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Money Laundering


									Informal Value Transfer Systems: Efficient, Reliable, and Worrisome

Problem: Although generally benign, efficient and reliable, Informal Value Transfer
Systems (IVTS) can facilitate criminal money laundering, fund transfer for terrorism, and
lesser economic crimes such as currency speculation and tax evasion.

        Much has been written recently about “underground banking” systems largely because of

the discovery that one such system, the “hawala”, played a significant role in transmitting funds

that financed the September 11, 2001 terrorist attacks on New York City and Washington, D.C.

The hawala system has also been linked to bribery of government officials in India (the “Jain”

Hawala Cases) and Kashmiri terrorism. In addition, law enforcement officials in many countries

have long recognized that such systems facilitate money laundering from such operations as drug

trafficking and smuggling.

        However, the hawala and other such fund transfer systems are not “per se” evil. Rather

they are cost efficient, reliable methods of money transfer, used mostly for legitimate ends. The

“problem” with these systems lies in the fact that they are unregulated and thus invisible to

government scrutiny, which means that they are attractive to people who want to use them to

transfer money secretly for illicit purposes.

“Informal Value Transfer Systems” Costs and Benefits:

       In this paper, I will use the term Informal Value Transfer Systems (“IVTS”) to refer to

these systems. Nikos Passas, a professor of Criminal Justice at Temple University, uses this term

instead of “underground banking systems”, or “alternative banking systems” because:

       (1) These systems are not always “underground”. Rather in many parts of the world they
           are highly visible and legal.
       (2) The systems are not strictly speaking “alternative”, because they predated formal
           banking systems, and thus did not evolve as an alternative to formal banking systems.
           In addition, they do not mimic formal banks, which take deposits, make loans, and
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            extend credit. The IVTS deal solely with transfers of value. The value transferred can
            be money or other assets such as gold or computer equipment.
       IVTS are found in many countries and under many names, such as “hawala” or “hundi” in

India, and “fei ch’ien” in China. Most contemporary forms of these systems evolved out of two

main variations, the South Asian and the Chinese, both of which originated centuries ago. In these

areas, IVTS developed largely to facilitate legitimate trade and predated the formal banking

system. Thus, they did not arise to assist illegal transactions or as a means to evade the regulation

of the formal banking system. Further, these systems were not generally associated with violence

and corruption, but with smooth, consensual, unremarkable transacting. They became “integral

elements of the culture” of both South Asia and China prior to the introduction of formal banking

and developed best in these areas in part because of the social structures which ensured the trust

essential to the completion these informal transactions.

How IVTS Work
        IVTS work something like a Western Union transaction. A typical transaction may

involve an expatriate or immigrant who wants to transfer money to his family back home. As an

example, say an expatriate Pakistani worker in the United Arab Emirates wants to send money

back to his family in Pakistan. The worker visits a hawala broker, gives the broker the money he

wants to send, a fee, and the name of the family member in Pakistan who will receive the money.

The broker in the UAE contacts a broker in Pakistan. The worker calls his family and tells them

that the money is on its way, and the designated family member picks up the money from the local

Pakistani broker.

        Note that the broker in the recipient’s country pays the money out of her own accounts,

without receiving any money from the broker on the sender’s end. The fact that the money does

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not move, either physically or electronically, highlights an important factor that both distinguishes

IVTS from formal systems, and makes IVTS difficult to monitor and regulate. This factor is the

network of trust and connections that exist between people who operate these systems. Transfers

of money take place based on communications between people who must trust each other to

eventually “balance” the transactions. The trust between the brokers secures the debt and allows it

to stand with no legal means of reclamation.

        This trust exists in part because many IVTS networks consist of members whose relation

to each other is based on family or tribal ties. In addition, broken trust between dealers would

result in community ostracism and economic suicide for the broker committing the breach of trust.

Benefits of IVTS
        Legitimate use of IVTS exists today even when formal banking systems and regulated

transfer systems exist. The existence of trust between the brokers increases the efficiency of these

transactions, because it lessens the need for costly, detailed contracting and outside insurances that

the deal will be fair or upheld. These systems are attractive to people who want to send money for

legitimate purposes because they are cost and time efficient, and reliable.

