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Hawala and Other Informal Value Transfer Systems: How to Regulate Them?

By Nikos Passas

Introduction

For many years, representatives of national, foreign, and international law enforcement agencies have been concerned about the role played by what used to be called 'underground banking' or 'alternative remittance systems' in the facilitation of serious crimes, including money laundering. The more accurately termed 'informal value transfer systems' (IVTS) are fairly open and involve no deposit taking or lending; in many parts of the world, they constitute the only alternative and functioning method of money transfer (Passas, 1999a, 2000; el Qorchi et al, 2002). IVTS refers to any network or mechanism that can be used to transfer funds or value from place to place either without leaving a formal paper-trail of the entire transaction or without going through regulated financial institutions at all (Passas, 2002).

Since the September 2001 attacks in the USA, 'terrorism' has leapt to the top of the Western political agenda (for example, the USA Patriot Act 2001). As soon as the word 'hawala', in particular, was uttered in Congress, lawmakers, policy think tanks and the media turned their attention to what they defined as a financial tool of terrorism (Jamwal, 2002). Mainstream outlets went as far as declaring hawala as a "system built for terrorism" (Ganguli, 2001). The evidence and information bases of the overwhelming majority of the articles and reports on hawala were thin to non-existent. Most of them repeated baseless earlier statements contributing to the creation of a faulty conventional wisdom or "facts by repetition" - the frequent mention of the same unfounded accounts generated a false sense of knowledge about hawala and related networks; Passas, 1999a: 20-23).

The following point needs to be impressed at the outset. The evidence in the 9-11 attacks shows that most of the funds received by the hijackers reached the US through formal financial institutions (e.g., wire transfers, credit card use). Even some of the cash that entered the country was declared to the authorities. In other terrorism cases, correspondent banking accounts have also been used. The role of trade in legal commodities is also very important. Hawala networks are, thus, by no means the only or main vehicle of illegal funds transfers or financing of terrible acts.

IVTS include various ethnic traditions or practices, such as hawala, hundi, fei chien, Phoe kuan, black market peso exchange. Very little original and systematic work had been done on this subject until recently (APG, 2001). Unfortunately, the current literature on the subject lacks depth and is replete with inaccuracies. My earlier study, which included original material and a review of public-source information and reports revealed that information was sparse and often completely unreliable. Exaggerations and contradictions were found even within single documents. Interviews with officials from different continents demonstrated significant differences of opinion. Equally well-intentioned people offered diametrically opposite assessments of the IVTS issue. Moreover, some interviewees questioned the validity of certain official reports (Passas, 1999a, 2000).

Yet, the study established that criminal organizations do use IVTS. The kinds of offenses committed include the following: evasion of currency controls; tax evasion; the purchase of illegal arms, drugs, or other illegal/controlled commodities; corrupt payments; intellectual property violations; the receipt of ransom; payments for the smuggling of illegal aliens; payments for illegal trade in body parts; financial fraud; financing militant/terrorist activities; and laundering the proceeds of crime. All of these findings have been confirmed by subsequent reports (APG, 2000, 2001; Howlett, 2001).

Given the knee-jerk response to hawala, concerns about the financing of terrorism and the serious effects all this could have on age-old methods employed by Asian expatriates remitting funds to their families, it is worthwhile taking a closer look at hawala and attempting to learn first hand some of the basic facts about hawala. This article summarizes some of the findings coming of an 18-month long project with respect to the mechanics and settlement processes in hawala networks and concludes with some policy implications.²

Hawala and Hundi

In Urdu, 'hawala' means 'reference', while in Arabic it means 'transfer'. Consequently, formal bank transfers are conducted in 'hawala departments' in parts of the Arab world. It is more accurate, therefore, to separate formal from informal hawala. For the purposes of this paper, hawala is used only as shorthand for informal hawala. The terms 'hawaladar' or 'hundiwala' refer to hawala or hundi operator.

