an essential aspect of
leveraging remittances to promote economic development.
The stability of remittance flows despite financial crises and economic downturns make them
a reliable financial resource for developing countries. As migrant remittances are sent
cumulatively over the years and not only by new migrants, remittances are able to be
persistent over time. Remittances are often sent by circular migrants, migrant workers who
move back and forth between their home and host countries in a temporary and repetitive
manner. These workers have the benefit of working in a high-income country and sending
their remittances to a low-income country, thus benefitting financially. At the state level,
countries with diversified migration destinations are likely to have more sustainable
remittance flows.From a macroeconomic perspective, remittances can boost aggregate
demand and thereby GDP as well as spur economic growth. However, some research
indicates that remittances may also have adverse macroeconomic impacts by increasing
income inequality and reducing labor supply among recipients.
A 2011 study develops a long-run growth model for a labour exporting country that receives
large inflows of external incomethe sum of remittances, FDI and general government
transfersfrom major oil exporting economies. The long-run economic benefits of external
income is then evaluated using data for Jordan
5.5 REMITTANCES TO INDIA
Remittances to India are money transfers from Non-resident Indians (NRIs), employed
outside the country to family, friends or relatives in India. India is the world's leading
receiver of remittances, claiming more than 12% of the world's remittances in 2007.
Remittances to India stood at $67.6 billion in 2012-13, accounts for over 4% of the country's
GDP. As per the Ministry of Overseas Indian Affairs (MOIA), remittance is received from
the approximately 25 million members of the Indian diaspora.
Under the Foreign Exchange Management Act (FEMA) of 1999, Non Resident Indians
(NRIs) and Persons of Indian Origin (PIOs) can keep three types of accounts namely, Non-
Resident Ordinary Rupee Account (NRO Account), Non-Resident (External) Rupee Account
(NRE Account) and Foreign Currency Non Resident (Bank) Account FCNR (B) Account.
Since 1991, India has experienced sharp remittance growth. In 1991 Indian remittances were
valued at 2.1 billion USD, in 2006, they were estimated at between $22 billion and $25.7
billion. which grew to $67.6 billion in 2012-13, up from $66.1 billion the fiscal year, 2011-
2012, when the remittance exceed the foreign direct investment (FDI) inflow of $46.84
billion into India.
Money is sent to India either electronically (for example, by SWIFT) or by demand draft. In
recent years many banks are offering money transfers and this has grown into a huge
business. Around 40% of the international remittances flow to the three states of Kerala,
Punjab, Uttar Pradesh and Goa which are among the top international remittance-dependent
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economies of the world. Research work on remittances to India is listed in the India
Migration Bibliography.
A 2012 study, by Reserve Bank of India revealed 30.8% of total foreign remittances was
from West Asia, compared to 29.4% from North America and 19.5% from Europe.






















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5.5.1 Remittance by fiscal year
The following table illustrates the remittances to India as percent of GDP, 19902013.
Year
Remittances
(US$ billion)
Percent
GDP
1990
1991
2.1 0.7
1995
1996
8.5 3.22
1999
2000
12.07 2.72
2000
2001
12.85 2.84
2001
2002
15.4 3.29
2002
2003
16.39 3.39
2003
2004
21.61 3.69
2004
2005
20.25 3.03
2005
2006
24.55
(projected)
3.08
2006
2007
29.10 4.08%
2007
2008
37.2 3.60%
2008
2009
51.6 3.12%
2009
2010
55.06 3.40%
2011
2012
66.1 4.00%
2012
67.6 4.34%
18





















Remittance inflows to GDP (%)








