Hawala

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Hawala
Informal practice commonly found in Middle East, India, Pakistan and Africa
Entry written by Nauman Farooqi.
Nauman Farooqi is affiliated to Mount Allison University, Canada.

Original Text: Nauman Farooqi

An informal value transfer system operating through a large network of money brokers that allows money to be transferred from one geographic location to another. The hawala system operates outside of more traditional financial and banking channels, and is based mainly in the Middle East, Indian subcontinent and parts of Africa.

In Arabic, the root h-w-l signifies ‘change’ or ‘transformation’. The word hawala is derived from this root and is defined as a bill of exchange or promissory note that can be used as hawala safar or a traveller’s cheque [1]. The word permeated into Hindi (national language of India) and Urdu (national language of Pakistan), retained its original meaning but acquired the additional connotations of ‘trust’ and ‘reference’. This reflects the basic principles on which the system operates. A hawala dealer is described as a hawaladar [2]

Hawala Market Afghanistan.jpg

An alternative term is hundi, a word which is etymologically rooted in Sanskrit and means ‘to collect’. This meaning is synonymous with promissory note, bill of exchange, or hawala. A hundi operator is referred to as a hundiwala.

Padayachee and MorrelL define hundi as:

“A kind of bill of exchange or written order for payment that its drawers used much in the same way that the Americans used checks to draw on their checking accounts. In order to draw a Hundi, a client had to open up an account and maintain a correspondence relationship with a [private] banker.”[3]

Essentially, hawala and hundi have the same meanings and are used interchangeably, especially now that the system has gained international notoriety. However, hawala is an Arabic term while hundi is its Indian and Pakistani variant. It has been suggested that hundi and hawala have amalgamated into one network and their distinctions have been dissolved [4].

Every year billions of dollars are transferred across countries and continents using Informal Value Transfer Systems (IVTS). The Financial Crimes Enforcement Network (FinCEN) defines IVTS as, “Any system, mechanism, or network of people that receives money for the purpose of making the funds or an equivalent value payable to a third party in another geographic location, or not in the same form.” Hawala is one of the key forms of IVTS. It is estimated that every year US$100 billion to US$300 billion flow through the Informal Value Transfer Systems [5].

Stacks of cash in a Hawala market in Afghanistan

Informal Value Transfer Systems were established means of transferring valuables and money long before any of the formal methods were conceived. However, since the growth of formal value transfer systems, informal systems have operated in the shadows, albeit maintaining a devoted following. Many of today’s IVTS originated among ethnic Asian peoples who based codes of conduct for value/money transfer on mutual trust within groups and individuals. The various systems derived their names from the geographical locations and the ethnicity of the groups that practised them. Passas has summarised some of the more common names for IVTS practices in different parts of the world:[6]

  • Hawala (trust, reference, exchange; The Arabic root h-w-l means “to change” or “to transform”) — India
  • Hundi (commonly translated as trust; means bill of exchange or promissory note; comes from a Sanskrit root meaning “to collect”) — Pakistan
  • Fei ch’ien (flying money) — Chinese
  • Phoe kuan — Thailand
  • Hui k’uan (to remit sums of money) — Mandarin Chinese
  • Ch’iao hui (overseas remittance) — Mandarin Chinese
  • Nging sing kek (money letter shop) — Tae Chew and Cantonese speaking groups
  • Chop shop — non-Chinese use this term for one of the Chinese methods
  • Chiti banking — refers to the “chit” used as receipt or proof of claim in transactions introduced by the British in China (short for "chitty", a word borrowed from the Hindi “chitthi”, signifying a letter, document or mark).
  • Hui or hui kuan (association) — Vietnamese living in Australia
  • Stash house (for casa de cambio) — South American systems

A simplified model of a hawala transaction is provided by El-Qorchi:[7]

  • Customer A (CA) wishes to send money to customer B (CB)
  • CA visits hawaladar A (HA) in country A
  • HA receives money to be remitted (Q) to CB plus a service fee from CA
  • CA receives code of authentication and passes it on to CB
  • HA then instructs hawaladar B (HB) in country B to remit Q to CB
  • CB discloses the code to HB who then presents CB with the funds

Model of Simple Hawala Transfer

Model of Hawala Transfer

Hawala persists due to a number of reasons, which include; anonymity, cultural friendliness [8], low transaction costs [9], less transit time [10], enhanced level of trust versus banks and other conventional channels [11], and increased efficiency[12].

