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A conference on migrant remittances in London

this October, the second of its kind hosted by the

World Bank and Britains Department for

International Development (DfID), once again

underlined the potential for remittance flows to

enhance economic development in the poorer parts

of the globe. While discussion at the event

concentrated on how to develop financial service

sectors that can better capture the developmental

impact of remittances through so-called formal

channels, informal channels were largelyignored. Yet when considering the issue of how

remittances can aid development, an understanding

of these informal channels is crucial. Hawala or

Hundi,1 which are the same, is one such channel.

But before elaborating further, a clarification of

terminology is required.

First what are formal flows? These are

essentially flows of money resulting from any

channel that falls within the modern financial

system. A more accurate definition might therefore

be flows through a modern and recognisably

western banking system. A definition of informalflows is altogether more tricky, as this inevitably

cross-cuts an extremely fuzzy

area, namely, a definition of

money service businesses or

alternative remittance services,

as it is referred to by the

Financial Action Task Force

(fatf). The fatf defines

informal flows as any

transmission of money through

non-bank financial institutions

or other business entities or any

other mechanism either through

the regulated financial system (for example, use of

bank accounts) or through a network or mechanism

that operates outside the regulated system.2

Remittance vehicle

Hawala fits squarely into this last definition, and is

regarded by the World Bank, International Monetary

Fund (imf) and other bodies as a core channel for

informal flows to and from the Indian subcontinent and

the Middle East. The term hawala, which stems fromthe Arabic word meaning transfer, is more commonly

used today than hundi, and as a consequence, hawala is

largely understood as a remittance vehicle. Hundi has

Sanskrit and Persian roots, but carries the same

linguistic and functional senses as hawala, although

some wrongly believe that hundi was simply a bill of

exchange or promissory note. In fact, the hawala/hundi

system provides more than pure money remittance, so is

more accurately described as a traditional or indigenous

South Asian banking system. As historical examination

of hundi/hawala shows, this system has a long

operational history in South Asia and the Persian Gulf,and provided a core instrument for trade.

Can hawala emerge from the

shadows?

Often dismissed because of unsavoury associations, payment channels such

as hawala can be more cost effective than banks

Marina Martin

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Marina Martin

Marina Martin is writing her PhD on

hawala/hundi at the London School of

Economics, and consults for businesses

and government. She was previously a

research associate at the University of

Cambridge, a senior analyst with Frost &

Sullivan and a broadcast journalist with

Bloomberg and the BBC.

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Taking this into account, informal value transfersystem (ivts), a term first coined by Nikos Passas, aprofessor of criminal justice commissioned by theHague to examine underground banking in 1999, andwhich has since been adopted by American TreasurysFinancial Crimes Enforcement Network (FinCEN), isthe best official description of the system. Though itdoes not exactly trip off the tongue. ivts applied tohawala correctly identifies the transmission of goodsor value as part of its operational character. Incontrast, many other contemporary descriptions havenarrowly represented hawala as a vehicle for movingforeign exchange or a cash-based system.

Today hundi/hawala operations are found all overthe world, in developed and developing economies,usually, but not solely, identified by the presence ofSouth Asian diasporas. One notable example isSomalia, where in the absence of any reliable modernbanking system, hawala is the preferred and mainartery for financial flows. Hawala has also shownitself to be more resilient to financial shocks in crisis

states such as Somalia and Afghanistan, than themodern banking system.3 In fact, aid and otherinternational organisations regularly use hawala as ameans of transferring money from the west toAfghanistan because of the ailing state of thatcountrys modern banking system.

Unpleasant associations

Today, hawala has become the subject of scrutiny fortwo core reasons: a glance at the international pressreveals its notoriety on a number of levels. In some

countries it is regarded as the grey economy, but inothers, and here India is a prime example, hawala isperceived as a marker of the criminal economy,although this perception has much to do with itsoutright prohibition. Second, since 11 September2001, allegations of links with terrorist financing andmoney laundering have been prominent.

