For many people in certain parts of the world, hawala is the traditional way to send money to others. It is an alternative way of transferring money that differs from the established money transfer systems used in the western world.
This article explains how hawala functions, the aspects of it that make it unique and the challenges that it can pose.
What is the hawala system?
Hawala, which is also known as hundi, is an informal trust-based value transfer system. It is a legal money transfer method but is unregulated in many jurisdictions. The system operates via a network of hawala brokers, known as ‘hawaladars’, who transfer money for clients without using traditional financial institutions, such as banks.
Hawala is believed to have originated in ancient India before being used in the Middle East and other regions, such as the Horn of Africa and South Asia. It is a system that is based on trust and it relies on the hawaladars ensuring the transfer of funds from one person to another. This is done through hawaladars in different places being linked through a network of relationships, with the money being transferred using methods such as the internet or courier services.
Hawala is a popular way to transfer money internationally. It is used heavily in countries that have restrictions on the movement of money or where formal banking systems are not fully developed. Migrant workers often use hawala to send money they have earned abroad back to their relatives in their home countries.
Yet the Financial Action Task Force (FATF), which is an intergovernmental body set up to tackle money laundering, identifies what it calls three types of hawalas and other similar service providers (HOSSPs).
These are:
- The pure, traditional and legitimate providers of hawala services that have been used for centuries.
- Hybrid providers that may use similar methods as the traditional providers of hawala services and may interact with them. They develop their business in areas where there is a need for transaction services.
- Providers who set up in business or expand their business in order to offer a service to criminals.
FATF emphasises that each of these faces the risk of being used for money laundering and terrorist financing. This is due to factors such as their lack of official supervision, the movement of money across borders and outside of the traditional banking system, and the possibility of mixing legal funds with the proceeds of crime. This article examines these issues.
How does the hawala system work?
The hawala system will usually function in the following way:
- A client (also known as a sender) contacts a hawaladar and asks them to transfer money to a recipient (also known as a beneficiary) in another place.
- The hawaladar and the sender agree on a password or code that will be used to identify the transaction.
- The sender gives the hawaladar the amount of money to be transferred plus a fee for the service. The fee is usually based on a percentage of the amount that the hawaladar has been asked to transfer.
- The hawaladar contacts a colleague or counterpart where the recipient is based and gives them the details of the transaction, as well as the password or code.
- The counterpart in the recipient’s location receives the password or code and gives the recipient the amount of money that the sender wanted to transfer to the recipient.
- The two hawaladars will settle what they owe each other for the transaction. This will be done by funds being transferred between them for that transaction or by them balancing their accounts at a later date, when they can calculate what they owe each other for a number of transactions that have been carried out between them.
The hawaladars can also profit through bypassing official exchange rates, with the payment entering the system in the sender country’s currency then leaving it in the recipient country’s currency.
Why do people use the hawala system?
People use hawala for a number of reasons:
- Speed: A hawala transaction can usually be completed quickly, so it is useful for people who have to transfer money at short notice.
- Low Cost: The fees for a hawala transaction are lower than those charged by traditional financial institutions.
- Privacy: As hawala transactions are not documented, they can be attractive to people who want their financial affairs to remain private.
- Easy to Use: Hawaladars are often easy to find as they are located in convenient places such as markets or small shops.
Is the hawala system regulated?
As hawala exists and operates outside of the traditional financial sector, it is not regulated or subject to the same checks and responsibilities as banks. As a result, concerns about its use for money laundering and other criminal activities have led to some countries taking action to regulate it.
In the United Arab Emirates (UAE), hawala is regulated by the Central Bank of the UAE. In the UK, it is regulated by HM Revenue and Customs (HMRC). These two bodies have introduced rules requiring hawaladars to register with them and follow rules about reporting and record-keeping.
But hawala is largely unregulated in other countries. This means that it is vulnerable to abuse and criminal activity (which is explained later in this article).
Challenges in Regulating Hawala
While there are many that argue that hawala should be regulated globally in order to make it safer and less likely to be used for crime, there are reasons why doing this could be difficult.
These include:
Hawala Existing Outside of the Formal Financial System
As hawala is an informal system that keeps few records and is separate from the established financial system, governments may struggle to monitor its activities and place obligations on it, as they do with regulated financial bodies such as banks.
Trust
The hawala system relies on trust between hawaladars and their clients, which would make it hard for regulators to make sure those involved are complying with laws and regulations.
Hawala’s Global Nature
Hawala operates worldwide, with hawaladars in different countries connected through relationship networks. The government of one country would struggle to regulate and monitor all those relationships.
There is also the danger that any regulation that was introduced to prevent the use of hawala for illicit reasons may have a negative impact on the many who use it for completely legitimate reasons, such as moving money in countries where formal banking is not properly established.
The Financial Crime Risks the Hawala System Poses
While hawala is used regularly by millions of people for entirely legal reasons, there are financial crime risks associated with it. These are:
Fraud
As hawala transactions are based on trust and personal connections, there is little - if any - formal documentation or record-keeping involved. This can mean that the system could be abused by those looking to make fraudulent gains. Hawaladars may not be held accountable if they do not deliver the funds they were supposed to or if they use the money themselves.
