Hawala, also known as hundi, is a traditional informal value transfer system that is not regulated in many countries. It relies on a network of hawala brokers (hawaladars), who transfer money on behalf of clients without the use of a traditional financial institution (FI). It is believed to have originated in ancient India and was later adopted in the Middle East and other regions, including the Horn of Africa and South Asia.

The hawala system is based on trust and relies on hawaladars who facilitate the transfer of funds from one person to another. Hawaladars in different locations are connected to each other through a network of relationships, and they use various methods to transfer funds, such as courier services or the internet. Hawala has traditionally been used as a way to transfer money internationally, especially in countries where there are restrictions on the movement of money or where the formal banking system is not well developed. It has also been used by migrant workers to send funds to their families in their home countries.

While it largely remains outside the formal financial sector and is therefore not subject to the same regulatory oversight as traditional FIs, some countries have taken steps to formalize and regulate the hawala system in order to address concerns about money laundering and other illicit activities. For example, in the United Arab Emirates (UAE) and the U.K., hawala is regulated by the Central Bank of the UAE and the HM Revenue and Customs (HMRC), respectively. The Central Bank of the UAE and the HMRC have implemented rules requiring that hawaladars register with them and follow certain reporting and record-keeping requirements.

In other countries, hawala remains largely unregulated, which can make it vulnerable to abuse. It is important to note that using hawala carries certain risks, including the potential for fraud or loss of funds. There also may be limited recourse if something goes wrong.

How the Hawala System Works

Below is how the hawala system typically works:

1. A client or sender approaches a hawaladar and asks to transfer money to a recipient, or beneficiary, in another location.
2. The hawaladar and the sender agree on a password or code that will be used to identify the transaction.
3. The sender gives the hawaladar the amount of money to be transferred plus a fee for the service. The fee is typically based on a percentage of the amount being transferred.
4. The hawaladar contacts a colleague or counterpart in the recipient’s location and provides the details of the transaction, including the password or code.
5. The counterpart in the recipient’s location receives the password or code and gives the recipient the agreed-upon amount of money.
6. The hawaladars settle their accounts at a later date, either through the transfer of funds or by balancing their accounts with other transactions.

Why Hawala?

Some reasons why people might use hawala include:

• Speed: Hawala transactions can often be completed quickly, making it a convenient option for people who need to transfer money on short notice.
• Low cost: Hawala fees are typically lower than those charged by traditional FIs, making it an affordable option for people who need to transfer small amounts of money.
• Discretion: Because hawala transactions are not documented, they offer a level of privacy that is not available with traditional FIs. This can appeal to people who want to keep their financial affairs private.
• Ease of use: Hawaladars are often located in convenient locations, such as markets or small shops, making it easy for people to access their services.

How Hawala Providers Make Money

In addition to fees, hawaladars regularly make their profits by bypassing official exchange rates. Commonly, the payment enters the system in the sender country’s currency and leaves the system in the pay-out country’s currency.

Risks Associated With Using Unregulated Hawala

There are several risks associated with using unregulated hawala, including:

1. Fraud: Because hawala transactions are based on trust and personal connections, and there is no formal documentation or record keeping involved, there is a risk of fraud. Hawaladars may not be held accountable if they fail to deliver the funds as promised or if they use the money for their own purposes.
2. Loss of funds: There is a risk of losing funds when using hawala, either due to fraud or due to mistakes or errors in the transfer process. Because there is no formal dispute resolution process, it may be difficult to recover lost funds.
3. Illicit activities: Unregulated hawala can be used to facilitate money laundering, terrorist financing and other illicit activities. This can expose individuals who use hawala to legal and financial risks.
4. Volatility: The value of the funds being transferred through hawala may be affected by fluctuations in exchange rates or other market conditions. This can result in the recipient receiving less than the agreed-upon amount.

Hawala has been used by some individuals and organizations to bypass financial sanctions or to evade detection by authorities. For example, hawala has been used to transfer funds to countries or groups subject to international sanctions, such as Iran or Hamas. Because hawala transactions are not documented and rely on personal connections, they can be difficult to trace and can be used to evade detection.