‘Underground banking’ is a core term widely used to describe hawala. This term, however, is inherently fallacious. The actual transfer process rarely involves any banking procedures. It is structured more as an exchange on open accounts between two or more individuals [13]. For these reasons, ‘underground banking’ is a misnomer and incorrectly implies a submerged activity of illegality and corruption. Another term coined by media hype is ‘black hawala’, which alludes to illegal hawala transactions [14]. However, for some critics, ‘black hawala’ has come to define all hawala transactions. This is typical of the partisan thrust of many present day media commentaries.

By their nature, hawala networks enable transnational economic activity conducted in a world of increasing interconnectedness. However, unlike ‘formal’ transnational economic activities that operate from relatively static identifiable entities (such as banks and other multinational corporations), and which are regulated by national and international governmental institutions, the hawala economy is constituted by networks of spatially dispersed heterogeneous actors with no specific centre. As hawala is located in the ‘grey’ area of legality and may be illegal in some circumstances, one might expect that the default rate and default risk would be high, fraud would be rife, and exploitation common. However, there is a surprising consensus among scholars that the hawala has a history of being reliable, speedy and convenient [15][16][17]. Thus, hawala produces positive economic outcomes but without the traditional visible elements of management control (reporting processes, audit/documentation, formalized clearing system) normally associated with the formal sector.

Hawala gained increasing attention in the US and international media after the 9/11 terrorist bombings involving Al-Qaida. It has been alleged that Al-Qaida used hawala to transfer money – undetected – across international borders to finance its terrorist activities. Since then, research into various aspects of hawala by governments, academics and journalists has increased significantly. This sudden surfeit of information has generated a “fact by repetition” phenomenon [18]. Emanating mostly from the West, a large number of negative commentaries have cast hawala as a dangerous practice that needs regulation, monitoring, or even abolition. However, contrary to popular misconception hawala did not have their beginnings in criminal enterprise or financial malpractice, and continue to be used primarily for legitimate purposes all over the world [19]. De Goede has commented on the general misconception that hawala is an “underground” banking system, noting that these informal networks are connected to Western banking system in many ways[20].

Although hawala is considered an alternative to formal transfers involving banks and financial institutions, the processes involved are quite similar. Formal value transfers can take several forms: cash carriers, exchange houses, and money remitters. Apart from cash carriers, formal value transfer systems do not physically move cash or valuables, but an institution forwards a sum to an individual/business entity on behalf of another institution representing a different individual/business entity. An illustration of this is a transfer of funds through Western Union. Detailed records are kept which are then settled through the formal banking sector, while impartial third parties monitor and enforce rules and regulations.

Hawaladar in Afghanistan

In contrast, while hawaladars keep some records of transaction these are not to monitor their activity but as reminders for details of individual accounts, transactions, and balances. This record-keeping is a matter of individual practice, in contrast to the standardised procedures followed by the formal sector. However, the settlement process for hawala works on the same basis as the formal system: open accounts are kept and there is occasional netting off between hawaladars to settle accounts, although they may not necessarily use formal channels[21].

The biggest difference between the two systems is the monitoring process. As mentioned, the formal system relies on an impartial third party to monitor all transactions and ensure compliance with the rules. Any party that departs from fair transactions would become liable to penalties imposed by the laws governing the system. On the other hand, the informal system does not rely on third party monitoring. Individual hawaladars and other members of the network monitor all transactions. This is enabled by the customary trust that exists between the hawaladars, a trust that stems from a homogeneous set of beliefs that govern code of conduct within ethnic groups and communities. Any individual engaging in acts contrary to the code of the network is punished accordingly[22]. The informal mechanism does not have the detailed documentation that is the essential part of monitoring in the formal system. While records exist they are neither standardised nor available in a form that would be accessible to monitoring agents in the formal system. This makes it difficult to track suspicious fund transfers. The hawala system is based on a hierarchy of agents, each involved in a certain segment of the transaction, making it very difficult to trace the fund’s transfer chain.

