Mr. Chairman and Distinguished members of this Subcommittee:
I am pleased to testify before you today on the topic of the Hawala institution, its origin, how it functions and what can be done to regulate it. The Hawala institution has drawn much attention recently in the context of the US war on terrorism whose goals include interrupting and preventing the mobilization of resources and transfer of funds through formal or informal channels to finance terrorist activities in the US or elsewhere.
Let me first provide a context for understanding the place of the Hawala in the modern financial system including in the Muslim world. I will do so by reference to my own personal experience. Prior to the last decade, in all my travel and living experience in numerous countries in the Muslim world, I had never observed others nor did I settle a personal or business transaction by any means other than cash. The reasons are not hard to find. For historical and policy reasons, financial development in many developing countries including the Muslim world has lagged behind the advanced OECD countries.
The late start with modernization in the post-WWII era has implied that the financial systems of most countries in the Muslim world lack depth and sophistication and that the institutions of regulation and supervision are not fully developed. More importantly, extensive government intervention in these societies including through repressive financial policies, excessive taxation, foreign exchange and trade restrictions and a banking system that is driven by the needs of governments have retarded the emergence of modern financial systems.
Reflecting these conditions, cash remains the preferred medium for settling transactions and dominates the composition of liquidity in many banking systems. Banking institutions are concentrated in urban centers and cater mainly to the needs of governments and elite segments of society. Modern habits of banking have yet to affect the majority of populations especially in rural areas. Protection of personal property is imperfect, enforcement of contracts is weak, government corruption is endemic and tax evasion is widespread
The Hawala institution should be understood in this broader context as an informal means of transferring funds or other assets within or across borders that is used primarily by individuals who are constrained by the level of financial development and government policies. It is a market response by economic agents to their economic environment. Evidence of its existence goes back thousands of years and it is widely in use throughout the world especially in Africa, Asia and more recently in the US. It is but one example of numerous informal institutions in credit and foreign exchange markets that have given rise to and reflect the existence of large "underground," "unofficial" and "parallel" economic sectors in many countries.
As is well known, individuals interested in transferring money to remote parts of this world and who may want to circumvent trade and foreign exchange restrictions or minimize other risks to their funds make use of the Hawala. It is simple, efficient and low cost relative to other options and, in some cases, the only means to remit income to families in distant parts of the world. Millions of expatriate workers in the world remit incomes through informal money transfer services including the Hawala and the funds involved while significant in total are generally small per person and per transaction.
The appearance of the Hawala institution in the US is directly linked to the growth of immigrant communitiesí especially from South Asia. Although the well-developed US financial system is available for domestic transactions, foreign money transfers remain subject to the problems noted above in the receiving countries. Hence, the Hawala flourishes as a business in this country. Most individuals utilizing the Hawala system and most operators of the system in the US could be safely presumed to be conducting legitimate activities at both the sending and receiving end of transactions.
Unfortunately, the simplicity and anonymity of the Hawala system has also attracted the individuals and groups engaged in illegitimate businesses or those exploiting the Hawala to fund illegal activities whether they involve money laundering, gambling, smuggling or terrorism. Hawala operators may or may not be accomplices in such transactions. Their minimal documentation requirements act as both an asset to their business and a liability in case of unintended wrongdoing. More worrisome, the lack of a "paper trail" undoubtedly frustrates any effort by law enforcement agencies investigating the source and destination of Hawala driven financial flows.
Reports that the Hawala was used in the past by terrorist organizations and most recently by those responsible for the Sep 11 attacks have prompted calls for legal authority and executive steps to investigate and when applicable seize assets and prosecute those guilty of aiding terrorists financially including Hawala operators. Already, a number of money transfer services have been closed down and their assets frozen worldwide. The Anti-Terrorism Bill passed a few weeks ago empowers the government to monitor many channels suspected of use to launder money and finance terrorism including the Hawala. In particular, the recent bill took the important step of extending the reach of basic US regulations of money transfer services to the Hawala.
By requiring Hawla businesses, among other things, to be licensed, maintain records and report suspicious transactions, the legislation struck an important balance between protecting US financial and security interests and allowing Hawala operations to serve legitimate purposes for which they had been designed. Hawala operators and customers are both served. The business owner acquires a legal standing that facilitates his operations and the customer is protected by legal recourse. As a result, we may in fact witness a growth in these money transfers, benefiting individuals and families in distant countries. On the other hand, non-compliant Hawala businesses or those engaged in illegal activities would face sanctions for violating the new legal requirements, potentially limiting their customer base.
The gradual approach adopted recently by the US congress to regulate the Hawala will prove more effective than what has been attempted elsewhere in the world especially when outright prohibition was enacted. The latter approach did not achieve its intended goals and only served to drive the Hawala further underground. This allowed Hawala businesses to charge customers higher fees and further conceal their operations. They also became more prone to engaging in other illegal activities as part or in parallel with their money transfer operations. Their need for protection brought them under the influence of smuggling rings, money laundering networks and corrupt politicians.
But like all laws, the effectiveness of any legislation including the most recent will depend on its implementation and enforcement. And while there is every reason to believe that the majority of Hawala operators will want to comply with the new legal requirements, it will be some time before affected businesses will come under the regulatory umbrella. Apprehension, confusion and fear characterize the mode within some immigrant communities at present. Language and cultural barriers also often act as obstacles to understanding the implications of the US war on terrorism on their daily lives. A concerted effort needs to be made at the grass roots level throughout these scattered communities to explain the changes and clarify the obligations of those affected by any legislation.
Bringing the Hawala under regulatory control will lift the veil of secrecy that governs its operations. In particular, it would provide authorities with important technical information about its working across borders including the methods for settling accounts, the geographic distribution of operators, the size and destination of financial flows, and the use of deposits in the formal financial system. This information could prove invaluable for law enforcement agencies and future legislation especially when international cooperation is sought among national monetary authorities to harmonize definitions and regulatory practices.
But we should be realistic about the limits of what can be achieved in the short term within our national borders to bring the Hawala institution into the modern world. So long as their remains a divergence between the US and other countries in financial development, banking efficiency, taxation levels and laws pertaining to foreign exchange transfers, there will exist a demand for the Hawala and other means of moving money across the globe. More importantly, difference in regulation and supervision standards across countries will create loopholes to be exploited by Hawala operators and other informal practices. In this case, international cooperation in sharing information and closer monitoring of international money transfers would prove indispensable.
Beyond the Hawala, efforts to track terrorist financing will lead to consideration of other formal and informal institutions suspected of acting as conduits for raising or moving money across international borders. Specifically, several reports have indicated that national and foreign charities are being investigated for suspicious financial activities and other connections to terrorist organizations. In this regard, we face even bigger challenges than in the case of the Hawala. The variance in the objectives, scope of work, internal organization, and financial practices of charities is wide, making it difficult to apply uniform regulations. Given that these charities in many countries represent the only avenues for the emergence of civil society, we must proceed with caution and seek local cooperation for information and law enforcement.
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