The Hawala System: Unraveling the Mysteries of an Alternative Money Transfer Mechanism

In the vast landscape of global finance, there exists a shadowy network known as the Hawala system. This alternative money transfer mechanism has long been shrouded in mystery, with some hailing it as an efficient and secure way to move funds across borders, while others decry it as a tool for money laundering and illicit activities. So, is the Hawala system a legitimate alternative to traditional banking methods, or is it a rogue operation facilitating the underground economy? Let’s delve deeper into the enigmatic world of Hawala to uncover the truth behind this controversial system.

Originating in South Asia centuries ago, the Hawala system operates on trust and personal connections rather than formal contracts or documentation. In this informal network, money is transferred between individuals through a complex web of brokers or “Hawaladars” who settle balances through a system of mutual credit without physically moving the funds across borders.

Hawala system therefore refers to an informal method of transfer of money without physical movement of money. It is an alternative remittance channel that exists outside the traditional banking system.

Under Hawala System, the sender of money gives the cash to the remitting agent who notifies a corresponding counterpart in the country or location of the recipient, giving them instructions to remit an equivalent sum of money to the intended recipient.

The Hawala system is quite simple: the most common scenario is that a client hands in his/her money to be delivered from one country to another. The Hawala Operator/Broker (“Hawaladar”) accepts the cash usually at their place of business and charges a modest commission and a more favorable exchange rate than the banks to send the money. Delivery is free. The Hawaladar then contacts a fellow Hawaladar in the destination country, who then contacts the family of the client to receive the money. The whole process is complete within a day and no money is actually transferred between the countries. Instead, one Hawaladar enters into debt on behalf of another, who in turn trusts that the debt will one day be settled. Over time, transactions among the brokers mostly cancel each other out.[1]

Hawala transactions are untraceable as the systems are unlicensed, informal and they involve transfer of cash without any record of the amounts and parties involved in a transaction. Owing to the nature of the said transactions the source and the intended use of funds cannot be traced raising fears that it could be used for money laundering and financing of terrorist activities. This clandestine method of transferring money has  also made the Hawala system a popular choice for those seeking to evade the scrutiny of traditional financial institutions and government regulations.

Advantages of the Hawala System

The complexity of mainstream banking systems and its excessive regulatory oversight have prompted certain persons to operate informal banking and money remittance structures. The proponents of the Hawala system argue that it offers several advantages over conventional banking channels. Below are some of the reasons why Hawala is an attractive money transfer option:

1. Hawala systems are fast, cheap and informal. There is no bureaucracy involved;

• Hawala allows people to transfer money even if they do not have formal banking relationships;

• Hawala services are easily accessible. Hawaladar are mostly located in convenient places such as markets and shops;

• Hawala services are not documents and this provides privacy for people who want to keep their financial affairs private.

Disadvantages and challenges with Hawala

The critics of the Hawala system on the other hand point to its inherent risks and vulnerabilities as follows;

1. Hawala system is more likely to be used for money laundering activities due to the anonymity in its transactions by introducing illicit funds into the financial system;

• Hawala system is prone to tax evasion abuses since Hawala transactions are not recorded. Income generated from anonymous transactions that are not recorded cannot be taxed.

• Hawala transactions are more likely to be used to fund terrorist activities such as purchase of weapons and food for terrorists and channeling of funds for criminal activities as there is no paper trail on the source of funds to terrorist organizations.

• The interface with gray/black markets makes it harder to supervise hawala and offers opportunities to obscure transactions;

• There is a risk of losing funds when using Hawala and it may be difficult to recover such funds as there is no formal dispute resolution process.

What is the difference between money laundering and Hawala

Hawala system is distinct from money laundering. Money Laundering is the process of disguising the origin of illicit funds which is criminal in nature. On the other hand, Hawala is an informal money transfer system often associated with money laundering risks and hence requiring appropriate regulatory controls in order to mitigate the risks.

Regulatory Framework, objectives and challenges experienced with the Hawala System

Despite the controversies surrounding the Hawala system, it continues to thrive in many parts of the world, particularly in regions with high levels of economic instability and political unrest. Governments and international organizations have made efforts to crack down on Hawala operations suspected of being involved in illegal activities, leading to increased scrutiny and regulation of the system in some jurisdictions.

Regulation of money transfer and remittance services is aimed at reconciling two sets of public policy priorities: the need to  counter terrorist financing, money laundering, tax evasion and other financial crimes; and  the need to reduce the hurdles faced in remittance of funds on the other hand.

Due to the challenges connected with the Hawala System, Parliament enacted the National Payment System Act, Act No. 30, of 2011 (NPS Act) with the aim of providing regulation and supervision of payment systems and payment services providers and for connected purposes.

Hawala system is vulnerable to criminal abuse. Accordingly, the CBK vide its notice dated 6^th November, 2023 cautioned the public against rogue transfer agents offering alternative money transfer services such as Hawala from unlicensed service providers. The CBK through the said notice also requested members of the public to submit information on the identity and physical locations of entities and persons providing money or value services without a license or authorization from CBK.

The CBK has also issued the Money Remittance Regulations, 2013 (Money Remittance Regulations”) that require operator of cash remittance firms to register with CBK and pay a licensing fee of Kenya Shillings Five Million (Kes. 5,000,000.00) in addition to maintaining minimum core capital of  Kenya Shillings Twenty Million (Kes. 20,000,000.00)

Any person wishing to carry out money or value transfer services is required to obtain the requisite licenses and authorizations  from CBK.

Pursuant to Section 12 of the NPS Act, it is an offence to provide money or value transfer services without authorization from CBK and the same is punishable by a fine not exceeding Kenya Shillings Five Hundred Thousand (Kes. 500,000.00) or to imprisonment for a term not exceeding three (3) years.

Conclusion.

As the debate over the Hawala system rages on, one thing remains clear: the intricate web of trust and secrecy that underpins this alternative money transfer mechanism will continue to challenge conventional notions of financial transparency and accountability. Whether viewed as a legitimate lifeline for marginalized communities or a shadowy underworld of financial crime, the Hawala system remains a fascinating enigma in the realm of global finance.

In conclusion, the Hawala system stands at a crossroads between being perceived as an innovative alternative money transfer mechanism or a nefarious tool for illicit financial activities. As the world grapples with the complexities of regulating and understanding this clandestine network, one thing is certain: the Hawala system will continue to captivate and confound observers with its blend of tradition, trust, and controversy.

In the circumstances therefore any form of money transfers that do not conform to the existing laws in Kenya are greatly discouraged as they are more often than not associated with irregular and or illegal activities.

[1] https://www.dowjones.com/professional/risk/resources/risk-blog/hawala-risks