Inaccuracies about hawala abound in writings both before and after it became a matter of policy concern following September 11th. First of all, hawala did not originate ages ago in times of political turmoil in order to bypass laws and currency restrictions or out of distrust for banks (Bosworth-Davis and Saltmarsh, 1995; NCA, 1991; O'Hara and The Wild Palms Foundation, 1997). Secondly, it is not all that different from older and contemporary 'conventional' banking practices. It is erroneous to state that 'transfer without money movement' is a distinguishing feature of hawala (Jost and Sandhu, 2000; Passas, 1999a). Quite the contrary, this is a point of resemblance with formal financial systems. Thirdly, what I have described as "facts by repetition" with respect to the inner workings of hawala unfortunately continues with the same baseless quotation making the rounds of documents influencing policy and law enforcement practices. Thus one finds the claim that "these parallel banking systems are based on family or gang alliances and reinforced with an unspoken covenant of retributive violence" repeated almost verbatim in source after source (Malhotra, 1995: 1; O'Hara and The Wild Palms Foundation 1997: 1; Williams, 1997: 6; UN General Assembly, Special Session on the World Drug Problem 8-10 June 1998; Lambert, 2001).

Most writers agree that hawala is an old practice pre-dating paper money and formal banking in the Indian sub-continent, that it facilitated trade and helped avoid the risks of physical transportation (el Qorchi et al, 2002; Miller, 1999). Even though 'hawala' and 'hundi' are used interchangeably in parts of South Asia, they should be distinguished. Hundi was one of the earliest and most important credit instruments in India. It functioned as a remittance vehicle (hence the confusion with hawala), as an IOU, and as a bill of exchange. In simple terms, it was a popular bearer credit and remittance instrument, which resembled European practices in the 12th and 13th century. Bills of exchange were used in Florence and Venice at that time, but also in France and Britain later on, because of their convenience (Agarwal, 1966). As a forthcoming study notes, "The development of bills of exchange was the pillar behind the remarkable expansion of banking activity in Europe" (el Qorchi et al., 2002).

According to an early 20th century study, hundis enabled advances, but could also be used as finance bills or trade bills. The hundi was payable either on sight ('darshani hundis') or at a later date (deferred, usance or 'muddati hundi') (Jain, 1929). Hawala, on the other hand, is simply the practice of transferring money and value from place to place. Hawala, as I understand it, may or may not involve the use of a hundi (in modern times, it appears that most often it does not). Yet, in some countries, such as Pakistan and Bangladesh, the term used to describe the practice of hawala is actually 'hundi'.

Hawala Mechanics

Broadly speaking, there are two main aspects in the hawala business: the sending and receiving of money, and the settlement process. The former regards relationships between a hawaladar and his or her client, while the latter consists of relationships among intermediaries.

A fax, email or telephone call will communicate to the counterpart overseas the amount, name, address and telephone number of the recipient. The serial number of a rupee note in the hands of the recipient is also faxed: it is often used for identification. Hawaladars usually keep some details of the clients, such as payment instructions, names and telephone numbers as well as addresses of their contacts. Those records are maintained at least until accounts are settled. The same happened in the big 'hawala corruption scandal' that rocked India in the 1990s, which involved important politicians, industrialists and companies. Details for payments were going to India from operators in London and Dubai. Records of them were kept locally as well (the famous 'Jain diaries').

Payments are made reliably, fast, cheaply and conveniently (home delivery service too) in places where banking services are unavailable or inefficient. In others, the fees are close to extortionate, the process is burdensome, slow and awe-inspiring especially to illiterate customers. Hawala does not discriminate in such ways. Indeed, there are cases in which low-income customers are not charged at all for the transfer. It also reaches the most isolated parts of the world, able to reach locations deemed unprofitable for banks to open branches. In other instances, formal financial services are unreliable, and money gets lost or taken away from needy recipients. Trust, a defining element of hawala, makes the system extremely efficient. I have seen no instance of a cheated client. These are the main reasons South Asians still resort to hawala. In addition, while anonymity and informality constitute an advantage of hawala, they also make it vulnerable to abuse.

For hawala to operate optimally, there must be pools of cash on both ends of transactions. This is how each hawaladar will make payments for the other's clients and will not have to move money across borders. So, the question is what fuels the business in labor-importing countries on one side (pool A) and in remittance-receiving countries, such as Afghanistan, India or Pakistan on the other (pool B). The following is a list of the type of funds contributing to pool A: remittances of expatriates to their families; payments for imports; investment funds (in case of restrictions as, for example, in India); services provided overseas but paid for locally; over-invoicing of exports and bogus exports; tax evasion money; proceeds of criminal enterprises, such as cigarette or human smuggling, drug trafficking or any kind of fraud; contributions to militant and terrorist groups.

