What is Hawala?
Hawala is an informal method of transferring money without any physical money actually moving. It is described as a “money transfer without money movement.” Another definition is simply “trust.”
Hawala is used today as an alternative remittance channel that exists outside of traditional banking systems. Transactions between hawala brokers are made without promissory notes because the system is heavily based on trust and the balancing of hawala brokers’ books.
Hawala (sometimes referred to as underground banking) is a way to transmit money without any currency actually moving.
Hawala networks have been used since ancient times, and today are widely found among ex-pats sending remittances home.
Hawala provides anonymity in its transactions, as official records are not kept and the source of money that is transferred cannot be traced.
Hawala is also finding a footing in the world of financial technology, which grants access to money transfers among the unbanked and underbanked populations of the world.
Some countries, like India, have made hawala illegal due to its informal nature and absence of regulation or oversight.
inroduction of Hawala
Central to understanding the hawala system is to get a sense of the importance of the hawaladars, or hawala dealers who play an integral role, as well how the system is built on the heavy reliance on trust, family relationships, and connections, and regional affiliations.
For example, Amir lives and works in New York City and wants to send $1,000 to his cousin Iqbal in Pakistan. Amir decides to visit a hawaladar, Mohammad, in New York and provides him with the details of the transaction, which includes the name of his cousin, city of residence, and a password.
Amir also gets in touch with Iqbal to provide him with the password as well. Mohammad then contacts Shirin, a hawaladar in Iqbal’s city, through his list of contacts and asks her to meet up with Iqbal to provide him with Amir’s $1,000.
Shirin and Iqbal meet, and he gets the money after correctly stating the password he received from his cousin Amir. Shirin transfers $1,000 to Iqbal immediately from his own account and now is owed that amount by hawaladar Mohammad back in New York.
The above illustrates the important steps in the hawala system and confirms the importance of hawaladars.
Transactions of similar nature occur all the time, and it is important to note that the transfer of funds between Amir and Iqbal through intermediaries Mohammad and Shirin take place within one or two days, or even a few hours, even when time differences are taken into consideration. It makes the entire process much quicker than if the transfer were to go through the traditional banking system.
As mentioned, the hawala system is unique when compared to formal banking systems because it is built on an honor system and, often, strong family connections.
Another important distinguishing fact is how there is little written record documentation, and promissory notes or notes payable are not exchanged between the hawala dealers. The dealers keep informal records of all the credit and debit transactions on their accounts that can be settled in various forms, such as cash, property, services, or others.
As such, the hawala system operates independently of any legal, judicial system, which means that it does not rely on the legal enforceability of claims or other types of legal action.
It is where the use of connections, often familial ones, and a system of honor and trust come into play since many of the hawala networks are built by members of the same family, clan, village, or other association, and those in the network are expected to abide by the implied contractual system.
Individuals who cheat will lose respect and trust among the other members and may be excommunicated.
Hawala and Government Regulation
Since hawala transfers are not routed through banks and, hence, not regulated by governmental and financial bodies, many countries have been led to re-examine their regulatory policies in regard to hawala.
For example, in India, the Foreign Exchange Management Act (FEMA) and the Prevention of Money Laundering Act (PMLA) are the two major legislative systems that deter the use of hawala in the country. India prohibits informal hawala transactions and people from entering into them by strictly defining the types of transactions not allowed, which include the creation or procurement of any asset outside of India.
In Pakistan, informal Hawala transactions are prohibited as well. The country specifies what entities are allowed to make remittances and currency exchanges. There are laws in place that require money changers to register and comply with regulations to become foreign exchange companies within two years and if they do not register they are not allowed to operate.
Afghanistan’s 300+ money exchangers have organized themselves into a self-regulatory body that has created rules and regulations that all members must comply with. It has been more difficult for the country to bring unregistered money exchanges into the fold to prevent illegal activities through hawala exchanges.
Most countries have laws around informal funds transfer systems, like hawala, that seek to curb the negative externalities created by such a system.
Some Fintech companies are implementing the hawala system in providing financial services to the unbanked and underbanked populations of the world. Mobile banking and payment platforms, such as Paga and M-Pesa, are revolutionizing the financial system in certain African countries by promoting financial inclusion through the hawala system of providing financial services.
Why is Hawala Preferred by its Users?
In addition to the hawala system being much quicker and convenient in terms of transferring payments, its users are also attracted by other advantages such as the ability to transfer money between poorer, less developed countries where formal banking systems are expensive or harder to access by those from a lower socioeconomic status.
It is particularly true for migrant workers who send money and remittances to relatives in their home countries. Furthermore, hawala users are also attracted by the relatively lower commission rates compared to those charged by banks within the traditional banking systems.
Hawala and Money Laundering
Hawala is often considered a form of underground banking and has been frequently used by money launderers and terrorists to transfer funds globally across geographical borders.
One of the main concerns that countries have with this system is how it can be used for money laundering due to the lack of bureaucracy in the system since they are not routed through the banking system and do not face governmental regulation by official bodies.
It provides anonymity in its transactions, as the source of money being transferred cannot be traced, and there are relatively few written and official records.
Example of Hawala
How does hawala work? Let’s say Mary needs to send $200 to John, who lives in another town. She will approach a hawaladar, Eric, and give him the amount of money she wants John to receive, including the details of the transaction; the name of the recipient, city, and password.
Eric contacts a hawala dealer in the recipient’s city, Tom, and asks him to give John $200 on the condition that John correctly states the password. Tom transfers the money to John from his own account, minus commission, and Eric will owe Tom $200.
The transaction initiated by Mary and concluded by John’s receipt of the funds takes only one to two days or, in some instances, just a few hours. No money is moved and no IOUs are signed and exchanged by Eric and Tom, as the hawala system is backed only by trust, honor, family connections, or regional relationships.