2013
19
















5.6 FINANCIAL SECTOR DEVELOPMENT
Financial sector development in developing countries and emerging markets is part of the
private sector development strategy to stimulate economic growth and reduce poverty.
Financial sector is the set of institutions, instruments, markets. It also includes the legal and
regulatory framework that permit transactions to be made through the extension of credit.
Fundamentally, financial sector development concerns overcoming costs incurred in the
financial system. This process of reducing costs of acquiring information, enforcing
contracts, and executing transactions results in the emergence of financial contracts,
intermediaries, and markets. Different types and combinations of information, transaction,
and enforcement costs in conjunction with different regulatory, legal and tax systems have
motivated distinct forms of contracts, intermediaries and markets across countries in different
times.
The five key functions of a financial system in a country are: (i) information production ex
ante about possible investments and capital allocation; (ii) monitoring investments and the
exercise of corporate governance after providing financing; (iii) facilitation of the trading,
diversification, and management of risk; (iv) mobilization and pooling of savings; and (v)
promoting the exchange of goods and services.
Financial sector development takes place when financial instruments, markets, and
intermediaries work together to reduce the costs of information, enforcement and
transactions.A solid and well-functioning financial sector is a powerful engine behind
economic growth. It generates local savings, which in turn lead to productive investments in
local business. Furthermore, effective banks can channel international streams of private
remittances. The financial sector therefore provides the rudiments for income-growth and job
creation.
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5.6.1 Importance of Financial Sector Development
There are ample evidence suggesting that financial sector development plays a significant
role in economic development. It promotes economic growth through capital accumulation
and technological advancement by boosting savings rate, delivering information about
investment, optimizing the allocation of capital, mobilizing and pooling savings, and
facilitating and encouraging foreign capital inflows.A meta-analysis of 67 empirical studies
finds that financial development is robustly associated with economic growth.
Countries with better-developed financial systems tend to enjoy a sustained period of growth,
and studies confirm the causal link between the two: financial development is not simply a
result of economic growth; it is also the driver for growth.
Additionally, it reduces poverty and inequality by enabling and broadening access for the
poor and vulnerable groups, facilitating risk management by reducing their vulnerability to
shocks, and raising investment and productivity that generates higher income.
Financial sector development also assists the growth of small and medium sized enterprises
(SMEs) by giving them with access to finance. SMEs are typically labor intensive and create
more jobs than large firms, which contributes significantly to economic development in
emerging economies.
Additionally, financial sector development also entails establishing robust financial policies
and regulatory framework. The absence of adequate financial sector policies could have
disastrous outcome, as illustrated by the global financial crisis. Financial sector development
has heavy implication on economic developmentboth when it functions and malfunctions.
The crisis has challenged conventional thinking in financial sector policies and sparked
debate on how best to achieve sustainable development. To effectively reassess and re-
implement financial policies, publications such as Global Financial Development Report
(GFDR) by the World Bank and Global Financial Stability Report (GFSR) by the IMF can
play an important role.
The Global Financial Development Report, a new initiative by the World Bank, highlights
issues that have come to the forefront after the crisis and presents policy recommendation to
strengthen systems and avoid similar crisis in the future. By gathering data and knowledge on
financial development around the world, the GFDR report aims to put into spotlight issues of
financial development and hopes to present analysis and expert views on current policy
issues.
5.6.2 Measurement of Financial Development
A good measurement of financial development is crucial in evaluating the progress of
financial sector development and understanding the corresponding impact on economic
growth and poverty reduction.
However in practice, it is difficult to measure financial development given the complexity
and dimensions it encompasses. Empirical work done so far is usually based on standard
quantitative indicators available for a longer time period for a broad range of countries. For
21

instance, ratio of financial institutions assets to GDP, ratio of liquid liabilities to GDP, and
ratio of deposits to GDP.
However, since the financial sector of a country comprises a variety of financial institutions,
markets and products, these measures only serve as a rough estimate and do not fully capture
all aspects of financial development.
The World Banks Global Financial Development Database (GFDD) developed a
comprehensive yet relatively simple conceptual 4x2 framework to measure financial
development worldwide. This framework identifies four sets of proxy variables
characterizing a well-functioning financial system: financial depth, access, efficiency, and
stability.
[9]
These four dimensions are then broken down for two major components in the
financial sector, namely the financial institutions and financial markets


5.7 INDIA FINANCIAL DEVELOPMENT FUND
India Financial Development Fund (IFIF) is a USD$90 million fund that was set up in August
2008 as an off-shore India-focused equity fund, investing in high-growth, small to medium
MFIs and enablers.

