Updated July 25, 2021
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 they 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 cannot be tracked.
- 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.
Hawala originated in South Asia during the 8th century and is used throughout the world today, particularly in the Islamic community, as an alternative means of conducting funds transfers. Unlike the conventional method of transferring money across borders through bank wire transfers, money transfer in hawala is arranged through a network of hawaladars or hawala dealers.
Hawala dealers keep an informal journal to record all credit and debit transactions on their accounts. Debt between hawala dealers can be settled in cash, property, or services. A hawaladar who does not keep their end of the deal in the implied contractual system of hawala will be tagged as one who has lost their honor and will be ex-communicated from the network or region.
Hawala is thought to come from the Arabic word for “assignment” or “bill of exchange” or the Hindi word for “reference.”
Migrant workers who frequently send remittances to relatives and friends in their countries of origin find the hawala system advantageous. Hawala facilitates the flow of money between poor countries where formal banking is too expensive or difficult to access.
In addition to the convenience and speed of conducting hawala, the fees are usually low compared to the high rates that banks charge. To encourage foreign exchange transfers through hawala, dealers sometimes exempt expatriates from paying fees. The system is also easy to use, as one only needs to find a trusted hawaladar to transfer money.
Benefits of Hawala
Hawala allows people to transfer money even if they do not have formal banking relationships or access to established financial networks. For people without a government-issued ID or bank account, hawala networks may be the only way to send remittances, particularly if the destination is in another country. In other circumstances, it may be cheaper or faster than dealing with the paperwork of official channels.
- For this reason, hawala networks are frequently used in countries where there are strict capital controls or sanctions on the flow of money. Traders and expatriates from countries sanctioned countries, like Iran, might use hawala networks to make payments to their counterparties in neighboring countries.
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.
Hawala and Illegal Activities
The very features that make hawala an attractive avenue for legitimate patrons also make it attractive for illegitimate uses. Thus, hawala is frequently referred to as underground banking. This is because money launderers and terrorists take advantage of this system to transfer funds from one location to another.
Hawala provides anonymity in its transactions, as official records are not kept and the source of money that is transferred cannot be tracked. Because money laundering aims to hide the source of cash that is generated from illegal activities, hawala is a perfect system for money laundering.
In addition, corrupt politicians and the wealthy who would prefer to evade taxes use hawala to anonymize their wealth and activities. Cash generated from business transactions that are not recorded cannot be taxed.
Hawala is also used to fund terrorism and makes it particularly difficult to stop terrorism. A large portion of discovering terrorist cells involves tracing the movement of money, as terrorist organizations are funded and need money to buy weapons and feed their people. Hawala transactions make this movement of money easy as there is no paper trail from the source of funds to the terrorist organization.
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 reexamine their regulatory policies in regard to hawala.
Some countries have made hawala illegal due to the difficulty of enforcing regulations.
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.1
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.1
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.1
Most countries have laws around informal funds transfer systems, like hawala, that seek to curb the negative externalities created by such a system.
Hawala and Fintech
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.
Is a Hawala Illegal?
Hawala trades are illegal in the United States and many other countries because financial regulations require money services businesses to obtain appropriate licenses and follow anti-money laundering laws.
What Is Hawala Money?
Hawala money is money that is transferred using the hawala system, whereby no actual movement of funds from one account to another account happens, no paper trail is created, and no promissory notes exist.
What Is the Punishment for Hawala in India?
The punishment for hawala in India is as follows:
- A monetary penalty of up to three times the sum involved with a cap of 200,000 Indian rupees ($2,755).
- Confiscation of the currency, security, or other money and property related to the violation.
- Imprisonment if the penalty is not paid.2
Is Hawala Legal in Dubai?
Hawala is legal in Dubai as long as the hawala provider is registered with the Central Bank and abides by the regulations set forth.
The Bottom Line
Hawala is an informal funds transfer system that allows for the transfer of funds from one person to another without the actual movement of money. It is a simple process that requires no documentation and, therefore, is an anonymous system of moving money. This has been beneficial for many poor countries where individuals move abroad to work and send money home, avoiding costly transfer fees and other required documentation.
Because of its anonymity, hawala has also been a means for illegal activity to take place, such as money laundering and the financing of terrorism. For this reason, many countries prohibit hawala or have put regulations around it.
Combating the Financing of Terrorism is a set of policies aimed to deter and prevent funding of activities intended to achieve religious or ideological goals through violence.
Black money includes all funds earned through illegal activity and otherwise legal income that is not recorded for tax purposes.
A remittance is a sum of money sent to another party, usually in another country. Remittances are a major source of income for people in poor nations.
Money laundering is the process of making large amounts of money generated by a criminal activity appear to have come from a legitimate source.
A blockchain is a digitally distributed, decentralized, public ledger that exists across a network. It is most noteworthy in its use with cryptocurrencies and NFTs.
The USA PATRIOT Act was passed after the terrorist attacks of September 11, 2001, and increased U.S. law enforcement agencies’ investigative power.