Information about Middle East Oriente Medio
Chapter

2. Formalizing the Informal? Problems in the National and International Regulation of Hawala

Author(s):
International Monetary Fund
Published Date:
March 2005
Share
  • ShareShare
Information about Middle East Oriente Medio
Show Summary Details
Author(s)
Nikos Passas

Hawala means “transfer” in Arabic and refers to a traditional informal and efficient funds transfer method used by millions of expatriates to send remittances to their families around the world. Several studies emphasize hawala’s economic and humanitarian significance. In the midst of calls to shut down all potential means used by militants to finance their terror, the First International Conference on Hawala, held in 2002 in Abu Dhabi, was successful in offering an opportunity to examine hawala beyond media sensationalism and rushed policy responses.

Nevertheless, any optimism that the conference would lead to appropriate and effective regulatory arrangements was soon frustrated by hurried approaches at both the national and international levels that seemed to be more fitting for formal institutions than informal networks. Indeed, some of the measures introduced in the past two years have caused serious damage to ethnic communities dependent on their relatives’ remittances.

The argument of this chapter develops through the following main points:

  • (1) hawala serves honest people as well as serious criminals;
  • (2) financial controls of terrorism are critical but no panacea;
  • (3) there has been a counterproductive overemphasis on hawala as uniquely vulnerable to abuse;
  • (4) current regulatory arrangements fail to meet stated objectives; and
  • (5) careful consideration of sound empirical evidence and genuine dialogue with the sector are indispensable.

These points will be addressed as we examine the appeal of hawala—and the regulatory objectives, challenges, and risks. We conclude with implications for a sensible and evidence-based policy.

The Appeal of Hawala

Hawala originated in the Indian subcontinent and constitutes one of numerous informal value transfer systems operating globally (El Qorchi, Maimbo, and Wilson, 2003; Passas, 1999). Deliveries are made in cash quickly, cheaply, and conveniently in places where banking services are unavailable, expensive, or unreliable.

Two main aspects can be distinguished in the hawala business: the sending and receiving of money (the relationships between a hawaladar and his or her clients), and the settlement process (relationships among intermediaries).

The first part is relatively straightforward. Clients hand in their cash and request an equivalent amount to be delivered in local or, more rarely, another specified currency. Hawaladars (hawala operators) and those acting as their agents accept cash on their premises—usually some other business, such as a corner store, a delicatessen, a music or electronics business, a travel agency—or may go to their clients’ workplace or home for a cash pickup. In most cases, no fees are discussed. Rather, the transaction cost is factored into the quoted exchange rate or the amount that will be delivered overseas in local currency for their U.S. dollars, pounds, dirhams, riyals, etc.

At the end of each day, hawaladars consolidate all deals into ledgers for each agent and counterpart they do business with, including a running balance. The funds transfer requests are organized into payment instruction sheets—containing the amounts and the name, address, and telephone number of the recipient—and faxed to counterparts in other parts of the world. The serial number of a rupee or other note in the hands of the intended recipient is also faxed: it is often used for identification. Some communications may also be done by e-mail or telephone. Hawaladars maintain such records at least until accounts are settled; in labor importing countries (e.g., United States, Europe, or U.A.E.), ledgers are often kept for several years.

The delivery takes from a few minutes to 48 hours, depending on the urgency and the destination of the funds. Cash may be handed over at the recipients’ premises or taken to their doorstep. Each hawaladar keeps a pool of cash, which enables payments as soon as instructions arrive. Thus, local cash is typically used for payments on behalf of overseas clients. In this way, actual fund transfers are minimized (for more details, see Passas, 2003b, 2003c, 2004b).

Hawala serves millions of immigrants from South Asia, Africa, the Middle East, and elsewhere, whose remittances are often desperately needed as a means of survival. The funds also provide important support for economic development (Ratha, 2003). Formal financial institutions have recently made strong efforts to increase their share of the remittance market by lowering fees, widening their networks, and using better technology. The law enforcement and regulatory attention drawn by hawala has also increased operating costs in the informal sector. Nevertheless, hawala continues to be the best option for most immigrants and the only one for those coming from regions devastated by civil conflict and disasters.

