What is Hawala? How Does the Hawala Payment Works?

Hawala is an old trust-based money transfer system operating outside formal banking channels. It is simple and efficient, but Hawala’s lack of documentation and transparency poses great risks of money laundering and sanctions evasion. We will be looking at how Hawala works, why it is still commonly used and its potential risks.

What Does “Hawala” Mean?

The word “Hawala” originates from an Arabic term meaning “transfer” or “trust” and it refers to an informal money transferring system with no physical cash moves or traceable digital trails. Hawala relies primarily on intermediaries called hawaladars who facilitate money transactions based on trust.

Compared to traditional financial systems, hawala has:

• No Banks, No Receipts: Transactions are made relying on trust between the parties rather than any official financial institutions, and therefore, hawala leaves no digital or paper traces, which makes it difficult to monitor.
• No SWIFT or Formal Documentation: Hawaladars transfer money without using global banking networks like SWIFT or formal documentation, but they do it through codes or informal agreements instead of traditional banking processes.
• Regionally Focused: Hawala provides an alternative for financial transactions in areas with underdeveloped banking infrastructure, such as South Asia, the Middle East, and certain parts of Africa.

Hawala system is not illegal and is still used for legitimate transactions by migrant workers, even though it is often labeled as “underground banking”.

How Does the Hawala System Work?

Hawala enables fast and secure transfers without any digital or physical cash movement. It works simply but in an opaque way. Here is how it works:

Step 1: When the sender gives cash to a local hawaladar in Country A.

Hawala transactions begin when the sender, who seeks a fast and discreet transfer, gives cash to a trusted hawaladar, and it relies on a private and verbal agreement that leaves no official record.

Step 2: The hawaladar contacts their counterpart in Country B.

When the cash is received by the hawaladar in Country A, he gets in touch with their counterpart in Country B where the recipient resides. The communication between them may occur through coded messages that ensure the confidentiality of the transaction, as hawaladars maintain a strong network bound by family ties to make these exchanges easier.

Step 3: The counterpart pays the recipient hawaladar in the local currency.

This transaction is completed off the official records without any formal documentation or involvement of financial institutions, which is a popular method in areas where the banking systems are unreliable or somewhat inaccessible.

Step 4: In the final step, hawaladars settle balances among themselves.

When the transaction is complete, the brokers settle their balances through informal methods like trade settlements or remittances, which are conducted over time, depending on mutual trust within the network that ensures the system's smooth functioning and continuation without external monitoring.

Hawala is a decentralized network favored for its speed, low costs, and accessibility.

Is Hawala Legal or Illegal Around the World?

Whether hawala systems are legal or not varies from one jurisdiction to another:

• Legal (under certain regulations): Hawala systems are legal but strictly regulated in a few countries, such as India and Pakistan, where hawaladars have to register themselves as licensed money changers to ensure a level of monitoring and compliance with financial laws.
• Unregulated but tolerated: In the United Arab Emirates, Saudi Arabia, and Qatar, Hawala systems operate in a gray area as they are widely used in communities where traditional banking systems are less accessible, especially for migrant workers who send cash remittances.
• Illegal: Western nations like the U.S., UK, and EU consider hawala illegal if it is done without proper licensing, and many unregistered transactions are criminalized due to risks of money laundering, terrorist financing, and so on.

While hawala may not be illegal, transactions related to fraudulent activities or sanctions evasion within its system can lead to harsh penalties or even prosecution.

Why is Hawala Considered High-Risk for Financial Crime?

Hawala’s lack of transparency can potentially make financial crimes easier. Here are some of the key concerns:

• No Transparency: It is difficult to trace or monitor the flow of money in hawala systems as they operate with no formal documentation, which poses great challenges to regulatory authorities whose job is to monitor financial activities.
• No Customer Due Diligence: Hawala systems do not implement Know Your Customer (KYC) processes to verify the identities of those involved, which makes it almost impossible to ensure that hawala users are legitimate or to detect any suspicious activity linked to them.
• Money Laundering and Terrorist Financing: It is a possibility for criminal networks to exploit hawala systems to do illicit money transfer without detection, since unregulated channels can be used to launder money or fund criminal activities such as terrorist operations.
• Sanctions Evasion: Entities that seek to transfer money in violation of global regulations may favor hawala since it enables financial transactions in regions where international sanctions are enforced, avoiding formal banking restrictions that might complicate compliance efforts.

