Hawala is atraditional money transfer system where one cantransfer a particular amount from one place to anotherwithout any physical movement of the money.In India, thistransaction system is illegal under the Foreign Exchange Management Act (FEMA) and Prevention of Money Laundering Act (PMLA). Read on to learn more about what exactly is the meaning of Hawala and why is it illegal.
Meaning of Hawala
The word ‘Hawala’ traces itsorigin to Arabic, and the original meaning was ‘trust’ or ‘transfer’. It's an informal way of transferring money from one place to another without any actual physical movement of money. This system of transferring money was most prevalent in the Indian subcontinent, Africa and Middle Eastern region.
What Is Hawala Transaction?
According to the International Criminal Police Organisation (INTERPOL), Hawala refers to ‘money transfer without money involvement’. It’s a completelyinformal and unregulated mode of transferring foreign currencies between countries. While a Hawala system is similar to the workings of a formal bank, there’s no paperwork, questioning or accountability involved.
Hawala transactions are not regulated by the Reserve Bank of India (RBI).FEMA has declaredHawala transactions to be anillegal way of transferring money.
How Does Hawala Transaction Work?
Let’s look at thesteps involved in the Hawala transaction to understand it better:
Step 1:First, a sender or client goes to a Hawaladar and requests him to transfer money to another person located elsewhere.
Step 2: The sender and Hawaladar decide on a password or code that is used to identify the financial transaction.
Step 3: Then, the sender provides the amount to be transferred to the Hawaladar along with a service fee. The amount of service fee is a percentage of the amount that is to be transferred.
Step 4:The Hawaladar contacts his counterpart in the recipient’s location and provides him with the transaction details.
Step 5:Once the counterpart in the recipient’s location receives this code, he provides the recipient with the amount that has been agreed upon.
Step 6: Finally, the Hawaladars need to settle their accounts. They can do so at a later date. The settlement can take place either through the transfer of funds or the balancing of accounts with other transactions.
How Does Hawala Brokers Make Money?
Generally,Hawaladars (Hawala brokers) charge acommission for their services. The settlement of debt between Hawala brokers can take various forms. It’s not necessary that it would always have to take place in cash. Instead, settlements can take place through goods, services, and transfers of employees for manpower and properties.
Hawaladars bypass official exchange rates to profit from these transactions. Generally, the money enters a Hawala system in the currency of the sender's country and exits it in that of the receiver’s currency.
Why Hawala Transactions Exist?
You might be wondering why a person thinks of using the Hawala system instead of the traditional banking system.
One cannot dispute the fact that the traditional banking system is a much safer option. But it’s difficult for many people to send money to a different country with the help of traditional banks. TheHawala system is a convenient option for thoseimmigrants who need tosend money home urgently and vice versa. Hawala is a muchless expensive procedure so many people take the help of this system to transfer money in times of need.
The Financial Action Task Force (FATF) conducted a study in December 2013. As a part of this study, individuals from nearly 22 countries had to fill up a questionnaire. The main question to be addressed was why people use Hawala transactions.
Upon careful analysis of this FATF report, some of the importantreasons why people use Hawala transactions are as follows:
- Quicker transmission of money
- Process of transferring money is less expensive
- Cultural preference
- Lack of proper banking infrastructure in the receiver or sender’s country
- More trust in the Hawala system compared to the banking system
- Desire to avoid law enforcement agencies
- Desire to avoid currency control
- Tax evasion
- Transfer and mask criminal actions
What Are The Risks Of Using Hawala?
- Loss of funds
There remains a risk of loss of the entire amount either because of financial fraud or because of mistakes in the transfer process. Moreover, it might be difficult to recover the lost amount as there’s no formal dispute resolution process.
- Financial fraud
Hawala transactions are mostly based on personal connections, networks and trust. In other words, there’s no process of record-keeping or formal documentation process. So, there remains a risk of fraud. Hawaladars may not take up the responsibility if they fail to deliver the money. Moreover, such brokers may use the money for their own purposes.
- Illegal activities
Considering that the Hawala system is entirely unregulated, the system can be easily used to fund terrorist activities. It can also act as a catalyst for money laundering and all sorts of illicit activities. People using Hawala can be easily exposed to financial and legal risks.
- Volatility
The value of the funds being transferred is subject to market conditions and exchange rate fluctuations. As a result, the recipient may end up receiving less amount than was promised.
What Are Hawala Business Compliance Challenges?
Some of the techniques used by Hawala dealers to settle their debt among themselves are as follows:
- Reverse Hawala between two dealers
- Multilateral settlement between several Hawala dealers who belong to the same network
- Settlement through trade transactions such as over-invoicing
- Settlement through cash (cash carriers) and MSB (banking and money service business) channels
Governments worldwide have taken measures to address the menace of Hawala money. For instance, the Belgian parliament has introduced a Bill that prevents using prepaid and anonymous telephone cards. Topping up of prepaid cards should ideally be traceable and electronic.
Checking the special recommendations by FATF is crucial as it helps to tackle the problem of illegal money transfers. Money Laundering and Terrorist Financing (Amendment) Regulations, 2022 has recommended the extension of the travel rule, which is that information has to be shared while making wire/bank transfers.
Many experts think that Artificial Intelligence (AI) would greatly help people collect data for the movement of money in the country. People expect AI tools to aid in analysing and combining data to achieve transparency.
Another point that experts have often pointed out is that even the most successful Hawaladar would have to approach a financial institution at some point to store physical cash. Huge deposits of cash without any apparent reason can become a major red flag for compliance professionals.
Example of Hawala
Let’s use an example to better understand how the Hawala system works. Suppose Shubham needs to send Rs.10 lakh to Ahaan, who lives in a different country. She has received the contact details of Danish, who is a Hawaladar. He provides Danish with the money he wants to send Ahaan along with every transaction detail. Details include the name of the recipient, password and city.
Danish connects with his counterpart in the recipient’s country and asks him to provide Rs.10 lakh to Ahaan on one condition—The receiver states the correct password along with all the details. The Hawaladar in the receiver’s country provides Ahaan with the amount after deducting his commission.
It was Shubham who had initiated the transaction, which was concluded only after Ahaan received the amount. The process can take a few days. However, it can also take a few hours. Note that physical movement of the money does not take place. Moreover, one is not required to sign any IOUs as well.
Conclusion
The meaning of Hawala, in one sentence, is a system of transferring money from one location to another without physically transferring the amount. Considering that the system has been used to fund terrorism and money laundering, it has been banned in many countries.
