Making it easier for migrants to send and save

One of the most important first steps in capturing the full development potential of remittances is to shift them out of the informal channels that currently dominate the market and into the formal banking sector. A new directive issued last month by Ethiopia’s central bank points to one path towards that goal.

The National Bank of Ethiopia’s (NBE’s) new “Establishment and Operation of Foreign Currency Saving Account for Residents of Ethiopia, Non-Resident Ethiopians and Non-Residents of Ethiopian Origin, Directives No. EX1V 68 /2020” allows banks to open interest-bearing, no-fee foreign currency savings accounts for both in-country Ethiopians and those abroad. So as a practical matter, the new directive primarily affects migrants and their in-country loved ones; that is, those people who earn wages or salary in currencies other than Ethiopian birr and the people who receive the money they remit back home. To understand the significance of the new directive, it is helpful first to understand the issues it was designed to address.

Building a foreign exchange (forex) reserve of deposit savings

Like other countries, Ethiopia needs to maintain forex reserves to offset its forex liabilities. When that does not happen—when a country is taking in significantly less forex flows (at least, through formal channels where they can be seen and accounted for) than that country owes, the unmatched liability results in an unsustainable Balance of Payments position, affecting the country's standing in international capital markets. This may have a negative impact on business relationships, including those relationships (e.g., with money transfer operators, correspondent banks) which are key to creating a functioning remittance market, thus perpetuating the vicious cycle.

Of all the possible ways to encourage inbound forex flows, migrant remittances represent relatively low-hanging fruit. The new directive provides powerful incentives for migrants and their families to save, in foreign currency, in Ethiopian bank accounts. It also removes some powerful disincentives such as exchange rate arbitrage.

No surrender

Prior to the new directive, Ethiopian banks were required to surrender 30 percent of all forex deposits to NBE. Perhaps not surprisingly, the surrender requirement had the effect of discouraging banks from mobilizing such deposits as they created forex mismatch in their books. Ethiopians with forex assets were thus deprived of the opportunity to deposit that money into an Ethiopian bank, further perpetuating the dominance of the informal channels (and the practice of remittance-recipient households just keeping stashes of forex cash at home). The lifting of the surrender requirement, for the foreign currency credited in these accounts, will give banks some breathing space during these difficult times, and over the longer term, may improve their competitive position relative to the informal alternatives.

Ease of opening, ease of operation

From the migrants’ point of view, another disincentive has been the sheer inconvenience of doing business with the formal sector. The new directive provides for the opening of forex accounts not only via in-person visits to bank branches (often impractical for in-country Ethiopians, impossible for those abroad), but now also via email, fax, telex, or other electronic media, or via power of attorney. Of special importance to migrants, the directive also provides for account-opening services at the Ethiopian Embassies in the migrants’ host countries.

For the banks offering interest in these accounts, the interest rate shall be calculated in foreign currency, but paid in local currency. The directive sets the minimum interest rate at LIBOR* plus 4 percent subject to revision from time to time by NBE. The interest component will provide an incentive and encourage saving. Although the accounts can only be maintained in the US Dollar, Pound Sterling or Euro, banks may accept deposits in other convertible currencies including Canadian dollars, Chinese yuan, Saudi riyal, Japanese yen, Australian dollars and UAE dirham. This will provide flexibility for the many Ethiopian migrants living and working in those countries.

Finally, the directive allows savings withdrawals for specified purposes, including education, medical, or travel expenses for the account holder, spouse, or children (subject to valid documentation to confirm the relationship with the account holder). The balance in these accounts can also be used as collateral for credit in local currency as well as to purchase shares from financial institutions. The flexibility provided on the utilization of the balances in these accounts will provide some assurance to the savers and encourage the maintaining of reasonable balances for future use and investments.

Some possible next steps

The directive currently gives account holders the right to withdraw up to 10 percent of the foreign currency balance in debit card, but cash withdrawal is permitted only in birr. Despite their good intention of encouraging depositors to maintain balances in forex, the withdrawal limitations may end up discouraging account uptake to some extent. If so, the limits may be worth revisiting.

More generally, in order to enhance the flow of remittance through formal channels, it is important to have use cases of supportive products that can incentivize migrants. Building on this opportunity for migrants to save and invest in their home country through the forex savings accounts, migrants can be given the opportunity to secure their own savings separate and apart from those they remit to support their relatives back home. As their income grows, they can store savings separately, ring-fenced until they return to Ethiopia or invested while they are still abroad, all the while receiving financial literacy training from NBE and from remittance service providers.

The point is to give migrants the option to set up separate “endowment”-type accounts upon meeting the set requirements. The concept is setting up two accounts with one being similar to an Individual Retirement Account (IRA) of the sort commonly available in OECD countries. As with IRAs, the endowment focuses on creating a long-term growth investment for the migrant while providing a form of long-term capital mobilization. Contributions into the account would be income-based or simply a percentage of transfers. It should be noted that term deposits are not a good substitute since the holder can tap into the account balance at any time, thus eliminating the engine of the investment growth – compounded interest.

The savings in endowment accounts could also fuel the loan portfolios of microfinance institutions (MFIs), especially the rural ones. To increase MFI lending, since endowment savings constitute permanent long-term capital, MFIs could borrow from these accounts to make microloans, paying migrant endowment-account holders attractive, above-market returns, thus creating a significant incentive to fund these endowment savings accounts. The opportunity is to link endowment savings accounts to MFI lending activity while making sure that they remain safe and protected. Since the default risks are relatively low and the rates of returns received by MFI are still relatively high, these loans could be further protected with NBE special guarantees, further reinforcing the incentive to save into these accounts.

Such an approach could empower migrants to control their own destinies via these endowment savings accounts, and at the same time give them the opportunity to learn and participate in broader financial inclusion. In addition, this approach addresses the problem of remittances’ excessive use for consumption, directing more of this vital funding flow towards the productive sector instead, and spurring the country’s development.

Last month’s directive is the latest policy reform that the Ethiopian government has undertaken to tackle the issue of migrant remittances: how to keep them flowing despite pandemic-related lockdowns, how to shift them from the off-book, informal channels into the formal financial sector where they can help fuel the country’s development, and how to encourage the transition from cash-based to digital models. UNCDF has and will continue to write about the Ethiopian experience. We believe the country’s creative approaches to remittances can help point the way for other developing countries eager to tackle the challenges and seize the opportunities that their overseas citizens’ remittances represent.