Definition – AML-Specific
Hawala can be defined as an alternative remittance system involving the transfer of value or funds without the physical movement of money or the use of regulated financial institutions, primarily based on mutual trust between brokers and clients. This system functions largely unregulated, circumvents formal banking oversight, and lacks conventional record-keeping, creating vulnerabilities exploitable for money laundering, terrorist financing, and other illicit financial activities.
Purpose and Regulatory Basis
Hawala’s relevance to AML arises from its potential misuse for concealing the origin of illicit funds, circumventing regulatory controls such as Know Your Customer (KYC), Suspicious Activity Reporting (SAR), and transaction monitoring. Because it operates outside the regulated financial system, Hawala transactions are difficult to detect, trace, and audit, making them attractive for:
- Money laundering schemes to integrate illicit proceeds.
- Financing terrorism by transferring funds discreetly across borders.
- Avoidance of tax and capital controls.
Due to these inherent risks, major regulatory bodies have sought to regulate or prohibit hawala where possible:
- The Financial Action Task Force (FATF) classifies hawala under Alternative Remittance Systems (ARS) and has issued guidance and monitoring frameworks to curb related risks.
- In the United States, the USA PATRIOT Act expands AML rules to cover informal value transfer systems including hawala, requiring reporting and licensing.
- The European Union AML Directives (AMLD) incorporate ARS providers, mandating registration, due diligence, and reporting.
- In countries like India and Pakistan, hawala transactions are explicitly prohibited under the Prevention of Money Laundering Act (PMLA) and the Foreign Exchange Management Act (FEMA) due to their high abuse potential.
When and How Hawala Applies: Real-World Use Cases
Hawala typically applies in settings where:
- Formal banking infrastructure is limited or costly.
- Remittances from migrant workers to their home countries are frequent.
- People seek anonymity or to bypass exchange controls and taxes.
- Cross-border funds transfer needs to be rapid and flexible.
Real-world examples:
- A migrant worker in the Gulf pays a local hawala broker who contacts his counterpart in his home country to pay the equivalent amount to the worker’s family, without money crossing borders physically.
- Terrorist groups financing operations using hawala networks to obscure the money chain.
- Businesses or individuals avoiding regulatory scrutiny by using hawala for large value transfers that otherwise would trigger reporting.
Types and Variants
While hawala fundamentally is an informal broker-to-broker trust-based system, there are variants or related informal value transfer systems:
- Hawala networks: Traditional, multi-hop broker chains spanning regions.
- Hundi: Similar to hawala, more common historically in South Asia, often involving bills of exchange.
- Other alternative remittance systems (ARS): Informal systems for sending value that may include courier services, trade-based transfers, or informal banking parallel networks.
Each variant shares the common feature of bypassing formal channels but may differ in contractual or trust mechanisms involved.
Procedures and Implementation: Compliance Measures for Institutions
Financial institutions and regulated entities are required to implement specific procedures to address hawala-related risks:
- Risk Assessment: Identify and assess exposure to hawala and ARS usage, distinguishing customers likely to use informal systems.
- Customer Due Diligence (CDD): Enhanced due diligence for clients from high-risk jurisdictions or sectors.
- Transaction Monitoring: Watch for patterns typical of hawala such as large cash deposits inconsistent with customer’s profile, frequent wire transfers to/from known hawala hubs.
- Reporting: Suspicious transaction reports (STRs) must be filed if hawala use is suspected.
- Employee Training: Educate staff on recognizing hawala indicators and compliance obligations.
- Cooperation with Authorities: Share intelligence with law enforcement and financial intelligence units (FIUs).
Systems may include integrating sanctions screening, transaction monitoring software, and categorizing hawala as a high-risk activity for continual review.
Impact on Customers/Clients
From a client’s perspective, hawala offers:
- Advantages such as speed, lower costs, convenience, and access in underbanked areas.
- Challenges such as lack of consumer protection, no formal recourse in disputes, and potential legal risks in jurisdictions prohibiting hawala.
Regulations may impose restrictions on clients using informal transfer channels, requiring them to use authorized remittance channels and face penalties if caught using informal ones in prohibited regions.
Duration, Review, and Resolution
AML frameworks impose ongoing obligations on institutions to:
- Continuously monitor accounts and transactions for hawala indicators.
- Review and update risk profiles regularly.
- Investigate and resolve suspicious activity promptly.
- Retain records for prescribed timeframes, often 5 to 7 years, even if informal transactions are suspected or blocked.
Reporting and Compliance Duties
Institutions must:
- Identify and classify hawala-related transactions or customers.
- File timely STRs to FIUs where hawala suspicion arises.
- Maintain comprehensive records of due diligence and investigation outcomes.
- Follow regulatory sanctions and licensing requirements for ARS.
- Face penalties including fines, license revocation, or criminal charges for non-compliance.
Related AML Terms
Hawala is closely connected to:
- Alternative Remittance Systems (ARS): Broad category including hawala.
- Terrorist Financing: Hawala can be a conduit for terrorist funds.
- Money Laundering Stages: Placement, layering, and integration often involve hawala for layering.
- Financial Intelligence Units (FIUs): Authorities that receive reports on hawala transactions.
- Know Your Customer (KYC): Essential for detecting hawala usage.
- Suspicious Transaction Reporting (STR): Mechanism to alert authorities about hawala activity.
Challenges and Best Practices
Challenges:
- Lack of transparency and documentation.
- Difficulty in tracing funds across networks.
- Cultural acceptance and trust in hawala networks.
- Legal prohibition conflicting with socio-economic reliance.
- Cross-border coordination difficulties.
Best Practices:
- Collaboration between regulators and international bodies.
- Enhanced due diligence in high-risk sectors.
- Public education on legal alternatives.
- Integration of technology for pattern detection.
- Developing regulatory frameworks respecting socio-economic realities while enforcing compliance.
Recent Developments
- Increased FATF focus on regulating hawala as part of the broader fight against illicit finance.
- Introduction of technological tools (e.g., data analytics, AI) to detect informal transfer patterns.
- National legislations evolving to license or otherwise regulate hawala intermediaries under AML requirements.
- Enhanced international cooperation on tracing hawala networks linked to terrorism and organized crime.
In summary, hawala represents a complex challenge in AML compliance, blending informal trust-based financial flows with significant risks of money laundering and terrorism financing. It demands targeted risk management, robust regulatory oversight, and international collaboration to mitigate its abuse while recognizing its socio-economic role in informal remittances. Compliance officers and financial institutions must ensure systems, controls, and awareness are in place to detect, report, and prevent illicit use of hawala in line with global and national AML frameworks. Its critical importance lies in balancing effective AML enforcement without excluding vulnerable populations reliant on informal value transfer mechanisms