Workers' remittances to developing countries have become the second largest type of flows after foreign direct investment. This paper uses data on workers' remittance flows to 99 developing countries during 1975-2003 to study the impact of remittances on financial sector development.
In particular, the paper examines whether remittances contribute to increasing the aggregate level of deposits and credit intermediated by the local banking sector. This is an important question considering the extensive literature that has documented the growth-enhancing and poverty reducing effects of financial development.
The research finds that remittances have a significant and positive impact on bank deposits and credit to GDP. This result is robust to using different estimation techniques and accounting for endogeneity biases arising from omitted factors, reverse causation, and measurement error. These research findings provide strong support for the notion that remittances promote financial development in developing countries.