Dissecting Hawala – Its Vulnerability and Misuse for Financial Crime

What is Hawala?

Hawala Meaning

Hawala is an informal value transfer system in which one person transmits funds to another without using formal money transfer mechanisms, such as banking. It’s a system based on trust in which transmitting funds from one place to another is made possible without the actual movement of cash through a nexus of hawaladars facilitating such fund or value transfer for a fee or percentage.

Historical Context for Hawala Transactions

To understand the concept of hawala better, it’s important to understand that it started centuries ago. Traders and merchants intending to send funds home would make a deposit with a hawala broker at their location, and the broker would communicate within their nexus to let the designated recipient collect funds from a hawala broker located in that region.

Key Participants in Hawala Transactions

Remitter:

A person who wants to transfer funds to someone without using formal banking channels.

Hawaladars:

A Hawala transaction cannot take place without the involvement of a hawaladar. There could be one or more Hawaladars involved in a single transaction at the point of origin and the destination. Hawaladars receive and make payments on behalf of their clients and settle those transactions among themselves as trade transactions.

Beneficiary:

The intended recipient of the Hawala transaction.

Hawala Transaction Process

The hawala process generally has the following steps, as discussed.

Approach:

A person intending to transfer value to the recipient at another location, i.e., the originator, gets in touch with a hawaladar and finalises the terms of fund transmission. At this stage, the originator and recipient decide on the secret key or passcode type. This passcode or secret key is communicated to the hawaladar and the intended recipient of the funds.

Coordination:

The said hawaladar, i.e., the originator’s hawaladar, coordinates with other hawaladars in his network to identify who can disburse payment to the client’s intended recipient on his behalf while discussing other terms. At this stage, the originator hawaladar conveys the secret key or passcode to the hawaladar in the recipient’s region so that they can confirm the same prior to disbursing funds to the recipient.

Passcode or Secret Key Confirmation:

The recipient approaches the hawaladar in their region, which is responsible for disbursing payments, and gives the secret key or passcode that acts as a signal for the hawaladar to release funds. The hawaladars decide how they want to confirm or validate the fund originators’ and recipients’ identification based on the regulations, if any, in their jurisdiction.

Account Settlement:

The trust factor amongst hawaladars is the key component on which the entire hawala network and business exists. They trust one another adequately that the funds disbursed on the word of the other will be settled in time, along with their share of fees or commission as agreed. The entire business of hawala runs on mutual trust and understanding, where hawaladars settle each other’s accounts by way of trade transactions.

Legitimate Vs Illegitimate Uses of Hawala

Hawala, as an informal value transfer system, attracts legitimate as well as users with devious motives to launder or transfer illicit proceeds for funding illegal activities. Hawala has both legitimate and illegitimate uses, as discussed below.

Examples of legitimate uses of Hawala include:

Avoidance of bank fees for fund transfers
Lack of banking access in the remittance-receiving jurisdiction
Cultural preference
Lack of trust in formal banking.

Examples of illegitimate uses of Hawala include:

Transfer of funds for illicit purposes
Evasion of regulatory scrutiny about the source of funds
Sanctions and trade embargo or restriction evasion
Evade disclosure of the identities of actual beneficiaries of the transaction, which, if resorted to the formal banking system, would have required disclosure of Ultimate Beneficial Owners (UBOs)who might turn out to be sanctioned or Politically Exposed Persons (PEPs), triggering regulatory reporting or enhanced due diligence (EDD) measures, respectively.

Characteristics of Hawala Transactions

Some of the distinguishing characteristics of Hawala transactions are as follows:

There is No Physical Movement of Cash From Point A to Point B. It’s the hawaladar’s nexus that makes the funds available to the recipient as finalised between the sender and the hawaladar. The sender does give funds to the hawaladar, but those exact funds or currency are not disbursed or transferred. Those funds are rather settled by the mode of trade transactions among a nexus of hawaladars.
Hawala Transactions are Unregulated and hence circumvent the requirement of customer identification and verification, contrasting with formal value transfer systems.
There is No Element of Mandatory Regulatory Record-Keeping obligations that hawala transactions or hawaladars have to adhere to.
The Information of the Hawala Transaction is Coded: The subject matter of each transaction, such as sender, recipient, agreed-upon fees, secret passcode, etc., is transferred across in a coded manner that ensures the privacy and anonymity of the parties involved.
Geographical Spread: The geographical spread of hawala networks facilitates recipients’ receiving funds in any part of the world based on information or possession of documents containing identifiable and verifiable information that the hawaladar can confirm to disburse funds.

Why is Hawala Preferred Over Formal Banking Systems?

The very characteristics of the Hawala system that make it appear more appealing than the formal banking system are the lack of regulation, documentation, and compliance obligations.

Why Hawala Attracts Money Launderers?