Notes

  1. Jost, P. and Sandu, H. S. 2000. The Hawala alternative remittance system and its role in money laundering. Interpol General Secretariat, Lyon.
  2. Jost, P. and Sandu, H. S. 2000. The Hawala alternative remittance system and its role in money laundering. Interpol General Secretariat, Lyon.
  3. Padayachee, V., Morrell, R. 1991. ‘Indian merchants and dukawallahs in the natal economy’. Journal of South African Studies, 17 (1): 71-102.
  4. Jost, P. and Sandu, H. S. 2000. The Hawala alternative remittance system and its role in money laundering. Interpol General Secretariat, Lyon.
  5. Buencamino, L. and Gorbunov, S. 2002. Informal money transfer systems: Opportunities and challenges for development finance. Discussion Paper of the United Nations Department of Economics and Social Affairs, Discussion Paper No. 26. Obtained through the Internet: http://www.un.org/esa/desa/papers/2002/esa02dp26.pdf, [accessed 10/4/2009]
  6. Passas, N. (1999). Informal value transfer systems and criminal organizations: A study into so-called underground banking networks. Netherlands Ministerie Van Justice, The Hague, Netherlands. Obtained through the Internet: http://www.minjust.nl:8080/b_organ/wodcpublications/ivts.pdf [accessed 1/5/2003].
  7. El-Qorchi, M. 2002. ‘Hawala: How does this informal funds transfer system work and should it be regulated?’ Finance and Development of the World Bank, 39 (4): 31-33
  8. Chene, M. 2008. Hawala remittance system and money laundering, U4 expert answer, U4 Anti-Corruption Resource Centre. Obtained through the Internet: http://www.u4.no/helpdesk/helpdesk/query.cfm?id=170, [accessed 17/4/2009]
  9. Maimbo, S. 2003. The Money Exchange Dealers of Kabul. Washington, D.C.: The World Bank.
  10. Schramm, M., & Taube, M. 2002, June. ‘The institutional foundations of Al Qaida’s global financial system’. In DIW Workshop “The Economic Consequences of Global Terrorism”
  11. Schramm, M., & Taube, M. 2002, June. ‘The institutional foundations of Al Qaida’s global financial system’. In DIW Workshop “The Economic Consequences of Global Terrorism”
  12. Ballard, R. 2005b. ‘Remittances and economic development in India and Pakistan’. In S. Maimbo, & D. Ratha (Eds.), Remittances: Development Impact and Future Prospects. Washington, D.C.: World Bank
  13. Passas, N. (1999). Informal value transfer systems and criminal organizations: A study into so-called underground banking networks. Netherlands Ministerie Van Justice, The Hague, Netherlands. Obtained through the Internet: http://www.minjust.nl:8080/b_organ/wodcpublications/ivts.pdf [accessed 1/5/2003].
  14. Jost, P. and Sandu, H. S. 2000. The Hawala alternative remittance system and its role in money laundering. Interpol General Secretariat, Lyon.
  15. Ballard, R. 2005a. ‘Coalitions of reciprocity and the maintenance of financial integrity within informal value transmission systems: The operational dynamics of contemporary hawala networks’. Journal of Banking Regulation, 6 (4): 319–352
  16. Ballard, R. 2005b. ‘Remittances and economic development in India and Pakistan’. In S. Maimbo, & D. Ratha (Eds.), Remittances: Development Impact and Future Prospects. Washington, D.C.: World Bank
  17. Schramm, M. and Taube, M. 2003. ‘Evolution and institutional foundation of the hawala financial system’. International Review of Financial Analysis, 12: 405-420.
  18. Passas, N. (1999). Informal value transfer systems and criminal organizations: A study into so-called underground banking networks. Netherlands Ministerie Van Justice, The Hague, Netherlands. Obtained through the Internet: http://www.minjust.nl:8080/b_organ/wodcpublications/ivts.pdf [accessed 1/5/2003].
  19. Passas, N. (1999). Informal value transfer systems and criminal organizations: A study into so-called underground banking networks. Netherlands Ministerie Van Justice, The Hague, Netherlands. Obtained through the Internet: http://www.minjust.nl:8080/b_organ/wodcpublications/ivts.pdf [accessed 1/5/2003].
  20. de Goede, M. 2003. ‘Hawala discourse and the war on terrorist finance’ Environment and Planning D: Society and Space, 21, 513-532
  21. Wilson, J. F. 2002. ‘Hawala and other informal payments systems: an economic perspective’. Paper delivered at the IMF Seminar on Current Developments in Monetary and Financial Law, IMF Headquarters, Washington D.C. on 16 May 2002. Accessed: http://www.imf.org/external/np/leg/sem/2002/cdmfl/eng/wilson.pdf
  22. Schramm, M., & Taube, M. 2002, June. ‘The institutional foundations of Al Qaida’s global financial system’. In DIW Workshop “The Economic Consequences of Global Terrorism”