IFIFs triple bottom line objectives are financial Development, capital appreciation, and
social performance initiatives. Through its investments, IFIF will aim to:
Provide new MFIs with start-up, growth capital, strategic inputs, and technical advice
Support and enable product diversification by providing appropriate risk capital
Encourage the scaling up or creation of microfinance enablers, who will contribute to
building an efficient microfinance ecosystem
Play the role of an active, responsible investor seeking to deliver a competitive financial
return and support the expansion of social performance initiatives







22




6 DATA AND METHODOLOGY
Financial development, refers either to the ratio of bank credit to the private sector or the
share of bank deposits expressed as a percentage of GDP. These are the standard measures of
financial depth used in the literature (e.g., King and Levine, 1993). Data to construct these
ratios come from the International Financial Statistics (www.imf.org) and the World
Development Indicators (www.worldbank.org). Finding shows that where a higher proportion of
households receive remittances have a higher number of bank branches and accounts per capita, and
larger shares of deposits to GDP.
Second, by looking at whether households apply for loans, this study is able to examine the impact of
remittances on the demand for credit and not purely on credit outcomes. This is useful because it can
allow us to begin to assess to what extent remittances might relax credit constraints.


Depth
Private Sector Credit to GDP
Financial Institutions asset to GDP
M2 to GDP
Deposits to GDP
Gross value added of the financial sector to GDP
Access
Accounts per thousand adults(commercial banks)
Branches per 100,000 adults (commercial banks)
% of people with a bank account (from user survey)
% of firms with line of credit (all firms)
% of firms with line of credit (small firms)


The data on remittances are obtained from the IMFs 2013 World Economic
Outlook. With some exceptions, these data are constructed as the sum of three items in the
Balance of Payment Statistics Yearbook (IMF): workers remittances (current transfers made
by migrants who are employed and resident in another economy); compensation of
employees (wages, salaries and other benefits earned by non-resident workers for work
performed for resident of other countries); and migrant transfers (financial items that arise
from the migration or change of residence of individuals from one economy to another).


We empirically examine the relationship between financial development and remittances
by estimating a number of variants of equation (1), depending on the assumptions made about
the error term and the exogeneity of remittances.
FDi,t= 1Remi,t + 2Xi,t + i + ui,t (1)
where i refers to the country and t refers to the time period from 2002 to 2012.
23


We first examine the relationship between financial development and remittances
by running fixed effects (FE) and random effects (RE) regressions, ignoring the potential for
biases due to reverse causation, omitted factors, or measurement error. FE and RE
estimations make different assumptions about the error term in equation (1). In the FE model,
the error term is the sum of i and ui,t where i represents individual specific fixed
parameters to be estimated and ui,t are independent and identically distributed errors with
zero mean and constant variance In the RE regressions, both i and ui,t are independently
distributed and, furthermore, both are assumed to be independent from the regressors in the
equation. In conjunction with these estimations, we report F-tests for the joint significance of
the fixed effects and Hausman tests comparing the efficiency of random vis--vis fixed effect
estimates.

We conduct a number of different estimations to address the concerns outlined above.
First, we separately conduct estimations for the most recent period (2002-2012 ), because the
potential for measurement error should be smaller in this period, since remittance statistics
are likely to have improved over time. Second, we conduct estimations including time
dummies to mitigate the concern for omitted relevant regressors.
6.1 RATIOS
Studies Shows the impact of accessing and using savings products also find positive effects.
In particular, we focus on whether remittances promote the use of deposit accounts and credit
by examining the impact of remittances on the likelihood that households have a deposit
account, apply for loans, and receive loans from formal financial institutions.

6.1.1 Bank deposits to GDP Ratio
Year Bank Deposit to GDP(%)
2001 51.9
2002 53.2
2003 55.7
2004 57.6
2005 58.4
2006 60.9
2007 60.8
2008 67.7
2009 70.1
2010 71.8
2011 74.1
2012 76.6

24



















25

6.1.2 Share of bank credit to GDP Ratio

Year Share of bank Credit to GDP(%)
2001 27.8
2002 31.1
2003 31.9
2004 35.6
2005 39.4
2006 43.2
2007 44.8
2008 48.5
2009 47.3
2010 49.5
2011 49.9
2012 51.5















26

6.1.3 M2 to GDP ratio

Year M2 to GDP(%)
2001 53.7
2002 56.7
2003 61.5
2004 62.1
2005 63.5
2006 64.5
2007 67.4
2008 71
2009 75.8
2010 76.3
2011 76.7
2012 76.1
2013 77.7












Gross value added of the financial sector to GDP

27

6.1.4 Gross value added of the financial sector to GDP


Year Gross value added of the financial sector to GDP(%)
2001 51
2002 52
2003 53
2004 53
2005 53
2006 53
2007 53
2008 53
2009 54
2010 55
2011 54
2012 56
2013 57














