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Workings of the Hawala System
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The word "hawala" means "transfer" in Arabic. In some contexts, the word "hawala" is used synonymously with "trust," usually to express the personal connection between participants and the informal nature of the transactions.
In essence, Hawala is a transfer or remittance from one party to another, without use of a formal financial institution such as a bank or money exchange, and is, in this sense, an "informal" transaction.
There are several other common aspects to Hawala. First, in most cases, Hawala transactions go across international lines, such as with worker remittances to their home countries. Second, Hawala usually involves more than one currency, although again this is not absolutely required. Third, a Hawala transaction usually entails principals and intermediaries. To accommodate requests of the principals, the intermediaries usually take financial positions. Later, much as in the case of conventional banking practices, these transactions will be cleared amongst the units to balance their books.
A typical transaction often involves an expatriate remittance. For example, an expatriate Pakistani worker in the United Arab Emirates wishes to send money back home. To do this he goes to an intermediary, the Hawaladar, to arrange the transfer. He makes payment in dollars or other convertible currency. The Hawaladar in the UAE contacts a counterpart in Pakistan, who makes payment in rupees to the remitter's family or other beneficiary. Obviously, some network of family or connections among Hawaladars is required to make such a system work on a large-scale and ongoing basis.
It is important to note that although the remitter in this case wished money be sent to a distinct location, no money actually crossed the border physically and no money necessarily entered the conventional or official banking system (unless of course the Pakistani recipient decided to place it there). The transaction rests upon a single communication between Hawaladars and is often not recorded or guaranteed by a written contract. The trust between the two Hawaladars secures the debt and allows the debt to stand with no legal means of reclamation. There is an implicit guarantee on payments, however, because a broken trust would result in community ostracism constituting economic suicide for the Hawaladar (Jost and Sandhu, 2002).
Typically, poorer individuals use the Hawala system to take advantage of the low cost and quick delivery that the system provides. For the blue-collared worker who transfers a monthly stipend of $100, the unofficial Hawala is a far cheaper way to send money back home than the official banking system, at a rate of around 1% of the amount transferred. Because of its low overhead costs, Hawala provides a more favorable market exchange rate than the official one. In short, the economic attraction of Hawala to the customer is usually the speed, low cost, and reliability of the system compared to use of established financial institutions such as banks, money exchanges, or Western Union. The system is ideal for use in isolated localities like the tribal areas of Pakistan and Afghanistan where formal financial institutions are rare.
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Following the Terrorist Informal Money Trail: The Hawala Financial Mechanism