Chapter

VI Legal and Regulatory Aspects of the Informal Hawala System

Author(s):
Mohammed El Qorchi, Samuel Maimbo, and John Wilson
Published Date:
August 2003
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Because of their significance, IFT systems have been the subject of regulatory concern for a very long time. Their recent notoriety has merely rekindled and galvanized this interest. Overall, the study found distinct differences between remitting and recipient countries’ government policy toward the informal hawala system. On the one hand, in recipient countries, important influences on the regulatory attitude toward the system have been state policies prohibiting informal financial transfers, the quality of the formal financial sector, and the level of political stability. On the other hand, hawala-remitting countries generally have fairly liberal foreign exchange policies and developed financial sectors. In these countries, the interest in IFT systems primarily stems from concerns about their potential criminal abuse. This section briefly reviews the evolving oversight framework for hawala dealers in some countries in line with changes in government policy. The examples in this section illustrate current practice in a number of countries. The description of one country’s approach does not imply that it is the only country pursuing this approach.

Hawala-Recipient Countries

Prohibition of Informal Hawala Transactions

India. Under both the Foreign Exchange Regulation Act (FERA, 1973) and its successor, the Foreign Exchange Management Act (FEMA, 2000), hawala-type transactions have been explicitly prohibited. The number of institutions (notably, “authorized persons,” such as banks) permitted to deal in foreign exchange has been closely defined, and the kinds of transactions (travel, medical treatment, acquisition of foreign assets, and so on) permitted for customers have been set forth in regulations that have been frequently revised. The recent FEMA wording specifically addresses hawala-type transactions by prohibiting Indian residents from entering “into any financial transaction in India as consideration for or in association with acquisition or creation or transfer of a right to acquire any asset outside India by any person.” Similarly, one of the mandates of the Directorate of Enforcement has been to prevent “remittances of Indians abroad otherwise than through normal banking channels (i.e., through compensatory payments).”

Pakistan. A large number of Pakistanis live abroad and the Pakistani economy has a long history with various forms of capital controls. “Legitimate” remittance channels—on the Pakistani side—have been restricted to licensed banks. Exchange houses are only authorized to carry out currency exchange, not to serve as a channel for net inward remittances. Yet, the official rate for the Pakistani rupee has often been subject to large discounts in the parallel market, which is favorable to various kinds of informal transactions, including hawala. Confidence in Pakistan’s economic policies and prospects has fluctuated widely over time, and the stop-go nature of policy changes has sometimes exacerbated the problem. However, since July 2002, a newly promulgated legal and regulatory framework for the transformation of money changers into foreign exchange companies allows money changers a two-year period to register and comply with the relevant prudential rules or capital requirements (see Appendix Table A3.1). After the two-year period, however, money changers will not be allowed to operate unless they register as foreign exchange companies.

Enhancing the Quality of Formal Financial Sector Services

Philippines. Except for the usual business registration requirements with the local authorities, there are no regulatory or supervisory requirements for hawala operators. Although originally regulated and supervised by the central bank, money changers have not been regulated since the economy was liberalized a number of years ago. Instead of directly targeting IFT activity, the Central Bank, through the Bankers Association of the Philippines, has encouraged banks to innovate and replicate the advantages offered by the informal sector. Consequently, banks have started providing such advantages, and continue to do so, for example, door-to-door delivery of cash remitted from abroad. More recently, innovations have included remittance raffles, which allow each remittance to be entered into a raffle offering different prizes ranging from cellular phones to free medical services. Moreover, many banks from the Philippines second their own staff to banks operating in regions where there is a high concentration of Filipino overseas workers. Interaction with their nationals when visiting foreign banks encourages them to remit their savings to the Philippines through the formal sector. However, in light of the new international efforts against money laundering and terrorist financing, money exchange dealers were included in the list of covered institutions mandated to submit certain information about suspicious activities of their customers. They are also required to adhere to the basic principles of the Anti–Money Laundering Act of 2001. In addition, an implementing circular for the licensing and regulation of foreign exchange dealers or money changers is under consideration.