Data updated in November 2004 from the United Arab Emirates illustrate the competitiveness of hawala. Table 2.1 contrasts the cost of sending about US$100 from the U.A.E. to South Asia, including exchange rates, charges for telegraphic transfers or drafts by banks and exchange houses, and Western Union fees. In short, hawala offers much better exchange rates and no fees at all.

Table 2.1.Comparative Cost of Sending US$100 to South Asia from Dubai, U.A.E.
Charges (US$)
InstitutionDraftTelegraphic TransferRate of Dh/US$
Exchange house1.36–2.7229.52–16.333.6735–3.68
Bank2.722–6.8012.25–27.223.678–3.693
Western Union9.523.7
Hawala03.673–3.6736
Source: N. Passas.
Source: N. Passas.

The financial benefits to remitters’ families become clearer in Table 2.2, which uses Pakistan as an example and compares the amounts received by beneficiaries in local currency for about US$100 sent from Dubai. Hawala beats all the competition by far. The amount received in cash is higher than all other options. Moreover, all formal methods involve charges and fees requiring the remitters to add from US$1.32 to US$27.22 to the cost. In short, better rates and lower costs make hawala the best option financially. Other advantages include having convenient home delivery or pickup, interacting with people speaking the same language and from the same region, avoiding bureaucratic procedures and paperwork, preserving confidentiality, and achieving fast delivery even in the remotest villages. The relationship of trust and the mutual interests of hawaladars and their clients support the efficient global hawala networks. Finally, “cultural inertia” and the forces of old habits add to the hurdles faced by formal institutions seeking to capture a larger share of the multibillion-dollar (U.S. dollars) global remittance market.

Table 2.2.Comparative Amounts Received in Pakistan for Remittance of US$100 from Dubai, U.A.E.
Method of RemittanceChargesTotal PaidPK Rupees Received
Draft (exchange house)1.36–2.722101.36–102.7225,901–5,910
Draft (bank)2.722–6.80102.722–106.805,890
Telegraphic transfer (exchange house)9.52–16.33109.52–116.335,901–5,910
Telegraphic transfer (bank)12.25–27.22112.25–127.225,890
Western Union9.52109.525,858
Hawala01005,920
Source: N. Passas.
Source: N. Passas.

Need for Regulation

At the same time, research clearly shows that hawala is vulnerable to criminal abuse, just like all other financial institutions. We know that hawala clients include money launderers, militants, corrupt politicians, fraudsters, and tax evaders (Carroll, 1999; Howlett, 2001; Passas, 1999, 2003a, 2003b, 2003c, 2004b, 2004c; FATF, 2001, 2003). Legitimate clients and funds are occasionally commingled with illicit ones. As hawaladars use local cash pools to pay for overseas remittances, the father of someone sending honestly earned funds from the United States or U.A.E. could actually receive the cash that a corrupt official or smuggler wishes to launder or secretly take out of the country.

Most vulnerable to abuse, however, is the process of settlement among hawaladars. The cash pools on which they draw for payments are always asymmetrical, as each operator transfers funds to and from multiple locations every day. Apart from compensatory payments, other ways of balancing accounts include formal transfers (check, wire, bank-to-bank, etc.), the use of couriers, and payments in kind, as well as commercial transactions, falsified invoices, and third parties. Not being subject to the same rules as formal institutions and operating frequently in parallel economies through not always known third parties make the whole process susceptible to illegal uses. The problem is not merely theoretical; there is evidence that money derived from drug trafficking, illegal arms sales, body part trade, corruption, tax evasion, and all kinds of fraud have indeed moved through hawala networks.

In this light, leaving hawala completely unregulated, as was the case in many parts of the world before 9/11, is no longer realistic. The question is how to regulate it (Maimbo and others, 2005; Passas, 2003a, 2003b, 2003c). One important point to consider is that trust is a defining element of hawala, which makes the system not only more efficient, but also reliable. Informal dispute-resolution mechanisms most often resolve issues among hawaladars, and individual remitters have seldom lost their money even after law enforcement actions, accidents, or bankruptcy (Maimbo, 2003; Passas, 2004a, 2004b, 2004c). Hence, a consumer protection type of regulation is not as necessary as many a Westerner might think.

