The hawala system of informal money transfers is used predominantly in the Middle East and South India, and it is also used by migrant workers from these areas wanting to remit money back home from Europe and North America. How does it work?
As The Economist explains:
IF A Somali taxi driver in London wants to send earnings home to his brother, a nomad farmer, he probably uses an informal money transfer business. Going into a Somali-owned shop, he can hand over a wad of cash and within a few hours his brother will receive a text message telling him that his money–minus a commission–is ready for collection. Without either side of the transaction having a bank account, this is an efficient way of transferring cash. Such arrangements, known as hawala, help money flow between poor countries where formal banking is too expensive, heavily-regulated, or simply absent. As much as a third of Somalia’s GDP comes from remittances. (Economist 2015)
Key characteristics of the hawala system that explain its widespread legal and illegal use are the speed with which money can be transferred, the lower transaction costs, versatility, potential anonymity and of course their convenience.
This is not just unique to hawalas: other territories have their own names for such transfers: fei-ch’ien (China), hui kuan (Hong Kong), hundi (India), padala (Philippines), phei kwan (Thailand). As an IMF report into the subject finds, ‘their initial growth was primarily rooted in facilitating trade between distant regions at a time when conventional banking instruments were either absent or weak’ (IMF 2003). In regions where the formal financial sector might still be developing, or in circumstances which require quick and easy remittance of money across borders, hawalas serve an important function.
Are such systems easily abused by terrorists and criminals?
The informality of such systems has indeed meant that they have been abused by terrorists as well as other criminals. Since the attacks of 9/11, for which funds were partly transferred through Money Service Businesses, regulations have tightened: crucially, all money transfer firms must identify their customers and keep accurate records of transactions. Anonymity is not really part of the picture anymore.
Somali-based Dahabshiil is the largest international money transfer firm in Africa based on the classic hawala system and it has gone to great lengths to show compliance:
All transactions are now logged; identities of senders and recipients recorded and checked against blacklists. In countries where most people do not have passports Dahabshiil relies on tight-knit clan networks and references to prove identities; it then records biometric information and thumb prints for future checks. To convince western regulators of its security, the hawala system has adapted. The company, once a deeply informal business, is now a sprawling empire (Economist 2015).
A curious aspect of hawalas is trust: even if it is an informal system, the fact that it is based on tribal relationships means that it can be self-regulating to a large extent on issues of cheating and fraud:
“If someone doesn’t go by the rules, he will be ostracized forever,” said Nikos Passas, a Northeastern University professor who has studied hawalas. Moreover, a hawaladar’s family and legitimate business could suffer if he defrauded a customer, he added (Wall Street Journal 2015).
With increasing flows of refugees into Europe, the Wall Street Journal notes that many of these pay for their trip by entrusting hawaladars with their money until they safely arrive to their destination. It is a form of insurance that is mostly guaranteed by these tight-knit relationships.
Money transfers and the future
The ease and flexibility with which hawalas operate has prompted Western money transfer companies to pay attention, especially to lowering the cost of moving money across borders. New tech firms especially are at the forefront of such developments.
Also worth noting is the fact that it is in the interest of regional and national governments for such money transfer systems to be operating within a defined regulatory framework, both in terms of securing government income from taxation of such services as well as ensuring improved statistical information on the financial sector (IMF 2003).