India. The authorities have continued efforts to increase the efficiency and cost-effectiveness of banking services thereby making IFT systems seem less attractive. Massive bank branch expansions in the 1970s and 1980s have also reduced the per branch population. Branches of commercial banks in rural areas have increased access to the formal financial sector. The Reserve Bank of India has also allowed nonbank financial companies to undertake Money Transfer Service Schemes to facilitate swift and easy transfer of personal remittances from abroad to beneficiaries in India. These approved agents can, and do, in turn appoint subagents to ensure wide urban and rural coverage.

Self-Regulation

Afghanistan. The more than 300 registered money exchange dealers in the market have organized themselves into an operational self-regulating market.32 Estimates of the number of unregistered money exchange dealers in Kabul and around Afghanistan vary widely from 500 to 2,000.33 The market’s equivalent to a conventional Securities and Exchange Commission is an eight-member Executive Committee that meets regularly to discuss its members’ affairs. The committee’s executive director and his three assistants direct the activities of the Money Exchange Dealers Association and ensure that each member adheres to the association’s unwritten rules of conduct and practices. Membership in the association is voluntary and there are no subscription fees. Each member is entitled to attend the Executive Committee meetings. The open meetings facilitate a learning process for new members.

Hawala-Remitting Countries

In hawala-remitting countries, the regulatory approach varies between registration and licensing, with varying degrees of additional prudential, law enforcement, and anti–money laundering requirements.

Germany. Persons operating remittance services without a license from the German Financial Services Authority (BAFin) are liable to prosecution under Section 54 of the German Banking Act. Fines are imposed for contravention of this rule. Licensed remittance service providers are subject to regular supervision in the same way as other financial service providers. They must comply with the same requirements—fitness and propriety tests, obligation to draw up annual accounts and have them properly audited, regular special audits, and so on.

United Kingdom. Although hawala-type transfers are not in themselves illegal, the authorities’ main concern is the need for improvements in registration and record keeping. The recent legislative amendments of late 2001 are aimed primarily at strengthening registration and record keeping by those who participate in hawala-type transactions.34 As in other hawala-remittance countries, the primary focus is on the potential criminal dimensions of informal payment channels, especially money laundering and terrorist financing. In line with this approach, the administration of laws relating to the informal hawala system is entrusted with H.M. Customs and Excise Department rather than the Financial Services Authority. The U.K. hawala regulatory regime is interesting in two respects.

First, it requires only the registration and not the licensing of hawala operators. H.M. Customs can refuse to register a hawala business only if the applicants provide false information, fail to provide sufficient documentation as required by law, or fail to pay the registration fee. It will not conduct fitness and probity tests of applicants, determine the reasonableness of the applicant’s business plan, or assess the adequacy of the capital proposed for the business. Registration is one of the FATF-recommended options, and the U.K. authorities currently do not see the need for prudential regulation of hawala operators (see Appendix Box A4.2).

Second, it does not prescribe the minimum amount above which a “Suspicious Activity Report” must be prepared. Instead, the United Kingdom operates a suspicion-based system across the regulated financial sector. In its education campaign, H.M. Customs will emphasize that operators bear the responsibility of determining what is suspicious, regardless of the amount, and also be duty bound to keep “sufficient” documentation for adequate customer identification purposes. The only guidance provided is that the operator must be able to “identify customers and record or copy evidence of identity and address.”

United States. The government has strengthened the regulatory oversight standards for those remitting informal funds transfers. In the United States, the money remittance trade is well established, but not all participants are required to register with an appropriate authority. In 1993, federal legislation was passed to strengthen record-keeping requirements and integrate the requirements with anti-money laundering requirements. In 2000, the Uniform Money Services Act, promulgated by the National Conference of Commissioners on Uniform State Laws, created licensing provisions for various types of money services businesses. Licensing is set up as a threetiered structure—if a person is licensed to engage in money transfer services, he or she can also engage in check cashing and currency exchange without having to obtain a separate license for that purpose; if a person is licensed to engage in check cashing, he or she can also engage in currency exchange (but not money transfers); if a person is licensed to engage in currency exchange, he or she may only engage in currency exchange services. In the case of money transmission services, the act specifies the disclosures that must be made in an application for licensure, including information about the licensee (criminal convictions, prior related business history and operations in other states, and material litigation), information about proposed authorized delegates, sample payment instruments, banking information, and any other information reasonably required by the state regulator. After September 11, 2001, the United States passed the USA Patriot Act, which reinforces the responsibility of hawala dealers to register their activities, report suspicious transactions, and be subject to on-site inspections.