Money Laundering, Terrorist Financing and Sanctions
The informal, unregulated nature of hawala can attract those looking to hide the fact that the money they are moving has come from crime. The process of disguising the criminal origins of money, known as money laundering, can only succeed if nothing is done to attract the attention of the authorities. Unlike with banks, hawala does not involve any reporting of suspicious transactions to the authorities. This makes it appealing to money launderers, which can create a legal or financial risk for other hawala users. This also make hawala attractive to those looking to move money undetected to evade sanctions or fund terrorist activities.
Loss of Funds
With hawala, there is a risk of losing funds, due to fraud or a mistake being made when the money is transferred. As there is no formal process in hawala for resolving such situations, it can be a huge challenge to regain lost funds.
Volatility
The movement of money via hawala means that the value of the funds being transferred can be affected by changes in exchange rates, meaning the recipient may receive less than the amount that had been agreed.
How Hawala affects Banking Systems
Hawala can affect banking systems in various ways:
- Competition: Hawala is able to compete with traditional, established financial institutions such as banks for the business that is available in the money transfer market. It may be possible, in some circumstances, for hawala to charge lower fees and / or offer a quicker service than other financial institutions; which can make it attractive to customers.
- Illegal Activities: If hawala is used to carry out illegal activities it can pose a threat to the stability and integrity of the whole financial system.
- Regulation: Hawala may, as mentioned earlier in this article, require more regulatory intervention than there is at present, in order to address concerns about illegal activity such as fraud or money laundering.
Any effect that hawala has on the more established banking world will depend on factors such as how much it is used, the approach taken to regulation of it, whether it is being used for criminal purposes and whether it is viewed as a rival by other institutions in the financial sector.
How to Combat Hawala Financial Crime
Combating the use of hawala by criminals is not straightforward, due largely to its informal and unregulated nature.
There are, however, some ways in which the criminal use of hawala could be tackled:
Enhancing International Cooperation
As hawala is a practice that crosses borders, international cooperation is essential if any attempts to tackle its use by criminals are to be effective. There is a need for countries (and their enforcement agencies) to work together to build up a full, international picture of how criminals use hawala.
Intelligence needs to be shared between countries. Agencies from the countries where hawala is believed to be being used for illegal purposes have to combine their efforts to identify and disrupt such activity.
Strengthening Legal Frameworks
If efforts to prevent hawala for criminal purposes are to succeed, countries will need to introduce legislation – or amend existing legislation – so that the use of hawala for money laundering, terrorism financing and other illicit activities is a specific offence.
Once this legislation has been introduced, countries must make sure it is fully enforced. This will require the relevant law enforcement agencies being given the resources and training necessary to investigate and prosecute such cases.
Increasing Financial Institutions’ Awareness of Hawala
Financial institutions play an important role in detecting and reporting suspicious transactions related to money laundering. But many may not be fully aware of the money laundering risks associated with hawala networks and the way these networks are used by the money launderers.
These institutions need to have in place strong anti-money laundering and counter-terrorism financing programmes - if they do not already. These programmes must include procedures for conducting comprehensive risk assessments, carrying out customer due diligence, transaction monitoring and the reporting of suspicions. And these procedures have to be devised by those who have an in-depth knowledge of the risks associated with hawala.
If an institution lacks the knowledge of hawala that is needed for this, it should seek help from those with the relevant expertise. Advice could be sought from legal experts or the relevant trade association. As with cooperation between countries (mentioned above), those in the financial sector should share their knowledge with each other so that problems are identified and tackled as early and effectively as possible.
A Notable Financial Crime Case Involving Hawala
There are many examples of hawala being used for criminal purposes. For obvious reasons, there will be many incidents of it that have not yet come to light. But the scale of the criminal use of hawala – and the lengths criminals will go to in order to use it - can be illustrated by reference to a 2022 case.
This case saw one of Europe’s biggest money launderers and two of his associates arrested in Spain as part of an international law enforcement operation led by the Spanish Guardia Civil. The arrests followed a complex investigation led by the Guardia Civil, who worked on the case with the UK’s National Crime Agency (NCA), the Dutch National Police (Politie) and the Irish Garda (An Garda Síochána), with international activity coordinated by Europol’s European Financial and Economic Crime Centre.
The investigation discovered a scheme which saw large amounts of cash collected from criminal organisations and then delivered to other criminal organisations in other countries using hawala. During the one and a half years the investigation was conducted, an estimated 200 million euros were transferred around the world using this scheme.
The main members of the money transfer organisation in Spain had created a brand of vodka promoted in nightclubs and restaurants in the Costa del Sol to disguise the source of their money. They had also founded a company in the United Kingdom, dependent on a shell company based in Gibraltar, which was utilised to conceal the true identities of those running the companies that were being used to launder money using the hawala system.
Conclusion
Hawala is a complex system that is used by many people in many countries for completely legal purposes. For them, it is an essential service. Yet for others, it has come to be viewed as a way of enabling criminals to go about their illegal business.
The lack of regulation of hawala and its informal nature have led to concerns being voiced about its use by criminals. Those in business who may come into contact with individuals or organisations that use hawala must be aware of the potential for it to be used for illegal purposes – otherwise they may find themselves with legal problems.
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