28

6.1.5 Private Sector Credit to GDP

Year Private credit by deposit money banks to GDP (%)

2001 27.81271
2002 29.91763
2003 30.77909
2004 31.4495
2005 35.2787
2006 38.54082
2007 41.11208
2008 44.39661
2009 44.6119
2010 44.66758
2011 47.14732
2012 49.9854
2013 51.4589















29

6.1.6 Financial Institutions asset to GDP
Year Central bank assets to GDP (%)

2001 6.782355
2002 5.61084
2003 3.224716
2004 2.197755
2005 2.197881
2006 2.053165
2007 2.016809
2008 1.787643
2009 1.998486
2010 3.368102
2011 4.613224
2012 4.935669
2013 5.186456

















30

6.1.7 Accounts per Thousand Adults


Year Accounts per thousand adults
2005 9
2006 9
2007 8.9
2008 9
2009 9.4
2010 9.6
2011 10.1
2012 10.5
2013 11.4















31





32


Our estimations show that households that receive remittances are more likely to have a
deposit account at a financial institution. Our most conservative estimates indicate that
receiving remittances increases the likelihood of having an account by at least 11 percent and
an additional colon per capita in remittances raises this probability by 5 percent. These effects
are sizeable given that on average only 9 percent of households have an account. However,
remittance-recipient households are not more prone to request or receive a loan. In fact, some
estimations show the opposite. This suggests that though remittances might have the potential
to encourage the use of savings instruments, they do not necessarily foster the demand for
and use of credit, perhaps because they help to relax credit constraints.
FDi,t= 1Remi,t + 2Xi,t + i + ui,t
where i refers to the country and t refers to the time period
Data to construct these ratios come from the International Financial Statistics (IMF) and the
World Development Indicators (World Bank). As shown in Table 2, there is considerable
variation in financial development for our sample of countries with the ratio of deposits to
GDP ranging from 1.74% to 161.40% and the ratio of credit to GDP varying from 0.46% to
121.46%.
Financial Developmentit=+1Remittancesit + 2Income/Wealthit + 3Educationit +
4Returned migrantit + 5Other household characteristicsit +it








33

7 RESULTS
SUMMARY OUTPUT



Regression Statistics(Table-1)


Multiple R 0.922010996


R Square 0.850104277


Adjusted R Square -1.111111111


Standard Error 0.000109802


Observations 1



ANOVA(Table-2)


df SS MS F Significance F


Regression 10 6.15385E-07 6.15385E-08 51.04174 56


Residual 9 1.08509E-07 1.20565E-08


Total 19 7.23894E-07



(Table-3) Coefficients Standard Error t Stat P-value Lower 95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercept


1.9E-
201
1.9E-
201
60.02205


1.9E-
201
1.9E-
201
62.05344


-4E-306
3.9E-
306
60.47448


6.2E-
308
3.4E-
307
67.136


-2E-306
2.5E-
306
73.67519


-2E-307
6.2E-
307
76.57478


0 0
74.62669


0 0
75.26033


4E-241 -1E-240
71.31186 0 #N/A 0 1 -2.3156E-306
2.3E-
306 -2E-306
2.3E-
306
76.31182 3.4669E-06 4.85265E-07 7.144350195 5.4E-05 2.36916E-06
4.56E-
06
2.37E-
06
4.56E-
06
75.83173












34

RESIDUAL OUTPUT
(Table-4)


PROBABILITY OUTPUT



(Table-5)