Hawala system attracts money launderers due to its abovementioned characteristics, but the following two are the major reasons discussed as follows:

No paper trail: As launderers do not prefer to be linked to their transactions and are always trying to separate their illicit proceeds from their origin, hawala helps by quickly getting rid of large sums of cash that an unwitting hawaladar accepts, not knowing the origin of those illicit proceeds.
Anonymity: The Hawala system does not follow the stringent practice of ID verification and customer due diligence that regulated entities under AML obligations do. Hence, money launderers can almost anonymously send and receive funds across the world through the hawala network.

At Which Stages of ML Can Hawala Take Place?

Money laundering takes place in three stages: placement, layering, and integration. Hawala network can be misused by money launderers at any stage of the money laundering process. The hawala system can facilitate placement, as it readily accepts large sums of cash without knowing that those could be illicit proceeds. The same goes for the layering stage, where funds are structured and remitted to and fro, and the integration stage, where the funds come back to the launderer after placement and layering, making it impossible to trace the origin of such proceeds.

Why Hawala Attracts Terrorism and Proliferation Finance Actors?

Hawala attracts terrorism and proliferation financing (TF and PF) actors for similar reasons as money laundering. The element of anonymity and lack of a paper trail that can be traced back to the actual person makes the hawala system highly vulnerable to misuse for TF and PF.

At Which Stages of the TF/PF Can Hawala Take Place?

TF has stages such as collect, store, move, and use, and PF has stages such as program fundraising, disguising the funds, and procurement of proliferation-sensitive materials. The misuse of hawala can be done at the moving stage of TF. With regards to PF, hawala can be misused for concealing as well as making payments for procurement of proliferation-sensitive materials in a high-risk, blacklisted, or sanctioned country. The limited amount of scrutiny and the existence of unlicensed or unregistered hawaladars who do not keep up with regulatory obligations are prone to be misused by TF and PF actors.

ML, FT, and PF Typologies Associated with Hawala Transactions

Typologies related to hawala transactions:

Structuring: Criminals break down a large sum of illicit money into small sections and launder the funds through several hawala transactions to avoid any suspicion.
Back-to-Back Transfers: Matching one client’s need to send money to another’s need to receive money in the opposite direction creates a circular or offsetting mechanism that avoids any actual money movement.
Trade-Based Settlement: Settling Hawala debts through over- or under-invoicing of goods. Hawaladars may run import-export businesses and manipulate trade values to balance their books.
Use of Third Parties or Mules: Criminals use third parties or mules to transfer funds among countries. These third parties or mules are often unaware that they are being misused for illicit fund transfers.
Integration with Criminal Proceeds: Criminals use hawala transactions to legitimise their illicit proceeds by disguising them as legitimate payments.
Use of False Invoices and Shell Companies: False invoices are often used to legitimise the transfer of illicit funds, creating the appearance of genuine transactions to meet regulatory requirements. Shell companies may also be established solely for the purpose of laundering money, with illicit funds disguised as proceeds from legitimate business activities.
Charities and Non-Profit Organisations: Funds are sent through Hawala to support terrorist organisations or individuals in high-risk jurisdictions, often linking them to charitable organisations or seemingly legitimate donations.
Cross-border Value Transfer Without Currency Movement: Hawaladars never physically transfer money; rather, one hawaladar contacts another hawaladar in another jurisdiction to give the same amount of money to the recipient without actually moving it.
Reverse Hawala Flows: Hawaladars settle their accounts without physically moving money. They maintain running accounts of corresponding Hawaladars, offset the balances against other transactions, and, if needed, settle the accounts periodically.

Harnessing Technology for Mitigating ML, FT, and PF Risk Emanating from Hawala Transactions

FIs, DNFBPs, and VASPs can rely on technology, such as transaction monitoring powered by data analytics and artificial intelligence, to detect patterns indicating hawala activities and help identify and report illegal hawala activity to comply with AML/CFT and CPF obligations. Implementing robust transaction monitoring systems helps detect any illegal and unregulated hawala transactions.

Concept of Hawala: Concluding Remarks

Conducting or encouraging hawala transactions comes with the inherent risk of being linked to illegal activities and funds for ML, FT, or PF activities. Regulated Entities must exercise caution when dealing with customers who might be using funds from questionable origins. Seeking sources of funds and sources of wealth to corroborate a paper trail of funds helps mitigate ML, FT, and PF risks, particularly from hawala, to a great extent, followed by senior management approval and enhanced due diligence measures.

About the Author

Pathik Shah

FCA, CAMS, CISA, CS, DISA (ICAI), FAFP (ICAI)

Pathik is a Chartered Accountant with more than 26 years of experience in governance, risk, and compliance. He helps companies with end-to-end AML compliance services, from conducting Enterprise- Wide Risk Assessments to implementing the robust AML Compliance framework. He has played a pivotal role as a functional expert in developing and implementing RegTech solutions for streamlined compliance.