Underground finance: What’s the danger?

Alternative remittance systems fill a need traditional banks can’t

By John Cassara, former special agent for the Department of Treasury

Financial services firms know money is being transferred without their assistance and without adequate consumer safeguards. Does the money flowing through alternative remittance systems present a hazard? Let’s focus on “hawala” to get an understanding of the niche these systems fill and the countermeasures we should be taking.

What is it?

Hawala means transfer in Arabic and trust in Hindi. Immigrants often know someone they trust who will facilitate the transfer of money. The hawaladar (a broker who handles the transfer) can be a person or agency. In comparison to banks, the hawaladar charges a much less-expensive transfer fee, offers a better exchange rate and can often complete the transaction in one day. The transaction is anonymous and the hawaladar usually provides free delivery of funds to the recipient.

... economists put the total hawala transfers worldwide at about $100 billion per year. Most of those transactions are nonthreatening. But there is also a huge opportunity to profit from “black hawala” – the illegal transfer of money.

Alternative remittance systems (like hawala) are also called underground banking, parallel banking and informal value transfer. The underground financial systems are found around the world. They generally operate in the same manner and historically and culturally, most use trade in the settling of accounts between brokers.

Most hawala transactions are benign. They generally represent the remittance of wages from an immigrant back to his or her home country. This is sometimes called “white” hawala. For example, Ali is an Afghan immigrant who lives and works in Washington, DC. His father lives near Kandahar where there is poor security. Ali wants to send his father money to help support his family members, who are still living in Afghanistan. But Ali and other immigrants like him generally won’t go to a traditional bank for the transfer. Why?

  • Ali doesn’t trust banks. In fact, the de facto banking system in Afghanistan is hawala.
  • He may have to open account. The bank will require identification.
  • He or his father may be illiterate and intimidated.
  • Banks charge high transfer fees and offer unfavorable exchange rates.
  • The bank won’t deliver the money to his father.
  • Government authorities monitor bank transactions.
  • Taxes.
  • Some governments control the amount of money sent abroad.

How does it work?

Ali gives his money to the hawaladar in Washington, DC. The hawaladar is often a member of his same extended family, tribe or clan. Remember, hawala means “trust.” Ali receives a code number to send to his father. The DC hawaladar contacts a hawaladar (directly or indirectly) in Kandahar via email, fax or phone, and arranges the transfer. The Kandahar hawaladar arranges a courier who personally delivers the money to Ali’s father in exchange for his code.

No money passes between the two hawaladars during this transaction. Instead, they may later bundle transfers and courier the cash between themselves. They may also use virtual currencies or trade to provide countervaluation. Most hawaladars also use bank transfers.

A hawaladar is not always a friend or extended family member. It’s becoming more and more acceptable to employ a hawaladar who is fronting his hawala business with another legitimate business, for instance a travel agency, payday loan store, import/export companies, jewelry companies and used car lots. Hawaladars make additional money from these side businesses. They also earn income by engaging in currency trading and speculation and the collection of small fees.

Can this be legal?

According to Gretchen Peters in her book Seeds of Terror, economists put the total hawala transfers worldwide at about $100 billion per year. $100 billion dollars!

Most of those transactions are nonthreatening. But there is also a huge opportunity to profit from “black hawala” – the illegal transfer of money. Because hawala lacks transparency, criminals and terrorists are also attracted to the underground financial system. For example, The World Bank and UN calculate that hawala dealers in Helmand and Kandahar alone move $1 billion in drug money every year.

Some cultures embrace hawala. And so the answer to whether or not hawala (and other alternative remittance systems) is legal depends on the country. Hawala is legal in the US; it’s considered a money service business (MSB) and is subject to the same regulatory scrutiny and consumer protection policies as other financial services firms – and the same taxes. In the US, a hawaladar must register with FinCEN and renew that registration every two years. They must also register in the state they operate. And as an MSB, the hawaladar must file suspicious activity reports (SARs) - which goes counter to the anonymity of the system.

Few register. Few report.

Although most transactions are benign, there are some high-profile cases of hawala being used as the conduit for money laundering and terrorist financing:

What can we do?

Monitoring this underground banking system is a huge challenge. By now, you’re probably wondering if we stand a chance at defending against the nefarious use of alternative remittance systems. There are no easy fixes and many of the countermeasures are out of our control because they are influenced by foreign actors.

Some international and domestic countermeasures include:

  • Ensure that hawaladars and other money service businesses are registered and licensed.
  • Implement increased currency controls.
  • Increase awareness among compliance officers.
  • Provide low-cost alternatives to traditional banking services.
  • Be diligent in SAR filings.
  • Move away from a cash-based economy.
  • Raise awareness of trade-based money laundering.
  • Increase the number of trade transparency units.
  • Increase customs inspections and control.
  • Investigate new payment methods that provide greater transparency.
  • Increase literacy.
  • Improve outreach to immigrant communities so that they are made aware that unregistered money remittance services are illegal.

And since many hawaladars and similar underground financial networks often use financial institutions, advanced analytics should be employed to provide the transparency the hidden systems seek to deny. For example, I recently spoke to a bank representative that uses SAS® Fraud Network Analysis to monitor all trade financing and tie those transactions to wire transfers. Additional data sets can be examined and red-flag indicators installed (for example, transfers to suspicious locations, individuals on designated lists, etc.). The bank then gets a holistic view of the connections across its global organization. In other words, once again we can use big data and advanced analytics to get down under the covers to spot suspect activity.


Read More

Read A Layered Approach to Fraud Detection and Prevention. Dan Barta and David Stewart of SAS call for a more holistic approach to fraud detection than the silo systems in use today. They describe a layered approach with controls at multiple levels across the organization, with network analysis to reveal links among entities and uncover fraudulent behavior that would otherwise go undetected.

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