Regulatory Objectives and Challenges

The main task is to reconcile two sets of public policy priorities. On the one hand, we must counter terrorist financing, money laundering, and other financial crime. Labor exporting countries are also concerned about the economic or other damage caused by hawala in local economies thirsty for foreign currency.1 On the other hand, we need to reduce the hurdles faced by laborers remitting funds to their homeland and to avoid unnecessary disruptions of capital flows and commerce, both of which are vital to economic development.

More specifically, the crime-control objectives are to (1) achieve more transparency by identifying operators and clients and by enhancing the traceability of transactions, (2) provide a measure of deterrence and prevent abuses of funds transfer networks, (3) prevent the financing of terrorist operations, and (4) collect intelligence and monitor the activities of criminal groups and extremists.

The economic aims are to (1) lower the cost of remittances, (2) widen the range and increase the speed of remittance options, (3) ensure compliance, (4) protect the consumer, and (5) ensure a level playing field for the various competitors in the remittance market.

The synchronization of these objectives is complicated by the dilemmas of undocumented immigrants, who may be earning legitimate funds without authorization to work, which means that they could not use formal institutions for remittances or other business. Another serious challenge is the harmonization of controls internationally and regionally, as the contexts vary dramatically and render some rules unenforceable or unrealistic.

Challenges specific to hawala networks include the following:

  • There is often no uninterrupted transparent audit trail.
  • It may be hard or impossible to interpret idiosyncratic hawala records.
  • The fusion of hawala with other businesses makes it hard to disentangle transactions and may easily hide illicit activities.
  • The interface with gray/black markets makes it harder to supervise hawala and offers opportunities to obscure transactions.
  • Fine-tuning regulations and law enforcement targets to avoid harm to innocent actors is particularly difficult and requires study and appreciation of ethnic, cultural, political, and socioeconomic specificities.
  • Ensuring a balanced approach and proper regulation of the formal sector requires the conception and implementation of rules appropriate for very different actors, modi operandi, and traditions.
  • Finally, assessing and measuring the effects of measures and policies relative to hawala are hard, given the availability of a wide range of other informal methods that could be used by those determined to evade regulation. Thus, reduced illegal hawala activity may not necessarily be a positive development, to the extent that activities get displaced to less transparent and less understood informal value transfer methods (Passas, 2003c).

Shortcomings of Current Arrangements

No thorough and systematic effort has been attempted to assess the effect of policies that were introduced very shortly after the terrorist attacks of September 11, 2001. There are strong indications, however, that most of the policies—both national and international—are not producing the desired effects and may indeed be counterproductive.

In South Asia and other labor exporting countries, for example, hawala has been and remains either criminalized or outlawed. This means that certain large parts of hawala networks are by definition illegal, forcing operators and clients to keep a low profile and hide their business as much as they can. Some European countries, such as France and Spain, allow no IFT operations. Others require costly and burdensome procedures for de facto licensing, pushing a number of hawala operators underground.

The same applies to the United States, where federal efforts to increase compliance and transparency through registration are completely undermined by an uncoordinated patchwork of state regulations. With the exception of a few U.S. states that do not regulate money transfers at all, the overwhelming majority mandate licensing. In some of them, however, the capitalization or bond requirements amount to hundreds of thousands of U.S. dollars. If a hawaladar has clients in more than one jurisdiction, he would need to comply with the rules of all states. This is an unaffordable and nonpragmatic arrangement that effectively seeks to formalize the informal. Attempting to apply to hawala rules that are appropriate to formal financial institutions and corporations is unwise and unworkable. Hawal-adars are left with three options: to introduce or substantially raise fees and charges to customers, to stop offering the funds transfer service to their ethnic communities, or to operate without a license. However, operating without a required state license has become a federal offense. This has effectively pushed many hawaladars out of business or underground. Judging by media and official reports of arrests and charges for this offense, hawala has been largely criminalized in the United States.

