1. Introduction
Remittances are monies sent by migrants (through a mobile transfer or bank) to their countries/communities of origin. Despite the COVID-19 pandemic, remittances remained buoyant in 2020. The amount of remittance flows to developing regions (including low- and middle-income nations) was as high as
$540 billion in 2020 (
Bidawi et al. 2022). Interestingly, the decrease in remittances associated with COVID-19 pandemic was smaller than the decrease experienced during the 2009 global financial crisis. Given the mounting prominence of remittances, it is natural to ask about the impact that they have on the welfare of the remittance-receiving communities. The remittance-welfare nexus is well established in this field. The investigation transcends various fields, including poverty (
Bertoli and Marchetta 2014;
Azam et al. 2016), education (
Adams and Cuecuecha 2010;
Bredl 2011), labor supply (
Jadotte and Ramos 2016) and health (
De and Ratha 2012). A growing body of literature suggests that remittances contribute to financial development in developing countries such as South Africa (
Gupta et al. 2007;
Chowdhury 2016;
Cooray 2012;
Kakhkharov and Rohde 2019;
Shahzad et al. 2014).
Figure 1 depicts not only the growth in remittances but the growth in financial development (with domestic credit as proxy), which is indicative of a positive complementary relationship between remittances and domestic credit. From 1980 to 1985 remittances remained unstable, reaching their lowest level from 1986 to 1989 due to the state of emergency and Soweto uprising (
Cowell 1986). In 1994 South Africa transitioned to a new democratic government and a new constitution for the Republic of South Africa was unveiled in 1996. South Africa’s domestic credit grew more as remittances increased. In the early 2000s, a government intervention required all banks to sign the Financial Sector Charter and provide a basic savings and transmission account, known as Mzansi, for the poorest, including those without a regular income (
James 2014). From May 2004, up until the 2010 Soccer World Cup both remittances and domestic credit rose in South Africa. Investigating the effect of remittances on finance is important for South Africa because the country still struggles with issues of high levels of unemployment, income inequality and poor financial inclusion across different racial groups. Despite the existence of financial services in South Africa, these services remain inaccessible to the excluded and underserved.
Amuedo-Dorantes (
2014) highlights the micro- and macro-economic level benefits of remittances. At a micro-economic level for households and individuals, the main benefit of remittance flows is that it assists to stabilize income. Remittances can help unbanked households in impoverished rural regions through easing credit limitation and facilities asset accumulation, business investment and the promotion of financial literacy. At a macro-economic level, the resilience and countercyclical nature of remittance flows, both of which promote economic stability and have shown to help prevent sudden current account reversals during periods of economic instability, improve a country’s credit rating, and facilitate the inflow of new investments,
Amuedo-Dorantes (
2014).
Misati et al. (
2019) state that more receivers and senders of remittances stimulates a greater demand for financial systems and encourages greater interaction with financial institutions and financial products, thus expanding financial development. Thus, the aim of this study is to investigate not only the symmetric effects of remittances on financial development, but also shed light on the asymmetric short and long run effects of remittances. Specifically, the investigation is on whether or not remittances might have both a negative and positive effect on financial development, and to identify the most predominating effects. The remainder of this paper is structured as follows:
Section 2 provides the literature review,
Section 3 discusses the methodology, including data and modelling.
Section 4 discusses the results, while
Section 5 provides the conclusion and policy implications.
2. Literature Review
The relationship between financial development and remittances is premised on two key hypotheses: complementarity and substitutability. The premise for the complementarity hypothesis is that, like any substantial external financial source, official remittance inflows that come through the banking sector should in principle enhance financial development for the receiving communities/households, especially in developing nations (
Aggarwal et al. 2011). However, this premise is not universally shared among scholars in this field. Some scholars take the view that remittances are a substitute for credit in that they act as an alternative for credit, thereby lessening their financial constraints—remittances might therefore lead to a decrease in the demand for credit, which in turn impacts negatively on credit market development, especially for poor countries (
Bettin et al. 2009).
Studies which find a linear relationship include
Gupta et al. (
2007) who, using the 1975 through 2004 data, examined the impact of remittances on poverty and financial development in 44 countries in sub-Saharan Africa. Applying a three-stage least-squares technique the authors found evidence to suggest that remittances reduce poverty and promote financial development. Based on these results, they conclude that “formalizing such flows can serve as an effective access point for “unbanked” individuals and households, and that the effective use of such flows can mitigate the costs of skilled out-migration in Sub-Saharan Africa.”
Similar findings that indicate the positive influence of remittances on financial development in developing countries were found by
Azizi (
2020) in a panel data study of 124 developing countries during the period 1990 to 2015. Using the fixed-effect model, the results indicate a 10% increase in remittance-to-GDP ratio increased domestic credit to the private sector by 1.7%, also increasing bank credit with 1.9% and 1.2% in bank deposits.
