Helpdesk Research Report: The Hawala System 15.08.08 Query: Please identify literature on the Hawala system. In particular, how widely used is it? Is it predominantly used by poor people? To what extent does it link in with the idea of the „ummah‟ (global community of Muslims)? Enquirer: DFID Middle East and North Africa Department 1. Overview 2. Key Documents - Socio-cultural dimensions - The trust factor - Hawala and Islam - Reform efforts 3. Additional information 1. Overview Since September 11, there has been a great deal of interest in informal systems of transferring money around the world. Much of this has focussed on the hawala system (a type of informal funds transfer system functioning outside the formal banking sector and prevalent in South Asia, the Middle East, and some parts of Africa); its alleged role in financing illegal and terrorist activities; and proposals to bring it into mainstream financial and regulatory structures. There is, however, little in-depth analysis on the socio-economic or cultural dimensions of the hawala system, or of the extent to which it is used by poor people. However, it may be possible to draw some inferences about the latter from the information that is available. Most commentators agree, for example, that hawala has experienced a resurgence in recent years, mainly as a result of the significant rise in immigration from developing to developed countries since the 1970s. This has produced an increase in migrant worker remittances to their home countries. There is some evidence that while some remittances are sent for investment purposes, mostly they are sent to cover the basic needs of families at home.The Sharma (2006) study (below) found that the majority of expatriate workers from the Punjab in India came from middle to lower income groups. Also, most commentators agree that one of the reasons for the enduring popularity of the hawala system is that it provides financial services to remote rural areas where formal banking arrangements do not exist. Some analysts have also highlighted that many hawala users are illiterate or lack formal education, and prefer the hawala system to the impersonal and intimidating environment of banks. Most commentators also agree on the additional reasons that many expatriate workers opt for the hawala system and why the formal financial sector finds it hard to compete. These are that hawala systems are more expedient and speedy; they offer competitive exchange rates; they are convenient – hawala brokers often travel to remote locations to deliver funds in cash; and they are anonymous and don‟t require any documentation. In addition, according to many observers, the formal financial infrastructure, in both developed and developing 1 countries, has proved both unable and unwilling to handle large numbers of small transactions simply and has failed to offer the efficient services needed by migrant workers, especially in rural areas. This helpdesk report does not address the general characteristics of hawala systems in much detail, as this work has already been undertaken by the recent research report commissioned from the U4 Helpdesk. A number of the papers below, however, do focus on what is considered a particularly distinctive feature of the hawala system. This is that hawala transactions are underpinned by a deep sense of trust between participants, which is fostered through religious, national, ethnic, tribal, and linguistic links. Hawala brokers often work within a particular community to which they themselves also belong. As a result their customers are members of a wider network in which everyone is ultimately connected to everyone else. Therefore if anyone betrays the trust of the transaction, he or she is likely to be held accountable by the whole network, leaving the person unable to operate as a network member. While some commentators identify some Islamic principles which formed the basis of the evolution of the hawala system, there is little evidence that the system is considered a global „Islamic‟ institution. In fact, hawala systems mostly operate within very specific national, ethnic, and tribal communities, which can often be non-Muslim. However some literature does highlight that hawala systems seem to incorporate the Islamic prohibition against usury by not charging interest – hawaladhars take only a nominal commission fee instead. In light of these factors, experts argue that any intervention to regulate hawala systems must understand the social, cultural, ethnic, and economic factors from the perspective of the people who use hawala system, as well as its potential for illegal usage. Most analysts also agree that the extent to which hawala systems are used is difficult to quantify reliably and accurately given the informal nature of the transactions. However, they are widely considered to have a vast global reach, serving millions of people and channelling several billions of dollars every year, mainly to countries in Africa and South Asia. Most of the available estimates have already been detailed in the U4 Helpdesk‟s research report. This research report also briefly considers recent government and international efforts to understand the economic and regulatory implications of hawala systems and to design approaches for dealing with them. This stems from concerns expressed by many commentators about the social costs of the criminalisation of these systems. Some of the reports below highlight the closure, in the aftermath of September 11, of the US/Somali bank Al-Barakaat which the administration believed to be a major player in terrorist financing. Al- Barakaat offered hawala services to the Somali expatriate community in the US and the closure had far-reaching consequences as it interrupted the flow of vital funds to conflict- affected Somalia. For the average Somali migrant, such agencies are the only reliable means of sending money to their country. 2. Key Documents Socio-cultural dimensions De Goede, M., 2003, ‘Hawala Discourses and the War on Terrorist Finance’, Environment and Planning D: Society and State, Vol. 21, pp. 513-532 http://envplan.com/epd/editorials/d310t.pdf This paper argues that the negative stereotyping of hawala in press and policy discourses has implicitly constructed Western banking as the normal and legitimate space of international finance. The author argues however that hawala addresses the financial 2 exclusion of migrant workers. She documents the case of the closure of the Somali bank, Al- Barakaat, on suspicion of terrorism financing through its hawala services. The author highlights that: “It transpired that al-Barakaat was the only bank, the largest employer, and the only Internet provider in war-torn Somalia. The bank offered international money transfers to the Somali diaspora for example, to Somali families living in the USA sending money to relatives in refugee camps. The actions against al-Barakaat “made it harder for Somalis and other immigrants to send money to destitute family members in Africa'', one journalist noted” (p. 521). The author also argues that while there has been little research into exactly how remittances reach their destination, it is clear that hawala and other informal money transfer networks are indispensable to remittance flows, in particular to Africa and Asia. She cites an ILO study on Bangladesh which found that 40% of remittances take place through hundi (an informal funds transfer system, comparable to the hawala system). This is compared to 46% through official banking channels. The average cost of sending remittances through hawala is significantly lower than those of sending the money through Western banks or money-transfer companies such as Western Union. The author argues that there are further reasons for the popularity of hawala systems: “Migrant workers may be excluded from Western banking and `legitimate' money-transfer institutions for a complexity of reasons, including a lack of required paperwork in order to open a bank account (most importantly in the case of illegal immigrants), lack of language skills, lack of a formal education and the skills required to understand and fill out banking documents, and a distrust or fear of banks and other unfamiliar financial institutions. In Western countries in general, and in the USA in particular, opening a bank account is a complicated process which requires a number of official documents. In the USA, customers have to pay a fee in order to maintain a bank account, and account holders can be penalised for having bank balances below minimum requirements. In fact, financial exclusion of migrants has been exacerbated in the USA as a result of the Patriot Act, which requires additional identification of foreign nationals wishing to open bank accounts...Finally, it is important to note that the services offered by Western banks for international money transfers are wholly inadequate: they are costly, time-consuming, and not designed for small individual transactions...Banks have not shown much interest in workers' remittances in the past...The rural areas in, for example, Afghanistan and Pakistan from which migrant workers originate are often not connected to Western banking networks. In the Muslim world, a professor at Georgetown University testified before (a) Senate hearing, “cash remains the preferred medium for settling transactions. Banking institutions are concentrated in urban centres and cater mainly to the needs of governments and elite segments of society” (p. 523). El Qorchi, M., 2002, ‘Hawala: How Does This Informal Funds Transfer System Work and Should It Be Regulated?’, Finance & Development, Vol. 39, No. 4 http://www.imf.org/external/pubs/ft/fandd/2002/12/elqorchi.htm This article argues that for the formal banking sector to compete with the informal remittance business, it would have to focus on improving the quality of its service and reducing fees and charges. This would need a longer-term and sustained effort to modernise and liberalise the formal financial sector, with a view to addressing its inefficiencies and weaknesses.