Not all of this money has to go through hawala and, of course, not all of it does. But these are the sources of the demand for this traditional service. Remittances of expatriates to their families and payments for imports are self-explanatory. One point to note about payments for imports, however, is that hawala is by no means necessary with respect to many countries. That is, US-based importers can and do settle their debts to partners in many countries through banks and other official channels. Using hawala for settling up with a Hong Kong or European trader makes little or no economic sense, if the transaction is legitimate. Whenever trades are off the books for whatever reason (for example, imports from a country subject to trade sanctions), then a hawaladar does come in handy.

Investment funds raise the question why one might go through hawala to make an investment. The case of India illustrates this. In India, the answer is that there have been restrictions over the years on foreign ownership of Indian company stock. As India seemed to be an area of economic growth, many investors wanted to get around those restrictions and used hawala channels and 'benami' (false name) or nominee accounts (the use of someone else's name for commercial or other transactions in not uncommon in the Middle East and South Asia).

Services provided overseas but paid for locally. A good illustration of how in-kind payments or services provided overseas can generate cash for pool A can be found in the tourism business. A travel agent in the US routinely sends groups of tourists to India, where all their costs are covered. The travel agent receives the payment in dollars but keeps it in the US. A hawaladar who wishes to send money to the US from India actually pays for all these expenses once the tourist groups are in the country as a means of settling up.

Over-invoicing of exports and bogus exports. Through over-invoicing of exports one effectively receives money. For example, if I ship goods worth $100,000 to Bangladesh but invoice my business partner for $150,000, I will be receiving an additional $50,000 in the US. My partners may wish to minimize the official (declared) profit from the sale of these goods in Bangladesh, or may like me to deposit these $50,000 in their account in the US. In other words, this is another method of evading currency and capital controls and getting the money converted to a hard currency overseas beyond the government's reach. Would such a practice not entail, though, a higher import duty overseas? Not for all goods and not everywhere. In India, for instance, duty would not apply at all or would be very low for books or software programs. So, people who wish to whisk their money away from India would place orders for practically worthless books or (blank) CDs for which they would pay the US exporter through a phantom company that will cease to exist shortly after the payment is made from India. There are masses of unclaimed such shipments in India (e.g., Mumbai), sitting in warehouses and highlighting the extent to which this practice occurs to this day. This is what I refer to as 'bogus exports'.

Tax evasion money includes money earned through legal activities in the US, but not declared to the tax authorities. This money could not be deposited in bank accounts or officially sent out of the country, so hawala presents an attractive method of disposing of it.

Proceeds of criminal enterprises. The business of illegal immigration has thrived in Europe and the US in recent years, as has the illegal traffic of drugs, weapons and cigarettes. Frauds of all kinds also generate a great deal of cash that needs to be laundered, if it is to be used in the legal economy.

Contributions to militant and terrorist groups. A frequent means of financing insurgency has been to appeal to expatriate communities in various countries. Almost any conflict in all continents has relied on the patriotism and convictions of immigrants to make a contribution 'for the cause'. In some cases, involuntary contributions are made through 'shakedowns' (Naylor, 2002). However funds are raised, they often become available as cash in host countries and can be added to cash pool A.

A second cash pool (B) will be used to draw on and make the payments at the other end. The following is a list of clients sending money to the West from India and Pakistan: families paying students' tuition overseas; families covering medical expenses overseas; tourists' money beyond amounts allowed by country with currency controls; flight capital; payment for imports; tax evasion; mis-invoicing of imports and exports; bribes of politicians and government officials; (laundered) money from criminal enterprises.

