Sunday, August 16, 2009

Hawala: An Early Precursor to Anonymous Digital Cash

By Jon Matonis

What is hawala and how does it work? Hawala operates today as an informal value transfer system outside of the normal, transparent banking apparatus where transactions can be completely anonymous. Its integrity rests on the performance and honor of a huge network of money brokers (hawaladars), which are primarily located in the Middle East, South Asia, and North Africa.

An ancient alternative remittance system, hawala has its origins in classical Islamic law dating back to the 8th century, and it was used for trade financing because of the dangers of traveling with gold and other forms of payment on routes beset with bandits. The concept of agency in common law and aval in French civil law were influenced by hawala, and the word aval is even derived from the word hawala.

How does the system work? (source: IMF 2002)

An initial transaction can be a remittance from a customer (CA) from country A, or a payment arising from some prior obligation, to another customer (CB) in country B. A hawaladar from country A (HA) receives funds in one currency from CA and, in return, gives CA a code for authentication purposes. He then instructs his country B correspondent (HB) to deliver an equivalent amount in the local currency to a designated beneficiary (CB), who needs to disclose the code to receive the funds. HA can be remunerated by charging a fee or through an exchange rate spread. After the remittance, HA has a liability to HB, and the settlement of their positions is made by various means, either financial or goods and services. Their positions can also be transferred to other intermediaries, who can assume and consolidate the initial positions and settle at wholesale or multilateral levels.

The settlement of the liability position of HA vis-à-vis HB that was created by the initial transaction can be done through imports of goods or "reverse hawala." A reverse hawala transaction is often used for investment purposes or to cover travel, medical, or education expenses from a developing country. In a country subject to foreign exchange and capital controls, a customer (XB) interested in transferring funds abroad for, in this case, university tuition fees, provides local currency to HB and requests that the equivalent amount be made available to the customer's son (XA) in another country (A). Customers are not aware if the transaction they initiate is a hawala or a reverse hawala transaction. HB may use HA directly if funds are needed by XB in country A or indirectly by asking him to use another correspondent in another country, where funds are expected to be delivered. A reverse hawala transaction does not necessarily imply that the settlement transaction has to involve the same hawaladars; it could involve other hawaladars and be tied to a different transaction. Therefore, it can be simple or complex. Furthermore, the settlement can also take place through import transactions. For instance, HA would settle his debt by financing exports to country B, where HB could be the importer or an intermediary.

When compared to the traditional banking infrastructure, hawala's attractiveness lies in six primary features: (1) cost effectiveness, (2) efficiency, (3) reliability, (4) lack of bureaucracy, (5) lack of a paper trail, and (6) invisible from scrutiny by the taxation authorities.

The hawala system has been immensely beneficial to the unbanked, and afraid, migrant workers sending money home to family members and for businesses transferring trade payments in largely underdeveloped economies lacking efficient banking services. It should not be dismantled to suit out-of-jurisdiction governments. The notion that some elements may utilize hawala for nefarious purposes does not outweigh the societal benefits, and it certainly does not outweigh the core principles of freedom of choice in banking and true financial privacy.

For further reading:
"Hawala and Hundi: vehicles for the long-distance transmission of value", Roger Ballard, August 2009
"Risk, regulation and the challenge of compliance in the operation of contemporary transjurisdictional Informal Value Transfer Systems", Roger Ballard, July 9, 2009
"Hawala remittance system and money laundering", Marie Chene, May 23, 2008
"Informal Value Transfer System – Hawala", Ion Pohoaþã and Irina Caunic, December 2006
"Hawala: criminal haven or vital financial network?", Roger Ballard, October 2006
"Fears over US hawala crackdown", BBC News, February 6, 2004
"Informal Funds Transfer Systems: An Analysis of the Informal Hawala System", Mohammed El Qorchi, Samuel Munzele Maimbo, and John F. Wilson, International Monetary Fund, Occasional Paper 222, August 18, 2003
"The Hawala System", Mohammed El-Qorchi, December 1, 2002
"The Principles and Practice of Hawala Banking: A Report", Roger Ballard, December 2002
"In Praise of Hawala", J. Orlin Grabbe, May 13, 2002
"A Banking System Built for Terrorism", Meenakshi Ganguly, Time, October 5, 2001
"The hawala alternative remittance system and its role in money laundering", Patrick M. Jost and Harjit Singh Sandhu, January 1, 2000
"Underground Banking and National Security", Larry B. Lambert, March 1996

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