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Hawala Underground Banking: Legal or Illegal – How to Identify the Risks?

Underground banking or Informal Value Transfer Systems is the most chosen way to move around funds, not only for money launderers and terrorism financers but also for immigrants who must support their families back home.


Hawala is an Arabic term and a type of informal banking that means “to change” or “to transform”. In simple terms, Hawala is "money transfer without money movement."


Process & operation


The basic principle of Hawala involves the transfer of the value of a currency without necessarily physically moving it. The below picture serves to illustrate the basic process. Value may be transferred to and from both jurisdictions. In either case, the Hawaladars need to be paid for their services:



Hawalader’s operate visibly in the open or the Hawala is provided as an additional service from otherwise legitimate businesses, such as:


  • Jewellers;

  • Car Rental;

  • Grocery stores/Deli;

  • Travel Agency;

  • Money Exchange Houses.


These businesses often serve as a front for the financial services that are being provided and in background they act as Hawaladars.


The Risks with Hawala


The lack of paper trail and no Know Your Customer (KYC) verification is the main concern with illegal or unlicensed/unregistered Hawala operators. The challenges faced by jurisdictions, law enforcement and financial institutions in detecting unlicensed Hawala service providers as well as lack of information of the concept make it difficult to assess the amount of funds, which are often illicit, that are moved through this type of remittance system.


There is a growing nexus between terrorist financers and the abuse of Hawala. The fact that hawala circumvents AML/CTF measures to facilitate both legitimate and illegitimate funds, makes it more difficult to detect the funds linked to terrorist financing and financial crime.


Reason for existence

Some Hawala operators/money remitters are now regulated as Money Service Bureau’s (MSBs) and must abide by the reporting requirements, register & licensed in the states they operate in and must file suspicious activity reports (SAR) when potential illicit activity is identified. However; it is the unregulated providers, those that are not registered and/or licensed, that are mostly exposed to be used to move funds for terrorist financing and other illicit purposes.


There are various reasons why those living and working in a foreign country prefer to use this method over the use of western banking. Some of these reasons are:


  • Lack of easily accessible formal financial institutions in remote areas of some countries.

  • Better exchange rates than Banks/Formal system.

  • Conversation rate is lower than the fee at a financial institution.

  • Faster & alleged anonymity.

  • Lack of Paper Trail & Bureaucracy.


To highlight - these advantages are not only attractive for migrants but also for criminals seeking to launder their illegally obtained funds. It is difficult to distinguish between the funds for terrorist financing and funds destined for families.


Growing Concern


Until 9/11, Hawala was more associated with money laundering and was often referred as some type of “underground banking”. After 9/11, Hawala became associated with terrorist financing. The attacks of 9/11 have been financed by means of credit cards and wire transfers, but the 9/11 Commission’s report states that Bin Laden may have relied on a trusted network of Hawala to move his funds effectively in the areas he operated in.


Law enforcement in many jurisdictions, see Hawala as one of the leading channels for terrorist financing and money laundering. It has become a growing concern, since in some jurisdictions a nexus has been established with the increase in crime rates and the illicit use of Hawala. Moreover, developing countries have voiced their concerns on the loss of tax revenue, foreign currency, destabilizing the local economy and increasing bribery and fraud.


Hawala- Legal or Illegal?


Underground bankers are difficult to identify or locate. Even if it were possible to identify them, their transactions are so varied and secretive it would be difficult to regulate them. It must be noted that not all Hawala customers are using this remittance system for unlawful purposes. The result is that Hawala remains illegal i.e. not registered and/or licensed in several countries around the world however if these operators are somehow identified and registered/licensed and forced to comply with local laws & regulation then chances of money laundering & terrorist activities around the world will fall.


It is important to achieve a balance between regulating the underground banking sector in an attempt to reduce the flow of illicit funds, and permitting its continued use as a legitimate, alternative remittance system.


How to Protect Against Hawala’s


Financial institutions must have robust policies and procedures in place when dealing with MSBs which may be a façade for a Hawala. This must include carrying out enhanced due diligence on identified MSBs as well as other business activities which are known to operate as Hawala’s.


Monitoring of transactions from these businesses must be meticulously undertaken to help identify, protect against and report potentially illicit and suspicious activity.


How Lysis Can Help:


We work with financial institutions to assess the maturity and effectiveness of a firm’s anti-money laundering and CTF framework and controls. We can review and enhance controls related to MSBs and other high-risk businesses to protect from illicit activity which may be related to Hawala’s.


We can also provide training to help personnel recognise instances of potential money laundering and financial crime.


For more information contact info@lysisfinancial.com.

By Sidhvek Nishad, Consultant at Lysis Group

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