Some of the important regulatory bodies, like the Financial Action Task Force (FATF) and OFAC, consider hawala a risky business for money laundering and authorize ongoing monitoring of its activities.

How Can Compliance Teams Detect Hawala Activity?

It may be challenging to identify hawala transactions in a traditional banking system, but it is essential to minimize financial crimes; thus, compliance teams should look out for these red flags:

1. High transfer volumes linked to high-risk jurisdictions: A Large amount of money transfers to or from countries with weak financial regulations or high corruption rates, which might indicate potential illicit activities.
2. Use of unlicensed money service businesses (MSBs): Use of MSBs with no proper licensing or regulatory monitoring can be a red flag for illegal financial activities or avoiding compliance checks.
3. Unusual transaction patterns that deviate from customer profiles: Sudden spikes in customer activities or money transfers to unfamiliar accounts may signal suspicious acts of financial crime.
4. Third-party involvement without a clear business purpose: Making transactions to third parties that have no relationship to the customer may indicate attempts to do money laundering or disguise the real beneficiary of the funds.

Mitigation Strategies

• For a more targeted approach to monitoring transactions, implementing geo-risk scoring is a good idea to identify high-risk locations by assessing areas known for financial crimes or sanctions violations.
• By scanning global media sources and databases for any red flags linked to certain individuals or organizations, adverse media and watchlist screening can be used to reveal potential links to sanctioned parties.
• Real-time transaction monitoring is key to notice unusual patterns in customer activity, such as sudden large transfers or transactions untypical of the customer's behavior.
• Providing comprehensive training to the staff for identifying informal value transfers is critical so that they can recognize subtle signs of illicit financial practices.

Tech tools like Sanction Scanner help compliance teams by monitoring transactions and doing proactive screening for informal systems like hawala.

Hawala vs. Banking Systems

We can investigate whether hawala can measure up to traditional banks or not:

As you can see, while hawala is not illegal by definition but its unregulated nature can make it susceptible to abuse.

Is There a Connection Between Hawala and Sanctions Evasion?

Yes. Hawala systems is and have been used to evade sanctions through:

• Funds from Sanctioned Countries: Since hawala transfers are made outside of traditional banking systems, it is easy to bypass formal regulations, which allows funds to flow in or out of sanctioned nations without detection. These unregulated activities can support criminal acts that don’t follow any international restrictions.
• Masked Identities: Sanctioned businesses can exploit the anonymity of hawaladars to disguise their involvement in illicit financial transactions, as these intermediaries make tracing the destination of funds hard for regulatory authorities.
• Illicit Trade Facilitation: Front companies may blend legitimate and illegal transactions by collaborating with hawaladars and obscure their movement of funds to illegal trades. This makes it even harder to identify unlawful financial activities that complicate enforcement processes.

While hawala fulfills an economic need, especially for migrant remittances and regions with limited access to formal banking, its informal, trust-based structure creates significant compliance challenges. According to our data, we can infer that hawala businesses operate in a legally gray area across jurisdictions, and the compliance challenges can be particularly severe in the context of Anti-Money Laundering (AML) and Counter-Terrorism Financing (CTF) obligations.

1. Absence of Regulatory Oversight

Hawala networks usually work without licenses; therefore, they can fall outside the reach of financial regulations and escape from institutions that monitor illicit financial acts.

Implication: Hawaladars can avoid mandatory AML compliance audits and obligations as they are not required to register themselves as Money Service Businesses (MSBs).

2. No Customer Due Diligence (CDD) or KYC Processes

Hawala system operates on mutual trust and personal relationships rather than formal identity verification. Thus, customers rarely go under Know Your Customer (KYC) checks.

Risk: Criminals may take advantage of these gaps to hide their identities and launder money without any detection.

3. Lack of Record-Keeping and Transaction Reporting

The undocumented nature of hawala transactions makes it impossible to track or monitor, which violates the core AML principles of transparency and accessibility.

Problem: No Suspicious Activity Reports (SARs), transaction logs, or paper trails available for law enforcement investigations.

4. High Vulnerability to Abuse by Criminal Networks

Because of its anonymity and secrecy, hawala systems may provide a secure environment for illicit activities tied to organized crime groups, tax evaders and human traffickers.

Example: Authorities have connected Hawala to terrorist groups and cross-border money laundering operations that involve millions of dollars.

5. Cross-Border Enforcement Difficulties

Hawala operators generally work internationally as they transfer money between countries without actual cash flows; therefore, it is hard for authorities to enforce regulations or carry out investigations.

