What is Hawala and the Related Laws | Problems related to Hawala
Keywords: Hawala, White Hawala, Black Hawala, banking
Author: Riya Garg
Introduction
Nowadays, bank transfer is the most common remittance system out there. For many of us, it is the only method to transfer funds that exists. However, a large number of alternative remittance systems operate outside the banking channels. One such system is Hawala. The term has now become somewhat synonymous to money laundering in many regions of the world. Especially in India, there are more than a few reasons why one would prefer to use the system instead of employing the traditional bank wire transfer. This article deals with topics apart from discussing the concept of Hawala and how it works. It aims to explore these reasons, which essentially are also the reasons why it is subject to much abuse and scrutiny. Lastly, the article will be mentioning the legal position of Hawala in India and several other parts of the world.
WHAT IS HAWALA?
Hawala system is an informal system for transferring money through a network of brokers (called hawaladars). The word ‘Hawala’ comes from an Arabic root ‘h-w-l’ meaning “change”/“transform”. The word ‘Hawala’ is defined as bill of exchange or promissory note. However, ironically, hawala, as a system, does not make use of promissory notes or any negotiable instrument, for that matter.
Sometimes, the meaning of the term ‘Hawala’ is associated with “trust”. This is because it is an honour system and trust plays an important part in its working. Hawala is the more common usage of the term in India, the system is known by various other names. These names are hundi (Sanskrit root meaning “collect”) in Pakistan, fei quian (flying money) in China, padala in Philippines, hui kuan in Hong Kong and phei kwan in Thailand. One of the most distinguishing features of this system is that it does not involve physical/actual movement of funds. For this reason, Interpol has defined Hawala as “money transfer without money movement”.
Hawala is an ancient system, with its origin dating back to the 8th century in the Indian subcontinent. This was long before more formal traditional western banking system was developed. The first bank in India was Bank of Hindostan, established in Calcutta in around 1770. It was used for trade between Indians and the Arabs and the Silk route. Over the centuries, it became the primary mode of fund transfer and functioned as the sole effective method of transferring money until recently. During the mid-20th century, the introduction of western banking system replaced the predominance of the Hawala system. Now, the Hawala system exists parallel to the bank wire transfer system. It is still used widely in the Middle East, Africa and Southeast Asia, especially by the Islamic community.
HOW HAWALA WORKS?
Hawala is a complex system thus it is difficult to understand its functioning as a whole. However, the steps involved in a single Hawala transaction are illustrated as below:
- The sender in country ‘A’ (XA), who wants to send money to a beneficiary in country ‘B’ (XB), contacts a hawaladar in his country (HA) and gives the money to him. HA, then provides a password/code to XA, same is intimated by XA to his relative XB. In most cases, no receipt is provided. Also, Hawala networks tend to be fairly loose, communication usually taking place by phone/fax (but email is becoming more and more common).
- HA then contacts his correspondent in country Y (HB). HA then asks him to deliver an equivalent amount in local currency to YB. The communication may take place through call, fax or email.
- HB, from his own account, gives the same to YB upon confirmation of the code. The delivery often takes place in each other’s physical presence.
HA can be remunerated by charging a fee or through an exchange rate spread. HA now owes HB an amount equivalent to what XA sent to XB and the same can be settled by various means, either financial or goods or services. In an alternate condition, HB might be just discharging any prior obligation to HA. The system does not employ use of any sort of negotiable instrument and entire system is based purely on trust. XA trusts HA to get money delivered without any receipt. HA trusts HB to make the payment. HB, in turn trusts that whatever is owed to him will be balanced out in future. Hawaladars are usually related to each other by familial, regional/ ethnic ties. Occurrences of fraud/cheating are very rare as they result in bad reputation.
HAWALA V. BANK WIRE TRANSFERS
As stated earlier, the Hawala system exists parallel to the modern western banking systems. While it may seem risky and cumbersome at the first sight, there are more than a few reasons why it has an edge over such traditional banking systems:
Cost effective:
Hawala is a cost effective method of fund transfer. The commission/fee charged by the Hawaladars is much less. It also offers more advantageous exchange rates than the banks, who have to comply with standards and regulations. One of the reasons for the same is low overhead cost. Additionally, the absence of regulatory costs are also beneficial. Since most hawala dealers are primarily engaged in some other business or trade and run hawala only as a side source of income this is possible. In contrast, banks involve a multitude of costs such as building/land, expensive vaults, alarm systems, etc. Another reason for Hawala’s cost effectiveness is exchange rate speculation. This enables it to turn a profit from Hawala transactions (which in addition to being remittances, almost always have a foreign exchange component). As a result, they are able to offer their customers rates that are better than those offered by banks.
Efficient:
A Hawala transaction is usually completed within a day or two. It might even take just a few hours in certain cases, if time differences are to be considered. This can be contrasted with about a week or so required by an international wire transfer involving at least one corresponding back. This may add up to be even more in certain cases if delays due to holidays, weekends or time differences are also taken into account.