There have been several cases in which hawala has been implicated in financial scandals or used to facilitate illegal activities. Here is an example of a real case involving hawala:

In 2015, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced that it had imposed sanctions on a network of individuals and companies based in Afghanistan and Pakistan for using the hawala system to facilitate the sale of opium and other illicit drugs. The individuals and companies were accused of using the hawala system to transfer funds to the Taliban and other terrorist organizations, as well as to launder the proceeds of drug trafficking. OFAC designated the individuals and companies as “Specially Designated Narcotics Traffickers” and imposed financial sanctions on them, including freezing their assets and prohibiting transactions with them.¹

This case illustrates the potential for hawala to be used to facilitate illegal activities, such as drug trafficking, and the risks that individuals and organizations may face if they use hawala to engage in such activities. It is important to note that using hawala to facilitate illegal activities is illegal in many countries, and individuals and organizations that are found to be doing so may face criminal charges and financial penalties.

Why Hawala Should Be Regulated

There are several reasons why some people believe that hawala should be regulated:

• To reduce the risk of fraud and loss of funds: Regulating hawala could help reduce these risks by establishing minimum standards and providing a formal dispute resolution process.
• To prevent illicit activities: Regulation could help prevent these activities by requiring hawaladars to comply with anti-money laundering and counter-terrorist financing rules and providing authorities with the tools to trace and investigate suspicious transactions.
• To improve financial inclusion: Regulation could help bring these people into the formal financial sector, providing them with access to a wider range of financial services and protections.
• To promote financial stability: Regulating hawala could help improve the overall stability of the financial system by reducing the risk of money laundering, terrorist financing and other illicit activities that can undermine the stability of the financial system.

How Hawala May Impact the Banking System

Hawala can affect the banking system in several ways:

1. Competition: Hawala can compete with traditional FIs for a share of the money transfer market. In some cases, hawala may be able to offer lower fees or faster service, which could lead people to choose hawala over traditional FIs.
2. Illicit activities: If hawala is used to facilitate illicit activities, it could undermine the stability and integrity of the financial system.
3. Financial inclusion: If hawala can bring people into the formal financial sector, it could positively impact financial inclusion.
4. Regulation: Depending on the specific context, the use of hawala may require regulatory intervention to address concerns about money laundering, terrorist financing and other illicit activities. This could create additional costs and burdens for hawaladars and their clients and may also impact the banking system in other ways.

Overall, the impact of hawala on the banking system will depend on a variety of factors, including the extent to which hawala is used, the specific regulatory environment and the goals that are being pursued. In some cases, hawala may pose a competitive threat to traditional FIs, while in other cases, it may offer an opportunity to expand access to financial services and promote financial inclusion. It is important to carefully consider the potential impacts of hawala on the banking system in order to determine the appropriate balance between regulation and innovation.

Why Regulating Hawala Seems to Be Challenging

There are several reasons why it is difficult to regulate hawala:

1. Hawala operates outside of the formal financial system: Because hawala is informal and operates outside of the formal banking system, it is more difficult for governments to monitor and regulate. In addition, hawaladars do not typically keep formal records of transactions, making it difficult to track the movement of funds.
2. Hawala is based on trust: The hawala system relies on trust between hawaladars and their clients. This makes it difficult for regulators to ensure compliance with laws and regulations.
3. Hawala is a global network: Hawala operates on a global scale, with hawaladars in different countries connected through a network of relationships. This makes it difficult for a single government to regulate the system effectively.
4. Hawala has legitimate uses: While Hawala has the potential to be used for illicit purposes, it is also used for legitimate purposes, such as transferring money internationally in countries with underdeveloped formal banking systems. This makes it difficult to regulate the system without affecting legitimate users.

Overall, the complexity and informality of the hawala system make it difficult for governments to effectively regulate and monitor its activities.

Conclusion

Hawala is an informal transfer system that has been used for centuries in many parts of the world. It is based on trust and relies on a network of hawaladars, who facilitate the transfer of funds from one person to another. While hawala has traditionally been used to transfer money internationally, especially in countries where the formal banking system is not well developed, it has also gained attention due to its potential role in money laundering and terrorist financing. The use of hawala in the context of money laundering and terrorist financing presents a significant challenge to governments and law enforcement agencies, as it can be difficult to detect and disrupt these activities.

Some governments have taken steps to regulate the hawala system, but it remains largely informal and operates outside of the formal financial system. Overall, hawala is a complex and multifaceted system with both benefits and risks, and it continues to play a significant role in the global economy.

Mohamed Abouzied, CAMS, CFE, CGSS, compliance advisory manager—Middle East and Africa, mdyazan@gmail.com

1. “Financial flows linked to the production and trafficking of Afghan opiates,” Financial Action Task Force, June 2014, https://www.fatf-gafi.org/en/publications/Methodsandtrends/Financial-flows-afghan-opiates.html