Karikari et al. (
2016) also analyzed remittance inflows from 50 developing countries in Africa from 1990 to 2011. Upon applying the fixed-effects and random effect estimations as well as the vector error correction model methods on the panel data, the results showed that remittances boost aspects of financial growth to some extent. According to their study, a better financial system fosters remittance receipts, which facilitates financial growth in the short term, while the development of the financial sector can help to improve the predisposition to send money through official channels in the long run. A study by
Bindu et al. (
2021) found a 1% rise in remittances results in a 4.5% increase in bank deposits.
Many other studies also find that remittances enhance financial development:
Misati et al. (
2019) for Kenya;
Oke et al. (
2011) for the case of Nigeria;
Sibindi (
2014) for the case of Lesotho;
Masuduzzaman (
2014) for the case of Bangladesh;
Fromentin (
2018) for 32 Latin American and Caribbean countries;
Chowdhury (
2016) for developing countries;
Cooray (
2012) for non-OECD. Unsurprisingly, some studies find a negative relationship between remittances and financial development.
Calderón et al. (
2007), for example, observed that remittances can hinder credit demands and thus have a reducing impact on credit demand markets.
The relationship between remittances and financial development is partly influenced or conditional on other factors that may affect this relationship. For example, recent studies have shown that countries with fairly strong institutions motivate banks to expand credit, whereas countries with weaker institutions may discourage banks from lending money, especially to risky borrowers, due to severe asymmetric information problems. For example,
Saydaliyev et al. (
2020) used data between 2011 and 2018, and a dynamic panel data technique to study the influence of remittance inflows on financial inclusion with a special focus on high remittance-receiving developing nations. Their findings revealed that remittances that promote financial inclusion are linked to higher institutional quality. Reaching a similar conclusion,
Bhattacharya et al. (
2018), applied dynamic system-generalized method of moments which showed that emerging nations have lower elasticity values than industrialized countries. Their findings are consistent across nations, highlighting the need to improve institutional setups to enhance remittance inflows.
Using unobserved dynamic factor model based on 46 countries for the period of 1996 through to 2016,
Kim (
2021) studied the effect remittances on financial development by accounting for the potential impact that institutional quality might have on the financial development. Upon employing the panel data models (such as fixed and random effects) and instrumental variable models, the author observed that financial development is positively associated with both institutional quality and remittances. The analysis support the hypothesis that institutional quality enhances the impact of remittances on financial development, when institutions are not be interfered by the authorities. Though many empirical studies have found a linear effect of financial development and remittances having a negative or positive relationship, other empirical evidence shows a non-linear relationship between remittances and financial development.
Akcay (
2020) used time-series data from 1980 to 2015, which displayed a normal U-shape in both the short and long run. To put it more succinctly, remittances depress financial development at first, but subsequently improve it, demonstrating rising returns, indicative of the complementarity hypothesis.
Akcay’s (
2020) study is consistent with work of
Pesaran et al. (
2001) who, using time-series data covering the period 1980–2015 and applying the autoregressive distributed lag bounds testing approach, observed a U-shape short and long run between and remittances and financial development.
In Bangladesh, a non-linear link between financial development and remittances was observed from 1980 to 2015. The findings indicate a non-linear U-shaped link between financial development and remittances, which supports the complementary theory in both the long and short term (
Akcay 2020). Similarly,
Das and McFarlane (
2021) discovered that the relationship between remittances and financial development is a U-shape function of remittances. When remittances increased, there was initially a negative impact on financial development until a threshold point was reached and the impact on financial development became positive. There is long list of empirical work that either finds the U-shaped relationship, e.g.,
Brown et al. (
2013) for the case of developing and emerging economies, or an inverted U-shaped relationship as demonstrated by
Esteves and Khoudour-Castéras (
2011) for eight European countries as well as
Sharaf and Shahen (
2022) for the case of Shahen Egypt.
Faheem et al. (
2019) researched the effect migrant remittances had on financial development in Pakistan. The study used period data from 1976 to 2018 and employed the linear ARDL and NARDL models. The ARDL results showed that, in the short run and long run, financial growth leads to rises of 0.5% and 0.6% for every 1% increase in remittance inflows. The NARDL long run results showed a more substantial effect negative changes of remittances had on financial development, and a 1% drop in remittances resulted in a 62% drop in financial development.
Mehta et al. (
2021) used data from 1975 to 2019. The NARDL revealed that the positive and negative shocks in remittances inflows were positively related to financial development, which was measured by bank-based indices, stock-based indices, and the financial development index.
It is apparent from the empirical evidence in the literature that there is no definite conclusion that remittances have a positive or negative impact on financial development. The literature provides mixed results, indicating that the relationship between remittances and financial development requires more research as the relationship differs across countries. Thus, the aim of this study is to contribute by investigating, not only the symmetric effects of remittances on financial development, but also the asymmetric short- and long-run effects of remittances. Secondly, to the best of the author’s knowledge, this is the first study that investigates the effect of remittances on financial development in South Africa. To investigate the linear and non-linear impact of remittances on financial development in South Africa, this study employs the ARDL and NARDL for the 1980–2018.