       Cost Efficiency: IVTS can offer better exchange rates (for international transfers) than
        banks or formal money remittance systems. Some of the reasons for this include:
           o IVTS typically operate with a very low overhead, either as part of an existing
             business or perhaps even out of a booth in a tea house;
           o Since the money in question does not go thru any formal channels, IVTS can take
             advantage of minute fluctuations in the “street” prices for currency;
           o As stated above, the trust between dealers facilitates transfers because it allows for
             lowered transaction costs. Poorer individuals therefore use IVTS to take advantage
             of the low cost and quick delivery that the system provides.

       Time Efficiency: An IVTS remittance takes place in, at most, one or two days. Contrast
        this with the week or so required for an international wire transfer involving at least one

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        bank, and the week required to send a bank draft from North America to South Asia via a
        courier service.

       Reliability: Trust between dealers means that there is no need for complex transactions
        which involve more than one bank, differing sets of regulations in each country, and
        different recording requirements. In addition, since the money really doesn’t “move”, and
        since the accounts between dealers need not be balanced within any required timeframe,
        the pay out doesn’t depend on externalized, unreliable factors. IVTS transactions are, in at
        least some cases, more reliable than similar international formal banking transactions.
        Patrick Jost of FinCen and Harjit Singh Sandhu of Interpol, write that in “at least once
        instance reported to the authors, money for a large commercial transaction (money being
        sent from the United States to South Asia) was lost “in transit” for several weeks while
        trying to conduct such a transaction. When the bank located the money, it was returned to
        the customer. He enlisted the services of a local hawaladar, who was able to complete the
        transaction in less than a day.” Jost and Sandhu, “The hawala alternative remittance
        system and its role in money laundering”, Interpol General Secretariat, Lyon, January

       Cultural/Social factors: In many remote areas where IVTS operate, there are no banks
        nearby. The system is ideal for use in isolated localities such as the tribal areas of Pakistan
        and Afghanistan. In addition, the countries in which IVTS flourish often have heavily
        regulated, difficult to use, unreliable banking systems in which transfers may cost a lot
        more than an IVTS transfer, and offer less value. Other social and cultural factors include
        cultural traditions, tribal connections, class systems, and mistrust of bureaucracy. In
        addition, many immigrants and expatriates from countries where these systems exist have
        traditionally remitted a large part of their income to their families in their home country
        through IVTS transfers.

        In sum, IVTS are efficient, low cost, reliable methods of money transfer that serve the

needs of many people who are not served by formal money transfer systems, either because of

rural isolation, poverty or onerous regulations which make simple money transfers prohibitively

difficult. These systems by themselves are economic, not criminal phenomena. IVTS would

continue to operate “even if there were no terrorist international transfers, drug trade, or money

laundering”. Robert E. Looney, “Strategic Insight, Following the Terrorist Informal Money Trail:

The Hawala Financial Mechanism”. (November, 2002).

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Costs of IVTS: Criminal Transactions:

        On November 7, 2001, the American government accused two groups, Al-Barakaat and

Al Taqua, of using the hawala system to secretly funnel tens of millions of dollars a year to

al-Qaeda, Osama bin Laden’s organization and froze their assets. Ashish Dewan and Sabrina

Saccoccio, “Money-transfer systems, Hawala style.” CBC News Online (November, 2001).

        Although terrorism is a recent concern, the unregulated nature of IVTS makes them

particularly attractive to anyone who wishes to hide a money trail. These systems have also been

and continue to be used for many other criminal purposes such as:

       Drug traffic (for example, money from the Afghan drug trade is laundered through the
        hawala system)
       Smuggling of illegal aliens
       Illegal arms transactions
       Intellectual Property violations (such as video piracy)
       Terrorist funding
       Ransoms from kidnapping
       Money laundering

        The efficiency and secrecy of IVTS works especially well to “launder” money. The term

“money laundering” is a catch-all phrase that denotes various methods of “transforming” money

by hiding its illegal origins and funneling it into “legitimate” markets. Interpol uses the following

description of money laundering: “Any act or attempted act to conceal or disguise the identity of

illegally obtained proceeds so that they appear to have originated from legitimate sources”.