Even in the liberal environment of the U.A.E., where hawala is legal and compliance is affordable (simple registration), hawaladars shun the limelight and would not come forward, even to attend the hawala conference.

Many countries are eager to heed calls by the Financial Action Task Force and others to apply anti–money laundering and terrorist finance recommendations and rules. However, interviews with officials suggest that despite formal compliance with such international standards, enforcement is problematic and impractical. Attempts to formalize the informal equal efforts to alter the age-old traditional networks, which successfully resisted prohibitions and authoritarian regimes in the past. The chances of succeeding are slim, particularly if the informal sector is not consulted.

The Risks of Unsuccessful Regulation

Financial controls are essential and necessary. They deter and prevent serious crimes, offer investigative leads to detect and arrest offenders, reduce the harm of planned or committed crimes, and generate opportunities for intelligence collection. However, if our aspirations get lofty, there is the danger of causing more problems than we solve. All of the objectives set out above risk being frustrated, and we can expect the following responses:

  • a reduction of the positive economic effects of labor remittances;
  • fewer, more expensive remittance options available to expatriates;
  • unnecessary criminalization of legitimate actors;
  • higher human costs to the families of immigrants;
  • alienation of large segments of the population which would be helpful in counterterror coalitions; and
  • shifts to less well known informal value transfer methods and thus less transparency and traceability of transactions

Contrary to popular perception, there were no hawala transactions in the 9/11 terrorist operations. Myths about huge amounts raised and made available to al Qaeda and associated groups have been dispelled (National Commission on Terrorist Attacks upon the United States, 2004). Terrorism is inexpensive and financed through a wide range of methods. Hawala has certainly been used to transfer militants’ funds, but it is not the most important vehicle. Assumptions about a centrally and rationally organized al Qaeda have also been rejected, as evidence points to loose networks unified by ideas and beliefs rather than structures. Militants tend to raise their operational funds locally and through ordinary crime, such as credit card fraud or tobacco smuggling.

Furthermore, because of the strong emphasis on naming, shaming, freezing, and seizing the assets of suspected supporters of terrorist groups, we may expect groups to use funds transfer methods and infrastructures akin to money laundering. Thus, instead of hiding the illegal source of money, people would now want to hide themselves as the source of funds given to extremist groups.

Conclusion: The Way Forward

As we try to avoid “collateral damage” and undermine our own objectives, the fight against transnational crime could turn out to be a very useful counterterrorism approach. Infrastructures set up for one kind of secret finance and smuggling can be employed by militants as well. Some of them may also team up temporarily with criminal groups. Hot spots of financial crime, which abound in all continents, must be investigated. Anticrime and counterterrorism policies ought not to be regarded as conflicting or competing, but as complementary and mutually supportive.

The most promising approach to hawala regulation, and an efficient separator of users from abusers, is through a dialogue and outreach to all stakeholders of this significant economic sector. By taking the views of hawaladars into account and by building a consensus, future compliance and transparency, or traceability of transactions, is far more likely. Encouraging further cost reductions and more convenient and accessible formal remittance avenues would ensure the continuation of vital services to needy communities.

At the domestic level, countries would be wise to harmonize their federal, state, and local rules and responses on the basis of evidence, appreciation, and understanding of the networks they seek to supervise and control. Internationally, it may be useful to establish specific policy goals and urge countries to meet them in their own way, consistent with local traditions, culture, and socioeconomic conditions. In that way, we would promote legal harmonization while allowing for the necessary diversity and flexibility.

Regulation will be most effective to the extent it becomes truly cross-agency and international. It must be emphasized, however, that financial control will never work while trade remains nontransparent. Gigantic sections of the world economy currently operate “under the radar” and constitute an enormous risk for proliferation of crime, terrorism, and weapons of mass destruction. Precious stones and metals have received some attention, but it is all trade that needs to be better regulated (Passas, 2004d). Once trade transactions are transparent, they must also be connected with financial transactions. This is the only way genuine transparency and accountability may be achieved.

