Demystifying Hawala: An Inside Look at the Middle East’s Underground Banking System
Patrick Lawlor, Dartmouth Business Journal
The Arabic word hawala translates to payment or debt transfer and is the name of an informal money transfer system, traditionally used in the Muslim world, that is both criticized vehemently and relied heavily upon. It has been used to fund terror but remains an essential part of the economies of numerous developing countries.
Existing in various forms and to various degrees throughout the world, informal funds transfer (IFT) systems are used to transfer money both domestically and internationally between two parties. Hawala refers to the financial payment system that is used primarily in the Middle East, North Africa and the Indian subcontinent to transfer funds between two locations via a network of money brokers called “hawaladars.”
The hawala money transfer system predates modern banking. In fact, its origins can be traced back as far as the early Middle Ages during which time Middle Eastern merchants operated in territory that was characterized by the complete absence of formal legal systems of order. This made complex business dealings unpredictable and expensive. Additionally, the contemporary Middle and Near East were composed of an amalgamation of small tribal regions that were only loosely associated by their adherence to Islam, making it hard to complete business transactions over distances. The hawala system arose to facilitate long-distance transactions and provide stability and consistency to the economic system of the ancient Middle East. The original hawala system operated as follows:
Person A approaches hawaladar A and gives him money to send to person B. Hawaladar A knows that his associate, hawaladar B, lives near person B so he sends a bill of receipt, rather than a large quantity of cash, to hawaladar B, who proceeds to contact and give the requisite amount of money to person B. Hawaldars A and B can balance their accounts by making a similar, reverse transaction with different clients, or hawaladar A can send the money on foot, but protected, to hawaladar B. The hawaladars make a profit by charging a small fee.
In this way, businesses were able to execute monetary transactions over large distances without, in many cases, physically moving money from one place to another. In the modern era, the hawala system is primarily used by foreign workers to send remittances home to their families, and requires the two parties exchanging money to also exchange a “remittance code,” over phone or email, in place of a bill of receipt. Thus, large quantities of money can be transferred in periods of less than 24 hours. The speed of money transfer, along with the informal, hassle-free, and non-bureaucratic nature of hawala (customers usually do not require an account or identification) makes it an attractive option to foreign workers looking to send money home. The hawala system can also be a much less costly option than modern banking due to hawaladars’ low overhead costs. This continues to allow their fees to be very competitive. In addition, because hawaladars only periodically balance their accounts, there is no physical movement of cash and no official foreign exchange transactions take place, allowing hawala operators to often provide better exchange rates than banks.
In developing countries such as Somalia, years of violence and economic upheaval have resulted in the lack of a formal banking infrastructure and a dependence upon the hawala system. Roughly 80 percent of the Somali population receives approximately $1.2 billion annually in remittances from the country’s diaspora. The money is largely used by the families of expatriate workers to cover basic needs and living expenses and vastly exceeds international aid flows in the region. Another developing country which has historically depended upon the hawala system is Afghanistan. A 2003 World Bank report on hawala in Afghanistan cited that the majority of the nation’s international aid institutions and NGOs use the hawala system to transfer money into and around the country to fund humanitarian efforts. Edwina Thompson, in her 2005 book studying the Afghan drug industry, estimated that up to $1.5 billion in remittances flowed into Afghanistan through hawala networks, highlighting their dependence on the system.
Unfortunately, just as relief money flows through Afghanistan’s hawala networks, so to does $1.7 billion in revenue from the country’s Opium trade according to Thompson. Throughout the rest of the Middle East, the system has been linked with similar black market activities such as the funding of terror and money laundering. Isolated from modern banking institutions, the Islamic State of Iraq and the Levant (ISIL) has relied heavily on the hawala system to move money domestically and abroad. Hawaladars are willing to facilitate these money transfers for a fee of 10 percent, twice the amount charged before ISIL’s rise. Thus, millions of dollars move in and out of the Islamic State every day, significantly undermining the efforts of the international community to isolate the group from its finances and disrupt its economy. ISIL uses the hawala system to import and pay for food for its subjects and supplies for its fighters. The group also collects revenue via a 10 percent religious tax (known as “zakat”) levied on funds moving out of the territory. The hawala system has also been linked to the funding of other terrorist organizations throughout the Middle East and North Africa such as Al-Qaeda and its affiliate Al-Shabaab.
In the aftermath of the terrorist attacks of September 11, 2001, the hawala system has been the subject of intense criticism and scrutiny from international lawmakers and financial regulators because of its potential use in the financing of terrorism. Being an informal, trust based money transfer system, hawala is very hard to track and regulate. Most hawaladars do not question who money is going to or what it is for, they merely move it. Thus, there is not much accountability on the part of service providers, and there is almost zero accountability for clients. These links have led to a crackdown on hawala organizations across Europe and the United States. More stringent regulations requiring hawaladars to keep records of transfers and the identities of clients as well as penalties upon banks associated with suspect hawaladars have been imposed. This causes problems as the hawala system remains very hard to track and rather than risk the consequences of being associated with the funding of terrorism, some western banks isolate themselves entirely from the hawala system. Consequently, it has become hard for legitimate hawaladars to operate efficiently as their access to bank accounts has been reduced and their bureaucratic costs have risen to meet regulations.
The pivotal role that the hawala system plays in the economies of many developing nations means that any attempts to regulate it could end in economic disaster. Despite their necessity, remittances to Somalia have been impeded by suspicion of the hawala system. Periodic shutdowns of hawala organizations, such as that implemented by Kenya in early 2015, run the risk of spurring economic and humanitarian crisis. In the wake of a terrorist attack on the country’s Garissa University College in April of 2015, the Kenyan government shut down 13 hawala firms through which most remittance money going from Europe and the US to Somalia was transferred. This shutdown lasted until June 2015 and cut off, for that period of time, the millions of dollars in daily inflows to the Somali region that remittances provided, causing the Somali currency to lose 25 percent of its value and increasing the quantity of black market transactions in the country.
The juxtaposition between necessity and exploitation is a central issue in the hawala system as it currently exists throughout the Middle East. The system simultaneously assists in the development of third world countries and is used to fund black market activities that keep such nations in a perpetually “developmental” state. The hawala system’s fluid, personal nature is such that too much regulation renders it obsolete, while too little removes any form of accountability. The next step in solving the problem of hawala seems to be the development and, more importantly, the ubiquitous imposition of effective regulations on the system. Once this step has been taken, a fundamental obstruction to economic growth in countries such as Somalia and Afghanistan will have been removed.