Money laundering involves three phases, “placement”, “layering” and “integration”. IVTS can be

used at any one of these phases.

       Placement: the money received from illegitimate transactions is gradually introduced into
        the legitimate banking system.

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           o At the placement level, the biggest problem for the money launderer is how to
             move cash into the formal banking system without raising red flags. The IVTS
             dealer (who often runs a legitimate business along with her IVTS business) can
             introduce small amounts of cash into her own bank account along with deposits
             from her legitimate business, and can further disguise the proceeds through invoice

       Layering: the money, now in legitimate accounts, is distributed and transferred between
        legitimate accounts. IVTS can be used to “layer” money by having IVTS dealers in
        different countries put money into their own accounts.

       Integration: finally this money is used to finance legitimate transactions such as real
        estate purchases
        Keep in mind that IVTS transactions, the money doesn’t actually “move” from account to

account. Brokers balance their accounts informally, and not on any particular timeline. As a result,

IVTS transfers leave a confusing paper trail if they leave any trail at all. Simple, legitimate IVTS

transactions are difficult to trace, and IVTS transactions that are designed to disguise money can

be nearly impossible to trace.

        It is a mistake, however, to think that money laundering transactions are confined to IVTS.

People wishing to launder money frequently use the formal banking system to launder funds by

setting up nominal accounts. In addition, money launderers can use other methods to transform

money, such as front companies and derivatives trading. Also note that it is relatively easy to

transport money illicitly by simply smuggling it in closed containers through container shipping.

        Finally, it is interesting to note that in some instances at least, governments have used the

secrecy of these systems to further their own ends. In Madagascar during World War II, British

intelligence agents used hawala brokers as informants against both the Axis and the Indian

pro-independence militants. More recently, the CIA used the hawala system to fund the

Mujahedeen in Afghanistan.

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Costs of IVTS: Economic Dangers:
        Although IVTS’ facilitation of drug trafficking and terrorism pose international threats,

there are more subtle economic threats for developing economies posed by tax evasion, currency

speculation, and “capital flight”. These economic dangers hurt developing economies more than

stable ones.

       Tax Evasion: IVTS provide a channel through which money can flow un-scrutinized and
        un-documented. IVTS transactions don’t alert tax authorities. A receiving country
        therefore cannot gain direct tax revenues from these funds.

       Currency (Exchange Rate) Speculation: One of the reasons IVTS transactions are so
        efficient is that dealers can offer better rates than a bank (which will only transact at
        authorized rates of exchange) while still turning a profit. Exchange rate speculation can
        distort trade in developing economies. Because these transactions are not reflected in
        official statistics, the receiving country doesn’t have the ability to monitor the received
        currency, and therefore misses the chance to acquire valuable foreign currency through
        these transactions. In addition, unregulated cash transfers increase the amount of cash in
        circulation, which can cause inflation, also leading to trade markets distortion. Trade
        distortions can further de-stabilize an already unstable economy.

       “Capital Flight”: This refers to the phenomenon where a person seeks to protect her
        money from an unstable economy by sending it to a more stable one. Capital flight drains
        money out of a developing economy, leading to loss of revenue.

        In addition to the above, there is some concern about the effect of large scale unregulated

money transactions on government policy and general respect for the law in a developing country.

Nikos Passas notes that economic policies can be undermined and the “normative” order of law

can be weakened by a perceived disregard for regulations. However, the negative effects of these

transactions on an economy should not be overstated, because ITVS are merely one of many other

value transfer options open to both legitimate and criminal actors.

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Regulating IVTS:

        Even given the potential dangers and the economic costs to a country, IVTS fill a need.

They exist in large part because they are economically more efficient than comparable formal

systems. Although many experts point out that these systems develop and flourish in countries

which have onerous governmental regulations on financial institutions and official corruption and

neglect; IVTS also work in a wider setting because they are incredibly efficient. IVTS are close to

being a “frictionless” value transfer system with very low transaction costs. In effect, they are

“Western Union without the hi-tech gear and the exorbitant transfer fees”. Sam Vaknin, Ph.D.

