Remittance Effects on Financial Development : A Case Study by Income Level Groups <Research Note>

Remittance inflows have increased dramatically over the past few decades, awakening the interest of scholars to how these inflows can affect an economy. Mostly by observing the relationship between remittances and financial development, scholars have also started considering how financial sectors can generate a larger impact from remittance inflows. Until now, the results have remained diverse with both negative and positive coefficients.

In order to gain a proper understanding of remittance effects on financial development, this paper considers how the stage of economic development can change the sign of the coefficient. Using country income levels as proxies, a set of 147 countries is divided into four income level groups, from high income to low income countries, for the period 1980 to 2011. Financial development is measured by the ratio of bank deposit and bank credit to GDP, while controlling for economic factors such as the size of the economy, current openness, and capital openness, which are also expected to affect bank deposit and credit.

The results indicate that remittances are positive and significant for lower middle and low income countries. The model uses OLS estimations for an unbalanced panel data set, where country and time effects are included. In order to address endogeneity between remittances and financial development, the model is estimated once again using GMM, with lag first difference of variables.