Saudi Arabia. Hawala transactions are illegal in Saudi Arabia. The Banking Control Law expressly prohibits unlicensed persons from engaging in any banking business.35 Any person who disregards this prohibition is liable to be imprisoned for a term not exceeding two years and a fine not exceeding SRls 5,000 for every day the offense continues unabated. Also, the regulations for Money Changing Business restrict money changers to the exchange of currency and purchase and sale of foreign currency, in addition to the purchase and sale of travelers checks and the purchase of bank drafts.36 However, the Saudi Arabian Monetary Agency may license any money changer to make cash remittances inside and outside the country.37 When so licensed, money changers are required to maintain, with their correspondents in Saudi Arabia and abroad, or in their offices, full coverage against all outstanding remittances on those correspondents to enable them to settle the value of remittances promptly upon receipt of all orders.38

In addition, Saudi Arabia has taken deliberate steps to improve the quality of the services offered by the formal financial sector. To reach out to expatriate communities, banks have launched new activities and services (such as Speed Cash and Tele Dial), which offer competitive services to their customers. Banks have also established branches in areas populated by expatriate communities and reduced charges on remittance-related services. Bank branches have changed their working hours to accommodate their targeted clientele and have started offering more rapid delivery of funds to home countries. Through correspondents in the recipient countries, some banks reportedly undertake door-to-door delivery of funds, using the post office and courier services. Banks have also introduced new financial technology, which has simplified account management and helped maintain loyal customers. On the receiving end, the authorities of some countries have launched campaigns to encourage the use of the formal banking sector by offering incentives to remitters and liberalizing trade and banking transactions. In Pakistan, for instance, the authorities have offered to reimburse the remittance fee to banks and money changers in remitting countries to encourage the channeling of funds through the formal sector.

United Arab Emirates. The U.A.E. has had formal banking-type regulations and supervision practices for nonbank money remitters’ operators since the 1980s but has also moved to strengthen its regulatory requirements. Federal Law No. 10 (1980) and subsequent Resolutions No. 31/2/1986 and No. 123/7/92 regarding the regulation of the money changing business in the U.A.E. permit money changers to be licensed as money remitters. The law provides, for example, specific guidance on the documentation required from clients engaged in the funds transfer business (see Appendix Table A3.2). Hawala operators must record details of persons or institutions that transfer an amount—for example, Dh 2,000 or the equivalent—in other currencies. The law requires that only the following original documents be used for customer identification purposes: (1) passport, (2) U.A.E. ID card for U.A.E. nationals, (3) labor card for non-U.A.E. nationals, or (4) driver’s license. The operator only needs to record the client’s telephone number without the address. In the case of transfers in amounts of less than Dh 2,000, the transferor should be given a receipt without the said details (see Appendix Box A4.1).

The Central Bank of the U.A.E. issued an announcement to hawaladars in the local newspapers on November 4, 2002. To regulate the informal hawala system, the central bank will start registering and issuing a “Simple Certificate” to all hawala brokers in the U.A.E., free of charge. In the announcement, the Central Bank of the U.A.E. assures hawala brokers that their names and details will be kept safe at the Central Bank. Hawala brokers, however, should provide the Central Bank with details of the remitters and beneficiaries who receive transfers from abroad on “simple forms” (available at the Central Bank). They are also required to report suspicious transfers.

The U.A.E. has also been working with the financial sector to improve its service quality. Formal institutions have in some cases attained a high degree of sophistication by adapting financial technology to their customers’ needs. Some of them currently offer accounts and electronic cards to their clients, which indicate the remitter ID and a list of beneficiaries with their addresses. These cards are aimed at reducing waiting time, accommodating the remitters, monitoring clients, and encouraging loyalty to the bureaus.

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