In fact one of the current known and documenteduses of the hawala system is to provide a networkacross South Asia for low-cost micro-payments bymigrant workers back to their dependents.Remittances have only attracted substantial attentionfrom academics and policymakers of late becausesuch flows are believed to play a major role in poverty

reduction. The Treasury in the United States citesPakistani officials estimates of more than $7bndollars in annual flows into the country via hawalachannels.4 However, as hawala does not leave a papertrail, there are no firm figures on flows through thischannel, much less a global figure.

Opposing views

So contemporary approaches to the system sit at twovery different ends of the spectrum: law enforcementand regulation trying to combat criminal abuse ofhawala, and development strategies which recognisethe benefits of remittance flows. It has becomeincreasingly clear that criminal and financialregulation must work in tandem with developmentpolicies, in order not to impede the very real benefitsof remittances. The position of the World Bank, Fundand DfID (as exemplified in the most recentconference on remittances) is clearly that thedevelopment potential of remittances is better

harnessed by shifting remittances to modern bankingservices. This, it is felt, would improve a countrysratio of savings and investment to gdp.

Although studies have shown that remittanceshave a significant impact on reducing poverty at thegrassroots level, there has been no comparative studyof the impact of remittances via hawala versusformal flows. Do hawala flows result in differentconsumption patterns or other forms of economic andsocial behaviour? For instance, as I was conductingfieldwork in the southern Indian state of Kerala,which is a major recipient of remittances from the

Gulf, I was given to understand that many hawalaflows are channelled into house building. Kerala hasincreasingly moved towards a nuclear family model,even outside urban centres, leading to a high demandfor new homes. All of this points of course to a needfor understanding the regional contexts in whichhawala usage flourishes.

While informal channels are often dismissedbecause of unsavoury associations, one key problemremains: a system such as hawala is more cost-effective than the vast majority of modern bankingservices. Not only does it offer cheaper transactioncosts, but it also offers point-to-point transfers, whichthe modern banking architecture within South Asia,

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for example, cannot currently compete with. A

migrant worker in Britain can, for instance, send

money back to a remote village in India very cheaply

and within 24 hours. Moreover, the migrants

dependents in that village need not be literate to

access the money, unlike modern bank transfers. Nor

do the dependents need to travel to an urban hub to

gain access to a bank. The local hawaladar will either

deliver the money personally using a courier, or the

customer will go to the local hawaladars premises,

which might for instance be the local village shop.

Hawaladars will often be persons operating other

forms of business, who possess the necessary capital

to support the hawala network in a particular region.

Hawala payment networks

How does it do it? Hawala is a trust-based system

grounded in networks characterised by social,

ethnic, linguistic and religious affiliations. The word

trust is potentially misleading, and has frequently

led to the perception that the system is risky as thereare no guarantees or licenses to indicate

trustworthiness or probity. However, the kind of trust

that is embedded in hawala operations is calculative

rather than altruistic in nature. A way of illustrating

this might be to liken the trust between hawaladars

(hawala dealers) with the trust that the modern

banking system places in credit ratings agencies: the

modern banking system assumes that the

information provided by credit ratings agencies is

reliable. Similarly, hawaladars more usually operate

through a reputation-based mechanism, which

means that financial activity between hawaladars isshaped by expectations of conduct. This may seem

flimsy in a modern world where legal parameters are

seen to provide penalties and guarantees but, in

reality, forms of calculative trust are integral to most

institutional processes.

Other key elements that contribute to hawalas

competitive transaction costs are its lack of

bureaucratic paperwork and the fact that transactions

are processed in batches rather than sent individually.

So, instead of currency exchange and transfer rates

being applied to each and every transaction,

hawaladars can pass on the benefits of converting a

large bundle of transactions in one go. This is possible

because, unlike a modern bank transfer, money is not

wired or physically sent across with each transaction.

If a customer approaches a British hawaladar to send

100 back to India, the hawaladar will provide the

customer with a remittance code, which the customer

will pass on to his dependent in India. The hawaladar

will then contact his relevant India hawaladar, and ask

him to pay out 100 in Indian rupees once the

customer presents the remittance code.