“Hawala, or the Bank that Never Was”.

        Given the benefits of and need for these systems, several questions arise with respect to

proposed governmental regulation of IVTS. First, how real is the threat from these systems?

Second, if they are a real threat, is prohibition desirable or even possible? Finally, if IVTS are a

threat and eradication is not a viable solution, what attempts can be made to regulate or monitor

IVTS use?

        Nikos Passas suggests that IVTS do not present a greater money laundering or “hard core”

crime threat than formal banking systems, which are used just as often to facilitate these crimes.

However, it is important to note that Passas’ article was written prior to the September 11th

terrorist attacks, and therefore, does not reflect current concerns about ITVS. While IVTS

themselves may not be threatening, there is a consensus that the potential anonymity of the

transfers afforded by these systems present strong risks for their use in criminal and terrorist


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         The discovery that the hawala IVTS system was used to finance the September 11th

terrorist attacks sparked calls for prohibition of these systems. The hawala system has been

banned in Saudi Arabia, and Pakistan has called for prohibitions of the system. However, FBI

agent Greg Bretzing, an expert in financial fraud, has stated, “The worst thing is to drive operators

underground and make it harder to track. The vast majority of these funds are for good purposes.

Only a fraction goes to criminal or terrorist activities”. Additionally, many participants in a

conference of over 300 bankers in Abu Dhabi held on May 16, 2002, concluded that trying to ban

IVTS would hurt more people than it would help, first because there is no guarantee that a ban on

IVTS would be effective, and second because these systems serve a very real function, and

therefore banning them may create more problems than solutions.

         Although in most cases, banning IVTS is not a desirable solution, there is a need to “keep

an eye on” these systems by means of some kind of regulation or monitoring. The purpose of a

regulatory approach would not ostensibly be to eliminate IVTS, but rather to prevent their misuse.

However, that this kind of focus involves distinguishing legitimate IVTS use from criminal abuse

which may be difficult, given the shadowy nature of even legitimate transactions. In addition,

many countries affected by IVTS have differing legal and economic systems, and therefore

regulating IVTS is complex, and country specific.

         Policy makers tend to favor regulation which attempts to either register or license IVTS.

Along these lines, participants at the 2002 Abu Dhabi conference called for government licensing

and regulation of IVTS offices. In addition, conference participants proposed setting up control

systems to monitor IVTS to guard against any diversion of such funds into illegal or criminal


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        Since IVTS have developed and flourished outside the formal banking system and have

shown themselves resistant to many attempts to impose record keeping and reporting requirements,

it is unclear just how effective a registration or licensing scheme would be. Any such scheme

would need to find IVTS dealers in order to license them. Perhaps one way to do this is to catch

IVTS transactions at the point where the money enters the formal banking system: in the IVTS

dealer’s own bank account. Just as bank officials may be trained to recognize credit card fraud

through records of a certain type of bank transaction, they could be trained to recognize bank

accounts from IVTS dealer activity. Additionally, in cases where IVTS dealers are known or

visible, they can be reached by regulations that impose licensing.

        Further any regulatory scheme that is too onerous may actually exacerbate the risk of

IVTS going further underground. If these systems are invisible, regulation may need to focus on

the proscribed or criminal activity facilitated by the IVTS rather than on the IVTS themselves.

        Lastly, it may be that the best way to “fight” IVTS is to make them less attractive by

reducing the economic incentives to use them. Liberalization of the banking system in some

countries could bring transaction costs down, and thus draw customers away from IVTS. If cheap,

fast, reliable remittances across international boundaries existed, there would be less reason to use

an IVTS. As Nikos Passas states, “This system has worked for ages. Instead of killing it, we need

to learn from this successful business model”.

Specific Regulatory Attempts:

        Many governments have addressed the problem of regulating IVTS. Some concentrate on

the criminal operations that are served by these systems, while some attempt to regulate the

systems themselves.