Observation
Predicted
9.85605059721601E-
05 Residuals

Percentile 9.85605E-05


1 0.000262901 -0.000164341

50 9.85605E-05



Table 3 shows the estimation results for the impact of remittances on the likelihood that a
household has a deposit account. Receiving remittances increases the probability that the
household will have a deposit account by between 11 and 30 percent, depending on the type
of fixed effects included. Furthermore, an additional colon per capita in remittances raises the
likelihood of having an account by between 5 and 14 percent. These effects are sizeable
considering that in the sample 9 percent of households have deposit accounts.
As expected, Real per capita income and House and land ownership are also significant and
positive: more income and wealth make households more prone to having an account.
However, House and land ownership is not significant in the household fixed effects
regressions in columns 4 and 8. Concerning the variables included in Other household
characteristics,
The results for the likelihood of receiving a loan from a formal financial institution.. These
results could be driven by the fact that there are potentially two opposing effects of
remittances on credit: (1) remittances can be used as an informal type of collateral or as a
means to provide information on households income that might make financial institutions
more willing to provide credit; and (2) remittances may help relax households credit
constraints and, hence, could reduce their demand for credit. Thus, these two effects may well
be counteracting each other, causing remittances to be generally insignificant.
We find that Adults average education has a positive and significant influence on the
probability of receiving a loan..
Nevertheless, to try to assuage concerns about endogeneity, we run instrumental variables
regressions. Our main instruments are Household level Data weighted averages of economic
conditions in US states where Salvadoran migrants reside.
We find that our main results are robust to controlling for the potential endogeneity of
remittances. Namely, while remittances have a positive effect on the likelihood that a
household has a deposit account, neither the fact that a household receives remittances nor
the actual per capita amount received has a statistically robust impact on the likelihood of
applying for and receiving a loan.




35

8 CONCLUSION
As the importance of remittances has grown, an issue which has received little attention is the
effect of remittances on the financial system. This issue is important given the evidence that
financial development matters for growth and poverty alleviation and the fact that financial
development has many beneficial effects for households.
This study examined the impact of remittances on financial development using data of India.
In particular, I analyzed the impact of remittances on the likelihood that households use
financial services such as deposit accounts and loans. Overall, I find that remittances have a
positive impact on financial development by promoting the use of deposit accounts. These
results hold controlling for unobserved household characteristics and using instrumental
variables regressions to correct for the potential endogeneity of remittances. On the other
hand, remittances do not have a significant effect on credit from formal financing institutions.
Hence, by relaxing credit constraints, remittances might reduce the need for external
financing by financial in stitutions, while at the same time increasing the demand for savings
instruments.
There are a number of potential avenues for future research. First, it would be interesting to
analyze the extent to which remittance recipients that have accounts, actively use these
accounts to save and manage their daily transactions. Second, it would be important to go
deeper into the reasons why those that receive remittances do not seem to have a higher
demand for credit. In particular, it would be useful to analyze whether indeed this is due to
the fact that remittances relax credit constraints or because the credit products offered to
remittance recipients are not considered adequate by this population.
Let me conclude with some thoughts on the challenges ahead.
First, weakening asset quality is an immediate concern for the banking sector. This is more so
as the banks credit composition in the recent years has changed towards longer term assets
such as infrastructure and housing. While improvement in macroeconomic policy
environment and expected revival in economic growth should help mitigate risks to some
extent, banks would have to make concerted efforts to improve asset quality.
Second, while on many efficiency parameters, Indian banks compare favourably to their
global peers, the net interest margin (NIM) remains relatively high. The banks need to further
enhance their productivity so that the intermediation cost between depositors and borrowers
is minimised. This, coupled with containment of NPAs, will help improve monetary
transmission.
Third, as the Indian economy reverts to its high growth path, the demand for credit will go
up. The consequent expansion of the banking sector will require more capital. Additionally,
as the Basel III norms are made applicable, the capital requirements would increase further.
The preliminary assessment by the Reserve Bank made in June 2012 showed a comfortable
position of Indian banks at the aggregate level to meet the higher capital norms. As per the
broad estimates from the Reserve Bank, public sector banks would require a common equity
of Rs1.4-1.5 trillion in addition to Rs 2.65-2.75 trillion as non-equity capital to meet the full
Basel III norms by 2018. Banks, therefore, need to design appropriate strategies for meeting
these capital norms.
36