Families paying students' tuition overseas, families covering medical expenses overseas, tourists' money beyond amounts allowed by country with currency controls and flight capital all relate to countries with currency and capital controls. The objectives are to prevent capital flight and to control exchange rates and foreign currency reserves. Citizens and residents are allowed to take out of the country a limited amount per year. Certain exceptions are allowed, but the bureaucratic process may be slow and inefficient. So, for parents whose children study abroad, the allowance may be insufficient. The same applies to urgent medical operations. Also, citizens traveling overseas often wish to spend more than their tourist allowance. Hawala enables the circumvention of currency controls. In addition, in terms of flight capital, economic or political uncertainties, high inflation or perceived lack of solid investment opportunities motivate people with substantial amounts of money to channel their funds out of a country with currency controls. Although capital flight is not seen as a matter for criminal law in market economies, the draining of capital resources and extreme volatility are issues of national security for certain societies. Capital flight from India to the US, for example, has been estimated to be in the billions of US dollars in the middle 1990s (Zdanovich et al, 1995).

Payment for imports. Importers would have no trouble using banking channels to pay their counterparts overseas. In some cases, speed and efficiency are the primary concerns, while in other cases the trading partners may be located in countries subject to sanctions, limitations, etc. For instance, some consumer goods have been subject to quotas in India. Illegal imports through smuggling have been financed through hawala.

Tax evasion is quite widespread in many parts of the world. So, a good part of the income and cash that is not declared to the authorities seeks to flee the country or get laundered. One interesting method of cheating on taxes is the use of laws in India making US dollar gifts to Indian residents tax free. Money leaves the country often through hawala and returns as a tax-free gift.

Whenever imports and exports are mis-invoiced, there is either plenty of cash from sale proceeds or over-payment of exported goods, which generate cash that can join a hawaladar's pool or a need to make a secret payment overseas in order to settle up. In the case of under-invoicing of imports, excess profit has been made in the local market part of which is owed to partners overseas.

Bribes of politicians and government officials. A common practice in parts of South Asia is that 'speed money' is paid by individuals and businesses in order to get things done or to avoid taxes. Companies do not wish to enter those payments in their books, so they need to find cash. Hawaladars will sell at a discount or 'rent' (loan) their cash. This generates additional profits for the hawaladar, who also ends up with the bribes received by corrupt politicians who wish to take them out of the country or launder. The interface between hawaladars, corporations, bureaucrats, and politicians is very strong indeed.

(Laundered) money from criminal enterprises. Finally, all proceeds from criminal enterprises ranging from extortion, kidnapping, drug trafficking, smuggling of gold and diamonds or other precious stones, human trafficking, human organ sales, theft or fraud potentially enter cash pool B.

Moreover, the demand for certain goods might exceed by far legally available supplies, as has been the case with gold in the Indian subcontinent. The insatiable and culturally driven appetite for gold is not quenched by imports of non-resident Indians, some of whom specialize in this practice. Smuggling takes care of the rest. Tons of gold have been smuggled over the years. The value of gold brought illegally into India has been estimated to be higher than $US1 billion each year (Reddy, 1996).

Therefore, hawaladar A will draw on cash pool A to make payments requested by hawaladar B. Conversely, hawaladar B will draw on cash pool B to honor requests from hawaladar A. This means that even if honest money is sent from one side, dirty money may be used to make the payment to recipients overseas. Sometimes, 'black money' is taken from cash pool B and used for illicit payments too. This was the case in a big corruption scandal in India, when instructions were sent from London on where to go to pick up cash (businessmen) and where to deliver it (politicians and bureaucrats) (Kapoor, 1998). The interface of legal and illegal actors becomes more complicated in the settlement process.

The Settlement Process

Each time a hawaladar sends payment instructions to a counterpart, he creates an informal debt or loan. The closer are relationships among hawaladars, the easier becomes the settlement process. Kinship and family ties made hawala work smoothly. In the contemporary, global economy and given the substantial amounts that are moving about, hawaladars also rely on people beyond kinship or, occasionally, even ethnic ties.

In fact, there is little mystical about the settlement, it being quite similar to the modus operandi of formal banks, with little or no actual movement of funds. The main difference is that hawaladars are unrestricted by rules on how and with whom they need to transact. In principle, of course, banks must follow the laws of each country in which they operate and transact with authorized people and institutions. Not so with hawala, where the informality of the networks renders them flexible and free to bend or disregard laws, as they must do in India, Pakistan, Sri Lanka, Saudi Arabia and elsewhere. There is no doubt that the underground economy or black markets play a large role in this part of the business.