Obstacle: AML authorities often deal with problems while coordinating across legal systems with different enforcement standards and definitions.

6. Low Awareness and Limited Guidance

Many regions lack regulatory clarity and education to bring Hawala systems under close scrutiny. Even though some countries (like the UAE) have started to implement registration programs lately, its global impact is consistent.

Impact: Legal hawala brokers may want to comply, but they often lack the tools and knowledge to implement compliance programs.

7. Reputational and Business Risk

Without a proper compliance framework, even legitimate Hawala operators can be blacklisted or shut down by governments and financial institutions.

Outcome: Hawala networks are further isolated from partnership opportunities with banks, fintechs, and regulators.

The Link and Differences Between AML and Hawala

Hawala is an important example of informal value transfer systems (IVTS) that may challenge Anti-Money Laundering (AML) efforts because many hawala networks operate outside of financial channels and escape from the restrictions posed by compliance teams and regulators.

Why Hawala Poses an AML Risk

1. Lack of Customer Identification (KYC):

The absence of Know Your Customer (KYC) procedures can make way for criminals to move their funds anonymously since hawala systems often do not require any formal documentation or identity verification.

2. No Record-Keeping or Audit Trails:

Hawaladars usually make their transactions off the books by using codes, personal contacts or verbal agreements which means that regulators cannot trace the origin of the funds and it makes it difficult for them to make proper investigations.

3. Cross-Border Complexity:

Hawala systems operate internationally with operators working in multiple countries who are responsible for transferring funds across borders, evading tax enforcement and AML regulations.

4. Use by Criminal Networks:

It is known that terrorist groups and corrupt officials have used Hawala to launder money, fund operations, and disguise their financial crimes. For this reason, FATF (Financial Action Task Force) reports highlight Hawala repeatedly for terrorist financing and money laundering businesses.

Global Regulatory Response

• United States: Any money service business (MSB) in the U.S has to register with FinCEN, implement AML regulations, and report suspicious activities, including informal systems like Hawala, mandated by the Bank Secrecy Act (BSA).
• India: Hawala is prohibited by authorities, who often link it to black money and terrorist financing. They can also press charges against Hawala operators under PMLA and FEMA.
• UAE: Even though informal Hawala is banned,the  UAE Central Bank has a Hawala Registration System for bringing selected operators into their regulated framework under strict AML supervision.

AML Tools Targeting Hawala Risks

Financial institutions and regulators increasingly make use of advanced technologies like:

• Name screening and watchlist filtering for the detection of indirect links to infamous hawaladars.
• Transaction monitoring systems are used to uncover suspicious patterns.
• To find out about hidden relationships between formal accounts and unregistered value transfers, AI-driven network analysis can be employed.

What Are the Pros and Cons of Hawala?

Although Hawala is widely used in South Asia, the Middle East, and parts of Africa, it is still considered controversial due to both its advantages and disadvantages.

Pros of Hawala:

1. Speed and Efficiency

Since hawala transactions are faster than traditional bank transfers for cross-border remittances, no actual money has to be physically moved, and the settlement can happen immediately between operators.

2. Low Transaction Costs

Hawala charges lower fees than banks or money transfer services, which makes it a great opportunity for migrant workers sending money back home regularly.

3. Accessibility in Underbanked Regions

We know that there are many parts of the world that have weak or inaccessible banking infrastructure, such as in remote villages; therefore, hawala offers a financial lifeline by functioning without internet access, IDs or paperwork.

4. Trusted Cultural Practitioner

Hawala is a trusted and culturally embedded financial system in many communities that relies on mutual trust, personal relationships, and social pressure.

Cons of Hawala:

1. Lack of Transparency and Oversight

There is no official audit trail of Hawala because of its informal networks and lack of formal documentation, which makes it really hard for regulators to monitor the flow of money.

2. High Risk of Abuse

Hawala systems are informal and anonymous, which create the optimum conditions to do money laundering, smuggling, corruption, and tax evasion, as authorities have linked Hawala with major criminal cases worldwide.

3. Legal Consequences

Individuals who are involved in unauthorized Hawala transactions may face severe penalties or imprisonment because it is illegal in many countries to operate a Hawala system without registration.

4. No Consumer Protection

Hawala operators are not regulated or insured as banks, and if a problem occurs, such as fraud or misdelivery, Hawala users may not take legal action to recover their funds.