veiled4allah: hawala: an alternate banking system

Patriot Watch (no permalinks) and TalkLeft both report on an article in the NY Daily News about the so-called "Victory Act" (Vital Interdiction of Criminal Terrorist Organizations Act).

I have no doubt that I'll be posting articles on this to The Clipboard blog in the coming days and weeks. However, PG asked a question in my comments section about the part of the proposed bill that promises to "clamp down on Arab hawala transactions, where cash exchanged in an honor system has been funneled to terrorists".

Hawala is an unofficial or parallel banking system used in South Asia, the Middle East and other parts of the world.

Back in November 2001, when the first news articles about terrorist financing and hawala appeared, I posted a question at an Islamic discussion board to Mustafa Kamal, an expert in Islamic finance. I wanted to know what exactly hawala is.

Kamal replied:

To answer the original question, under Hawala, a person living in country A gives local currency to Hawala dealer. The dealer, through an affiliate or a subsidiary dealer in country B, delivers the funds to the beneficiary in country B in that country's currency. The entire transaction is requested, processed, and executed verbally. There is virtually no paper trail except, of course, the dealer in country A must somehow communicate with the dealer in country B, i.e., via email, fax, or phone. The transfer is almost as fast as a wire transfer through a commercial bank if not faster. The exchange rate used to deliver funds is several units of currency (of destination country) lower than the open foreign exchange market of the destination country but higher than the official bank rate, or what is called 'interbank' rate. Commercial banks charge a fixed fee for wire transfers regardless of the amount being wired whereas Hawala charges per unit of currency transmitted. Therefore, from purely financial utility point of view, Hawala may be cheaper for the sender than a wire through a commercial bank as long as the amount in question is a few hundred dollars. Beyond that equilibrium amount, Hawala will lose its immediate financial benefit. For example, assume that you wanted to send US$400 to your family in Pakistan from the United States and that the open market exchange rate in Pakistan is Rupess 60 per US dollar and the interbank rate is Rupees 55 per US dollar. You will give that amount to a Hawala dealer in the U.S. The dealer will inform you that the exchange rate will be, say, Rupees 57. The Pakistani affiliate of that dealer will deliver Pakistan Rupees 22,800 to your family. Remember, the US dollars you gave to the dealer did not leave the U.S; There was no exchange of funds between a US bank and a Pakistani bank; and the dealer did not file any regulatory report with the IRS.

Also, the pure financial utility of Hawala will diminish if the open market exchange rate and the interbank rate in the destination country are so close together that there is no room for a profit margin for the dealer. Such is the case in most Western European countries, Malaysia, UAE, Saudi Arabia, and many other countries with strong economies.

Most countries' tax code requires financial institutions to report money transfers of above a ceiling amount per customer per day to that country's revenue department. In the U.S., financial institutions are required by the Internal Revenue Code to report to the Treasury Department when a customer transmits $10,000 or more to a foreign country on a single day.

The analysis of Hawala presented by the prior post seems accurate. There are a couple of issues that should be borne in mind.

Now let us examine these issues.

1) Muslims are required (by Quran and Hadith) to write the transactions amongst themselves and have the transactions witnessed. Granted that writing of transactions is not a Fardh like prayer or fasting or the like. However, the Hawala system, as it exists today, does violate that requirement.

2) We know that the funds transmitted through Hawala do not circulate through the foreign exchange market of the country they are sent to. We also know that the system is practiced by expatriates of mostly developing Muslim countries. Although the individual end of sending the funds for the family is served adequately, the collective end of benefiting from the additional foreign exchange is ignored in the Hawala system. In the end, the family receiving the funds needs local currency and will get local currency either way. In Hawala system the local foreign exchange market will be deprived of its precious product, foreign exchange. Could that be 'unpatriotic'?

3) Foreign exchange dealerships are state licensed and, to a limited extent, federally regulated. Hawala dealers are not licensed or registered with any regulatory authority. Therefore, if someone does request them to transfer funds in excess of the per day ceiling established by the regulation, they do not report it.

Hawala was a usual mode of money transmission up until early twentieth century. With the advent of International Monetary Fund in mid-twentieth century, most countries of the World had enacted legislation to regulate foreign exchange transactions. Of course, there are still countries that have no regulation of foreign exchange, but most countries have some degree of regulation. Usually, the poorer the country, the higher the regulation of foreign exchange. With the exception of a handful of Muslim countries, all have strong regulation of foreign exchange.

Having examined that, I personally do not share the 'concerns' of the media. I do see, however, that the Hawala system has the potential for abuse given its nature.

Allah knows best.

You can read more about hawala in the following publications: The hawala alternative remittance system and its role in money laundering from Interpol and Hawala from the International Monetary Fund (IMF). A briefer overview is provided by Wikipedia.

As Kamal indicated in his response to me, the hawala system as it is practiced today is not really in line with the rules of Islamic finance. Specifically, Islamic financial law requires transactions to be witnessed and recorded in writing. The lack of a paper trail is precisely what makes hawala problematic.

The point is, it is problematic under Islamic law as much as under any other law system. Hawala is not an "Islamic" banking system. It is a banking system that is used by Muslims. There is a difference. If hawala transactions were performed according to Islamic law, they would be witnessed and recorded in writing. Such a system would be much more difficult to use for money laundering.

From the various accounts that I have read, the idea behind the hawala system was developed many centuries ago in India and continues to flourish in that country, where it is known as "hundi".

The basic mechanism of money transfer through hawala is a lawful transaction under Islamic law, based on the idea of transferring debt (read this for a look at what a real Islamic hawala system would be like).

In the last century or so, the hawala system has been supplanted by modern banking systems established by Western countries. Because these systems are the formal and official ones, the hawala system has gone underground.

It is the underground or unofficial status of the hawala system that makes it vulnerable to use by money launderers. The same would be true of any other undeground or unofficial banking system.

People will continue to use hawala as long as it is convenient to them. The best answer seems to be to regulate it.

It's not clear what Ashcroft's plans to "clamp down on Arab hawala transactions" amount to. I assume that "Arab hawala transactions" is the reporter's way of saying "transactions in the Arab hawala system" and it doesn't mean "all hawala transactions by Arabs".