If cash pools A and B were equal, settling up would be fairly simple through reciprocal payments covering each other's debt. Yet, these pools are always asymmetrical. Whenever there is an economic or political crisis in Pakistan or India, for instance, cash pool B will grow a great deal, while cash pool A is likely to shrink. More importantly, each hawaladar will be sending payment instructions and money to a variety of places around the world.

Sometimes, a courier brings the cash from one party to another. This is common in the Middle East, where currency trades require the physical presence of money. Balances can also be evened out through postal orders, checks, official drafts, bearer instruments or wire transfers. If both parties have bank accounts, a bank-to-bank transfer is another option. A hawaladar in Pakistan or India may have accounts in the UAE, London, New York, or Hong Kong for at least three reasons.

First, it is easier to settle positions with counterparts in one central place, thus consolidating accounts and reducing costs (whichever side of a given transaction has a cash surplus sends it to a clearing account for use by the other party). Second, accounts in several jurisdictions make it possible for the hawaladar to serve his customers, even if he does not find a counterpart in a given country. Third, having accounts in hard currency makes conversion from and to other currencies easier. They also provide stability for the whole business, as the rates are unlikely to fluctuate dramatically in short periods of time. Such accounts also help hawaladars take their own profits out of the country in which they reside and diversify their financial resources. Most hawaladars settle up through centers like Dubai, New York, London, Hong Kong, Singapore and Switzerland, as this offers economies of scale and better rates for buying and selling currency.

Many international hawala operators employ quite complex settlement methods through legal and illegal trade, third party accounts, nominee accounts, shell companies and multiple jurisdictions. A small sample of scenarios illustrate how these operations work.

One scenario involves the smuggling of gold or precious stones. Hawaladars or other intermediaries maintain accounts that can be used for clearing purposes. Once hawala funds reach such accounts, an agent or partner uses them to purchase gold. The gold is then exported to Dubai and from there smuggled to India. The gold is subsequently sold in the black market (the proceeds go to cash pool B). The same mechanisms can be used with precious stones, medical equipment or any commodity.

It is important to note that tainted money does not return for the most part to Africa, South Asia or more generally comparatively unstable economies after laundering. The dirty cash can be used for all sorts of deals in the interim, of course. This is a reason why it is important to separate the hawala payment system from the settlement aspect.

Criminal proceeds will have to 'leave' the country on paper and get back clean. Actually, the money does not leave, but joins cash pool A to satisfy the needs of overseas remitters (cash pool B). If the amount is high, however, at least a large part will be wired or couriered overseas to a big trade center such as Dubai. Once physically moved or converted to cash, the funds purchase goods such as textiles or computer equipment. The goods can be 'exported' to Afghanistan to areas enjoying duty free status (i.e. under the 'Afghan Transit Trade'), but then are diverted to Pakistan, Iran or Turkey and Europe.

Whenever protectionist measures (e.g., subsidies and quotas) are introduced by governments, there is evidence of carousel frauds, whereby the origin, destination, quantity and quality of goods are falsified. If the smuggled goods are sold in the legal market, clean money is available and integrated back in the metropolis.

Another scenario involves invoice manipulation and bogus export of books to India. A wealthy trader wishes to send illegally derived funds from Mumbai to London. He orders and pays for the shipment of books that can be purchased cheaply in England. He places the order through a company that will be folded as soon as the deal is done. The value of the books is exaggerated on the invoice, and he sends a payment that raises no eyebrows. Similarly, the value of genuine imports can be understated, so that duties are evaded. In such a case, two things happen. The importer's profits will be officially much lower and income taxes will be evaded too. The extra profits may flee India or Pakistan via hawala.

Businesspeople involved in such practices do not have to be in the business of hawala themselves. If they are, however, they can easily mix the cash flows of their 'day jobs' with hawala and obscure their illicit deals. In this way, massive amounts can be transferred. So, the settlement process is likely to generate interfaces of innocent with dirty operators and clients. As transactions are fragmented, the settlement process can be intentionally broken up in ways that each jurisdiction only gets to see or detect a small part of the total picture. In this way, substantial amounts and serious misconduct can be masked.

Policy Conclusions

Apart from hawala, a long list of methods and networks operate in similar ways and perform similar services. That is, money and value transfers from place to place on behalf of legal actors, terrorists or other criminal groups are taking place informally or without leaving clear traces through IVTS. The most important IVTS I have looked into are the following: