The Contribution of International Remittance to Financial Development in Developing Countries: A Further Investigation

ABSTRACT This study analyses the impact of international remittances on financial development in 105 developing countries from 2003 to 2021. Using a two‐step system GMM estimator, we find that remittances have a significant negative effect on overall financial development. This effect is robust across most dimensions, negatively influencing the depth and efficiency of both financial institutions and markets. A key exception is financial access, where remittances have a positive effect, promoting financial inclusion. Our main contribution is identifying three transmission channels that explain this negative result. Using three‐stage least squares (3SLS) estimation, we show that remittances reduce domestic savings and stimulate the shadow economy, both of which hinder financial development. Conversely, they also promote entrepreneurial activity, which supports it. The net effect, however, remains negative. Furthermore, we show that this effect is conditional on national characteristics. The negative impact is stronger in countries with a colonial history, a civil law system, high FDI, high natural resource rents and a highly dependent population. It is weaker, or even positive, in linguistically homogeneous countries and in those with a large agricultural sector. These findings suggest that the mixed evidence in the literature is caused by the offsetting nature of these channels and contingent national factors. We conclude that policymakers must implement targeted strategies to direct remittances away from informal activities and consumption and towards formal investment and entrepreneurship to harness their developmental potential.