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        India (hawala): The Indian government set up a special federal police unit with the sole

function to fight economic crime in India such as bank fraud and the movement of money from

foreign countries through IVTS. This unit targeted the big known hawala brokers. Government

officials believed that strict enforcement of banking laws and more investigations of hawala

operations would reduce the amount of money sent through the IVTS and divert the funds into the

regulated banking industry.

        In addition, recent economic reforms by the Indian government may reduce the amount of

money flowing through the hawala by liberalizing the economy and making hawala less attractive.

When India lifted its ban on gold and silver importation, this resulted in less money going through

the hawala system from smuggling these metals.

        India’s targeting of known hawala dealers and reducing the incentives for criminal money

to go thru the hawala system by in effect decriminalizing certain activities, are country specific

solutions that have proved somewhat effective in fighting economic crime, and may be an example

of the type of regulations that can work to control the misuse of IVTS.

         Pakistan (hawala): Pakistani President Gen. Pervez Musharraf's government passed a

law in 2002 that requires hawala dealers to register with the government and document their

transactions. Since the law passed, the government has ordered the closure of dozens of

unregistered hawalas. In addition, this law requires that a hawala dealer’s license be revoked if the

dealer is found to be involved in illegal currency transfers.

        Pakistan’s attempt focuses on the hawala system itself, rather than on ways of reducing the

money flowing through the system, or on ways of making the system less attractive by liberalizing

banking regulations. In countries where IVTS are visible, licensing attempts are more likely to be


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       U.S. (hawala): Much recent legislation concerning IVTS arose post September 11th in an

effort to combat terrorist financing. Title III of the U.S. Patriot Act, which is called The

International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (the “Act”),

is divided into three broad subtitles:

       A. International Counter Money Laundering and Related Measures,

       B. Bank Secrecy Act Amendments and Related Improvements, and

       C. Currency Crimes and Protection

       The Act imposes significant anti-money laundering requirements on financial institutions

including U.S. operations of foreign banks, broker-dealers, and investment companies. It further

authorizes the Treasury Secretary to impose even more requirements. Under the Act, financial

institutions must maintain and file reports on transactions deemed by the Treasury Secretary to be

of “primary money laundering concern”, verify the identity of anyone wishing to open an account,

and consult lists of known terrorists or terrorist organizations prior to opening an account. In

addition, the Act requires all financial institutions to put an anti-money laundering program in

place, and prohibits anyone from “knowingly conducting, controlling, managing, supervising,

directing, or owning a money transmitting business” either without a state license or without

registering with the Treasury under 31 U.S.C. § 5330. It also provides criminal and civil penalties

for the transportation or transmission of funds that the transmitter “knows to have been derived

from a criminal offense or are intended to be used to promote or support unlawful activity”. (See §

373 of Subtitle C of the Act).

       The Act imposes broad duties on financial institutions. It is still unclear just how effective

it will be in actually regulating IVTS use in terrorism, and the U.S. has continually stressed the

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necessity for “global compliance” in efforts to stop terrorist financing, and indirectly to control



        Many organizations are currently addressing the issue of IVTS, in part because of concern

over terrorist funding post September 11th. Among them are the Paris based Financial Action Task

Force, whose “Special Recommendation VI” relates specifically to “alternative remittance”

systems, Interpol, and numerous governmental agencies. However, solution to the problem of

IVTS misuse must be balanced by recognition of the benefits of the legitimate use of the systems

themselves, and must not impose onerous regulations that may actually increase the use of IVTS.

Nikos Passas L.L.B, Ph.D. “Informal Value Transfer Systems and Criminal Organizations; a study
into so-called underground banking networks” (1999).

Jost and Sandhu “The hawala alternative remittance system and its role in money laundering”
Interpol General Secretariat, Lyon, January 2000.

Robert E. Looney, “Strategic Insight, Following the Terrorist Informal Money Trail: The Hawala
Financial Mechanism”. (November, 2002).


International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001

Betty Santangelo, “Analysis of Anti-Money Laundering Provisions of USA Patriot Act”
(December, 2001)

World Money Laundering Report

Sam Vaknin, Ph.D. “Hawala, or the Bank that Never Was”


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