Hawaladars rates are extremely competitive,

often only charging 12% of the principle although

the rate will vary per transaction and familiarity with

the customer. Due to very low overheads (often

operating from the back room of a shop), minimal

paperwork, efficient networks, and the fact that they

only do bulk currency conversions, hawaladars are

able to undercut modern banking services and

remain profitable. Clearing and settlement with other

hawaladars is carried out periodically, although this

process is not well understood and requires further

primary research. However, it is understood that

goods of value can be substituted as forms ofpayment, and we may speculate that under and

over-invoicing may play a part. The diagram

opposite, based on a World Bank model, illustrates

this example. This model merely illustrates a simple

bilateral settlement process, but in reality hawala

transactions are multilateral, with multiple hubs

distributed globally, further complicating the

clearing and settlement process.

The customer will in most cases be from the same

community as the hawaladar, which is why

appropriate networks will be in place to serve the

migrant community more effectively. For this reason,most customers are likely to know of the hawaladar

through word of mouth or community links, as hawala

dealers are usually well-established. This is also an

instance of trust between the customer and the

hawaladar, again linked to the reputation-based

mechanism. Renegade hawaladars are highly unlikely,

though not impossible, because the

customer-hawaladar network carries information

extremely swiftly. If the hawaladar fails to deliver, this

would significantly affect future relations with his

customers and his fellow hawaladars because he has

compromised the integrity of his network. Moreover,

because the hawaladar is part of a community or

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regional network, accountability is built into the

system. Hawala is a self-regulating institution, unlikemodern financial institutions which function through

legal parameters.

The problem of regulation

So much confusion reigns over definitions and

descriptions of hawala that policymakers and regulators

face real problems in determining the remit and form of

the system. The fatfs 40+9 recommendations have

proven as much of a bug-bear to apply for regulators

and legal enforcement agents, as has compliance with

them for the very poorly defined category of moneyservice businesses, of which hawala can form a part.

For those money service businesses which have sought

registration or licensing, regulation has intensified

administrative processes, in turn passing on higher

transactions costs to the customer.

At a conference on hawala in April 2005 in the

uae, hm Customs & Excise highlighted the

ambiguous nature of terms such as underground,

illegal, alternative and formal. They adopted

the stance that hawala itself is not the problem, but

rather criminal money laundering, using hawala

techniques. Broadly observed patterns of

transactions are often the only means of identifying

hawala for organisations such as

FinCEN and hm Customs &

Excise, yet such organisations

are increasingly sensitive to the

development angle, and do not

wish to penalise migrant

workers. Over-regulation will

either drive hawala underground

or increase transaction costs for

migrant remitters.

Lack of familiarity with

hawala has also made the process

of applying fatfs special

recommendation VI (one of the

nine in the 40+9 noted above) to

various national and regional

contexts even more arduous. The

way hawala is used in Pakistan,

does not necessarily correspond

to the way it works in India or Sri

Lanka. National laws, and financial requirements

will vary from region to region. Indeed, quite oftennational laws can shape the face of hawala usage

and operations. The fact that hawala is not

prohibited in Pakistan has meant that money-

exchange houses using the system operate openly

and are widely advertised. In Sri Lanka, hawala is

regarded as being fuelled by the civil conflict.

Therefore, applying regulations on a blanket basis,

without reference to local or national contexts, is

unhelpful. On the other hand, unequal regulation

merely shifts operations to different regions, as a

speaker from Interpol observed at the 2005

conference on hawala, or, worst-case scenario,drives the system underground. Eventually, this

leaves us with a classic conundrum: should

regulation on the basis of national experience come

first, or national compliance with international

standards? The jury is still out.

1 Hundi is the older term for the system in the Indian subcontinent.

2 fatf, Interpretive Note to Special Recommendation VI: Alternative

Remittances.

3 See Remittances in conflict and crises: how remittances sustain

livelihoods in war, crises, and transitions to peace, by Patricia Weiss

Fagen with Micah N. Bump, a policy report produced by the InternationalPeace Academy, Georgetown University, February 2006.

4 http://www.treas.gov/offices/enforcement/key-issues/hawala/.

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