Finally, a demand-side approach to counterterrorism must supplement the supply-side, law enforcement, and military approaches. Terrorism is also a socioeconomic and political issue reflecting both local and global problems. Our policies must pay attention to new recruits and sympathizers, who could use their illegal or legal businesses to facilitate fund raising and transfers “for the cause.” Our long-term success will be founded on long-term policies that address the fundamental problems underlying extremism of all kinds.

Bibliography

    CarrollL.1999“Alternative Remittance Systems,”FOPAC BulletinVol. 20.

    El QorchiMohammedSamuel M.Maimbo and JohnWilson2003Informal Funds Transfer Systems: An Analysis of the Informal Hawala System IMF Occasional Paper No. 222 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    FATF (Financial Action Task Force)20012000–2001 Report on Money Laundering Typologies (Paris: Financial Action Task Force, OECD).

    FATF (Financial Action Task Force)2003Combating the Abuse of Alternative Remittance Systems: International Best Practices (Paris: Financial Action Task Force, OECD).

    • Search Google Scholar
    • Export Citation

    HowlettC.2001Investigation and Control of Money Laundering via Alternative Remittance and Underground Banking Systems (Sydney: Churchill Fellowship).

    • Search Google Scholar
    • Export Citation

    MaimboSamuel M.2003The Money Exchange Dealers of Kabul: A Study of the Informal Funds Transfer Market in Afghanistan (Washington: World Bank).

    • Search Google Scholar
    • Export Citation

    MaimboSamuel M. and others2005Migrant Labor Remittances in the South Asia Region (Washington: World Bank).

    MaimboSamuel M.NikosPassas2004“The Regulation and Supervision of Informal Remittance Systems,”Small Enterprise DevelopmentVol. 15No. 1 pp. 5362.

    • Search Google Scholar
    • Export Citation

    National Commission on Terrorist Attacks upon the United States2004Monograph on Terrorist Financing (Staff Report to the Commission) (Washington: National Commission on Terrorist Attacks upon the United States).

    • Search Google Scholar
    • Export Citation

    PassasNikos1999Informal Value Transfer Systems and Criminal Organizations: A Study into So-Called Underground Banking Networks (The Hague: Ministry of Justice, The Netherlands).

    • Search Google Scholar
    • Export Citation

    PassasNikos2003a“Financial Controls of Terrorism and Informal Value Transfer Methods” in Transnational Organized Crime. Current Developments,ed. by H.van de BuntD.SiegelD.Zaitch (Dordrecht: Kluwer).

    • Search Google Scholar
    • Export Citation

    PassasNikos2003b“Hawala and Other Informal Value Transfer Systems: How to Regulate Them?”Journal of Risk ManagementVol. 5Issue 2 pp. 3949.

    • Search Google Scholar
    • Export Citation

    PassasNikos2003cInformal Value Transfer Systems Money Laundering and Terrorism (Washington: National Institute of Justice and Financial Crimes Enforcement Network). Available via the Internet: http://www.ncjrs.org/pdffiles1/nij/grants/208301.pdf.

    • Search Google Scholar
    • Export Citation

    PassasNikos2004a“Indicators of Hawala Operations and Criminal Abuse,”Journal of Money Laundering ControlVol. 8No. 2 pp. 168172.

    • Search Google Scholar
    • Export Citation

    PassasNikos2004bInformal Value Transfer Systems and Criminal Activities (The Hague: WODC, Ministry of Justice, The Netherlands).

    PassasNikos2004c“Law Enforcement Challenges in Hawala-related Investigations,”Journal of Financial CrimeVol. 12No. 2 pp. 112119.

    • Search Google Scholar
    • Export Citation

    PassasNikos2004dThe Trade in Diamonds: Vulnerabilities for Financial Crime and Terrorist Finance (Vienna, Virginia: FinCEN, U.S. Treasury Department).

    • Search Google Scholar
    • Export Citation

    RathaDilip2003“Workers’ Remittances: An Important and Stable Source of External Development Finance,” in Global Development Finance (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
Nikos Passas is professor at Northeastern University, College of Criminal Justice, Boston.
1Because hawala draws on local cash pools for making remittance payments, it is feared that hawala deprives the country of valuable foreign exchange.

    Other Resources Citing This Publication