During a recent conference at the Abu Dhabi Central Bankattended by members of the financial sector and experts fromthe region, Europe and the US, a focus was on how to betterregulate the informal money transfer system of hawala, whichhas been linked to money laundering, organized crime andterrorist financing.
Hawala, which can be traced back to the 8th century, is apopular, cheap and effective way to send money that isfrequently used by the Gulf’s massive expatriate Asianpopulation.
Money is transferred through a network of hawala brokers,or hawaladars. A customer approaches a broker in one cityand provides a sum of money to be transferred to a recipientin another country. The broker who has received the moneycalls his counterpart in the recipient’s city, providinginstructions on the disposal of the funds and promising tosettle the debt at a later date.
Although much of the money transferred is legitimate, adrug bust by the Italian police late last year connectedseveral Pakistanis with a Dubai-based Indian who receivedmoney through his informal bank to channel funds to drugcartels and arms dealers.
This incident is far from unique, with the UAE and Britishauthorities busting a drug network operating between the UKand Afghanistan only last month (March) that used the UAE asa ’cash pool’ to launder an estimated $194.7 million.
The ancient versus the modern
The problem facing central banks and regulatory bodies isthat the majority of hawala transactions are completelylegal and a primary source of income for many people aroundthe world. According to the UN, in 2005 there were 175million migrants worldwide sending remittances in excess of$300 billion, of which some $167 billion went to emergingeconomies and accounted for up to two-thirds of GDP incertain countries.
That trend is likely to increase, particularly as thedemand for young workers spikes in the aging populations ofEurope and North America.
The issue is of particular importance in Somalia, where upto 15% of the population lives abroad and remits $1.5billion annually to the Horn of Africa.
“The Somali economy is more dependent on remittances thanany other country on earth,” said Muhammed Djirdeh of theSomali Money Transmitters Association. Around 40% of theSomali population is reliant on remittances from relatives,and remittances are a source of finance for up to 80% of newbusinesses.
But with the recent clamp down on the hawala system,hawaladars are feeling the heat.
“We suffer, like all others in this business, from animage problem,” said Djirdeh, citing the example of theMogadishu-based Al Barakat money transmitter that was closeddown after 9-11 by the US authorities for connections toterrorism.
“Our problems are regulations, forcing some of us to quitthe business or work without compliance. The US is veryprohibitive for us to work in and with as we are the smallboy in the neighborhood—banks close our accounts, and wecannot do without working in the system. On top of that,transaction costs are going up. We charge 5% to send$100-$150, but have to pay agencies and commissions, so theoperator gets a small income,” added Djirdeh.
By comparison, a bank in Europe or the UAE will charge upto 20% for a transaction of the same amount.
But low costs are not the only reason for using the hawalasystem. In many developing countries, the banking system isso underdeveloped that informal money transmitters are theonly means to transfer money. In addition, hawala is highlyefficient, taking a maximum of two days to get to therecipient.
“What’s amazing is in today’s electronic world it takesfive days for a check to clear in the UK,” said ProfessorHannah Scobie of the European Economics and Financial Centerin London. “If there were hawala brokers between the UK andItaly, we would use them, as banks can take up to twoweeks,” she added.
Some observers also believe that hawala has been unfairlysingled out as a system abused by criminals and terrorists.As World-Check, a British company that runs an intelligencedatabase on financial risk, has pointed out, 60% of all bankfraud is internally driven. Equally, other forms oftransmitting funds are widely used but garner less attentionby regulators, the financial system or the press.
For instance, settlements can also be made via a cashcourier, as cargo, via diamond smuggling or through multi-country settlements.
“The latter is particularly popular as it is a way to cutcosts and make money on currency exchanges,” said NikosPassas, professor of criminal justice at NortheasternUniversity.
“The money of migrants wanting to send money goes into acash pool. The dollars go to an exporter of goods, and thenrupees go to the families—that’s how you minimizecross-border transactions and score tons of money,” headded.
As another example of avoiding cross-border transactions,Passas said Taiwanese boats going to meeting points ininternational waters to trade narcotics for commercial goodsthat will then enter Hong Kong, which acts as the financialhub to effectively launder the money.
“The other ways are through goods. The value of a good mayofficially be declared at $30, but only worth $1.20, whichis fraud,” said Passas.
Finding the right balance
The struggle for regulators is to find the right balancebetween over- and under-regulating informal moneytransmitters.
“It is difficult to regulate hawala without driving itunderground,” said Jean-Francois Thony, assistant generalcounsel of the financial integrity group at the IMF.“Regulations are not the panacea to avoid misuse,” he added.
If a regulatory body is particularly zealous, it will notonly be hawaladars and low-income workers that areaffected.
“Over-regulation can lead to capital flight,” saidProfessor Scobie. “But banks and regulators have gonecompletely wild following 9-11. Every time you turn around,there is a new form to fill in. This is very disturbing forcustomers, and on looking closer, these forms are for banksto get more information to sell more products.”
So what is the solution between excessive regulation thatcould drive informal transmitters underground and bankstrying to flog extra services?
In the UAE, the central bank has started encouraginghawaladars and exchange commissions over the last threeyears to come forward to register themselves.
“We realize hawala could be used to launder money andfinance terrorism, so we want to control—not end—hawala, asit is important for people in poor countries,” said AhmedIsmet of the UAE central bank
Initially expecting around 100 applicants, 215 dealershave been officially certified and 43 applications are stillpending.
“The first stage is registration [by hawaladars]. Morestringent and restrictive regulations will come in time asit could be counterproductive if done earlier,” said IbrahimAl Hosani of the UAE Central Bank.
Countering terrorist financing and money laundering is notconfined to reining in the hawala system, as such informalmoney transmitters also use official banking channels. Sothe financial community also needs to be brought onboard.
The issue is of major significance for banks, as evenallegations of being a channel for criminal activity couldhave long-lasting effects on a bank’s reputation and brandequity. Equally, Arab banks with branches in the US have tobe proactive in countering money laundering and terroristfinancing to comply with the USA Patriot Act’s InternationalMoney Laundering Abatement and Anti-Terrorist Financing Act of 2001.
But figuring out the bad transactions from the good is noeasy task.
“If every A4 paper transaction made by LloydsTSB worldwidewas piled up over a week, it would endanger a 747 jet flyingto the US—that’s 35,000 feet of paper. To single out one badtransaction is very difficult,” said Richard Stockdale, headof LloydsTSB Global Services.
Agreements between banks and central banks for automatedclearing houses to reduce the cost of money transfers inbanks was suggested as one way to wean customers off thehawala system.
Alex Cunningham, head of the New York-based Middle Eastand Balkans Program at the Financial Services VolunteerCorps, thought that one way out of the dilemma was a morerepresentative banking system.
“Banks need to become more focused on low-income bankingand offer different products, such as lottery tickets andphone cards in low-income branches,” he said.
Greater transparency between the private and public sectorwas also highlighted as necessary to make it easier to spotsuspicious activities.
“The whole financial control framework does nothing if tradeisn’t transparent,” said Passas. “Despite all thisinfrastructure for anti-money laundering and counter-terrorist financing, take a look at the business environmentand there are huge holes—not loop holes—but black holes thatany half-decent criminal entrepreneur can take advantageof.”