Reliable:
Complex international transactions, which might involve the client’s local bank, its correspondent bank, the main office of a foreign bank and a branch office of the recipient’s foreign bank, have the potential to be problematic. Surface mail is not a reliable option where the contents are valuable. It can also take several weeks to arrive and a transfer via a courier service and is usually very costly. As mentioned earlier, trust is a key component in the functioning of Hawala and a breach of interest is almost equally problematic. In countries plagued by political insecurity like Afghanistan, it is one of the most convenient, safe, reliable and inexpensive ways to move funds within the country.
Lack of Bureaucracy:
Hawala is an informal system and does not operate in a “bureaucratic framework”. This means that a customer does not have to go through the hassle of opening a bank account before making the transaction or providing adequate identification. This informal nature of the system makes it very attractive to users with tax, immigration or other legal concerns. For instance, illegal migrants who do not have proper identification and cannot use formal channels to send money home can use this mode. The minimal documentation and accounting requirements, simple management, and lack of bureaucratic procedures also help in reducing time for transfer operations.
Privacy:
Certain people wish to remain anonymous while sending the money. Hawaladars usually do not keep records of individual transactions. The registers they maintain are the records of the transaction itself. Thus, Hawala doesn’t leave a paper trail. Therefore, the possibility that such a transaction or the identities of parties to such a transaction will ever be detected is next to zero.
Tax evasion:
In South Asia, the “black” or parallel economy is 30%-50% of the “white” or documented economy. Money remitted through official channels might invite scrutiny from tax authorities. Hawala provides a scrutiny-free remittance channel.
Better reach:
Hawala facilitates transfer to money from and to even remote locations where banking facilities are not available, providing better reach.
Culture friendly:
The system is culture friendly. For migrant workers, ethnic or kinship ties with the Hawala brokers make this system particularly convenient and easy to use.
WHY IS IT A PROBLEM?
Despite Hawala being an efficient and most effective alternative to the formal banking system for the poor, it has a wide scope of being abused. The very advantages discussed in the previous section make Hawala a preferable alternative for both legal and illegal purposes. It follows no taxation rules, the money gets stuck on both sides and it hinders healthy circulation of cash reserves. For this reason, it is also sometimes referred to as ‘underground banking’. Every year around fourteen billion dollars foreign currency comes to India. Out of this only four billion dollars come through authorised banks and financial institutions and the remaining ten billion will enter India through the hawala system!
Below are some instances that illustrate how hawala leads to a plethora of criminal activities, directly and indirectly:-
Narcotics trafficking:
In mid-1997, several people were convicted of conspiracy to launder the proceeds of the sale of Pakistani heroin and opium. It also involved a legitimate foreign exchange business in the U.S. and a hawala network spanning several countries.
Terrorism:
Investigation into the assassination of an important Indian politician revealed that the assassins were, in fact, terrorists. They used hawala to transfer the proceeds of the sale of narcotics to arms dealers for purchase of military hardware. Further the series of bomb blasts in 1993 were financed through Hawala as well.
Hawala is an honour system built on trust and reputation. Breach of trust or instances of cheating can jeopardise the entire system.
Customs and Tax Violations:
A Pakistani living in Washington, D.C. metropolitan area was doing hawala transfers for other expatriates. Surgical instruments manufactured in Pakistan were being imported at inflated prices (over-invoicing).This was done to facilitate the transfer of money from the United States to Pakistan which was violative of Pakistani law. Also, an individual representing himself as a “gold broker” in the U.S., acted as a bank for various individuals and businesses assisting them in evading the payment of taxes.
Apart from these, various other illegal activities can be committed and easily concealed by the use of Hawala.
LAWS RELATED TO HAWALA
Hawala transactions can be “white” / “black”. “White hawala” is used to refer to legitimate transactions, where the source of money is legitimate. However, “black hawala” is where the source, and intent of the transactions are illegitimate. “White hawala” transactions are essentially remittances and are legal in most jurisdictions except for India and Pakistan. On the other hand, “black” hawala transactions are almost always associated with some serious offence. For example, narcotics trafficking, fraud, money laundering, etc are done through the latter. Though Hawala is legal in many countries and is carried out openly, it is illegal from a regulatory standpoint in some U.S. states, India and Pakistan.
India has made hawala transactions illegal in the country. This is because it is transacted through the unauthorized persons who are not recognized under the Reserve Bank of India. It is also additionally due to the lack of bureaucracy in the system. However, a specific legislation prohibiting hawala does not exist. Hawala transactions are made illegal via Sections 2, 6 and 10 of The Foreign Exchange Management Act (FEMA), 1999 and Sec. 2 (d)(a) of the Prevention of Money Laundering Act (PMLA), 2002.
However, enforcement of these regulations is difficult with respect to hawala. The advertisements are often printed in foreign languages and working like “sweet rupee deals” does not necessarily suggest remittance services. This makes it difficult to trace and identify them. Moreover, such remittances are usually not conducted as primary activity making it harder for enforcement authorities to identify them. Steps such as tracking suspicious activities, employing more investigating agencies ought to be taken. Additionally, introduction of stringent laws to punish involved parties, reduction of hindrances in normal banking routes, etc. need to be done, if Hawala transactions are to be completely subdued.
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