Fourth, a key factor that accentuated the global financial crisis was excessive leverage. While
the Indian banking system is currently moderately leveraged, according to the guidelines
issued by the Reserve Bank, banks should strive to maintain a minimum Tier I leverage ratio
of 4.5 per cent pending the final proposal of the Basel Committee. It would be prudent for
banks not to dilute their leverage position in the interim period
5
.
Fifth, there are proposals for expansion of the banking sector with new entrants. The Reserve
Bank has already invited applications for new banks. Further, as indicated in the annual
policy statement of May 2013, the Reserve Bank is preparing a policy discussion paper on
banking structure in India which would be placed in the public domain. The expansion of the
banking sector commensurate with the growth of the economy would not only enhance
competition but also facilitate financial Development.
What is interesting is that most receivers of small-ticket size cash remittances actually want
to open bank accounts in order to receive these transfers. Thus, offering them an opportunity
to access the banking channel and linking payments received to savings accounts will
promote financial Development.
After all, one must not forget the efforts and contribution of the over 11-million-strong
migrant worker population towards the country's social and economic development.
SMS alert facility for remitter and beneficiary is the highlight apart from instant credit to
Federal Bank accounts. The agreement was exchanged between A. Surendran, general
manager, retail & international business, Federal Bank and George M. Jacob, vice president,
legal corporate affairs and marketing, Muthoot Group.
Reserve Bank of India allowed various services such as payments to utility service providers,
tax payments, and EMI payments in India with a view to expand the scope of cross-border
inward remittances.
RBI also introduced facilities such as payments to utility service providers in India, for
services such as water supply, electricity supply, telephone (except for mobile top-ups),
internet, television, tax payments and EMI payments in to Banks and Non-Banking Financial
Companies (NBFCs) for repayment of loans, would be allowed under RDA.
Under RDA the existing arrangement, credit to non-resident (External) rupee accounts
maintained by NRI in Indian rupees, payments to families of NRIs, payments in favour of
Insurance companies, Mutual Funds and the Post Master for premia/ investments, and
payments in favour of bankers for investments in shares, debentures are allowed under RDA.
Among others, payment to cooperative housing societies, government Housing Schemes or
estate developers for acquisition of residential flats in India in individual names by the NRIs,
payments of tuition/boarding, examination fee to schools, colleges and other educational
institutions under RDA.
RDA also includes Payments to medical institutions and hospitals for medical treatment of
NRIs/their dependents and nationals of Gulf countries in India, payments to hotels by
nationals of Gulf countries/NRIs for their stay are allowed under the arrangement.
37

Payments to travel agents for booking of passages of NRIs and their families residing in India
towards their travel in India by domestic airlines/rail and trade transactions up to Rs 2 lakh
per transaction are also a part of the existing RDA.
Reserve Bank constituted an advisory group to implement a national bill payment system that
will enable households to pay utility bills, school fees, remittances and other bills using their
bank accounts. The RBI also announced the constitution of a GIRO Advisory Group (GAG)
to implement a national GIRO-based Indian Bill Payment System such that households will
be able to use bank accounts to pay school fees, utilities, medical bills and make remittances
electronically," RBI said in a notification. A GIRO is a payment instruction from one bank
account to another bank account initiated by a payer. It facilitates payment through cash,
cheque, credit/debit cards and prepaid payment instruments in transfer of funds to the bank
account of a beneficiary.
As the importance of remittances for developing countries has grown. An issue which has
received little attention is the effect of remittances on the financial system. This issue is
important given the evidence that financial development matters for growth and poverty
alleviation and financial Development has many beneficial effects for households. since
1993, remittance dependency appears to have grown in India as well as in different States
such as Kerala, Goa and Punjab. It estimates the domestic remittance market to be roughly
$10 billion in 2007-08, 60% being Inter-State transfers and around 70% being channelled
through the informal sector as against 25% in China. Further, around 50% of these
remittances went to households in the top consumption quintile suggesting that remittances
could be increasing source region inequality and its role in enhancing financial
Development. Recent studies on India have highlighted the positive impacts of domestic
remittances on wealth creation and asset accumulation as well as in increasing teen schooling
attendance. More research on India would be required to understand the direct and indirect
effects of remittances on poverty alleviation and inequality.












38

9 BIBLIOGRAPHY

Demirg-Kunt, A., Lpez Crdova, E., Martnez Pera, M.S., and Woodruff, C., (2011).
Remittances and banking sector breadth and depth: Evidence from Mexico. Journal of
Development Economics 95(2), 229-241

Gupta, S., Pattillo, C., and Wagh, S., (2009). Effect of remittances on poverty and financial
development in Sub-Saharan Africa. World Development 37(1)

King, R. and Levine, R., (1993). Finance and growth: Schumpeter might be right. Quarterly
Journal of Economics 108, 717-737.

Lopez Cordova, E., (2005). Globalization, migration, and development: The role of remittances.
Inter-American Development Bank, Integration and Regional Programs Department, Working
Paper 20














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