What Is Hawala? Money Transfer Without Money Movement

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.

Understanding Hawala

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 doesn't 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 excommunicated from the network or region.

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 with 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 don't 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 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 Maryam needs to send $200 to Amir, who lives in another country. She will approach a hawaladar, Nasir, and give him the amount of money she wants Amir to receive, including the details of the transaction: the name of the recipient, city, and password.

Nasir contacts a hawala dealer in the recipient’s city, Muhammed, and asks him to give Amir $200 on the condition that Amir correctly states the password. Muhammed transfers the money to Amir from his own account, minus commission, and Nasir will owe Muhammed $200.

The transaction initiated by Maryam and concluded by Amir’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 Nasir and Muhammed, 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.

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 aren't recorded can't be taxed.

Hawala is also used to fund terrorism, which makes it more 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

Because hawala transfers aren't routed through banks and, hence, aren't 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 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 don't register, they aren't allowed to operate.

Afghanistan's more than 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 exchangers into the fold to prevent illegal activities through hawala exchanges.

Most countries have laws related to informal funds transfer systems, like hawala, that seek to curb the negative activities 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 financial services.

The Bottom Line

Hawala is an informal funds transfer system that allows for the shifting of money 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 also has 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 placed regulations on it.