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Regulatory frameworks for hawala and other remittance systems— [Washington, D.C.] :International Monetary Fund, Monetary and Financial Systems Dept., [2005]

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Contents

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

1. Work of the IMF in Informal Funds Transfer Systems . . . . . . 1R. Barry Johnston

2. Formalizing the Informal? Problems in the National and International Regulation of Hawala . . . . . . . . . . . . . . . . . . . . . 7Nikos Passas

3. Comparing Mature and Nascent Remittance Corridors:U.S.-Mexico and Canada-Vietnam . . . . . . . . . . . . . . . . . . . . . 17Raúl Hernández-Coss

4. Hawala: A U.A.E. Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . 30Saeed Al-Hamiz

5. The Netherlands—Supervision of Money Remittance Offices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35Maud J. Bökkerink

6. U.K. Regulation of Money Service Businesses . . . . . . . . . . . . . 42David Faulkner

7. Challenges of Regulating and Supervising the Hawaladars of Kabul . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47Samuel Munzele Maimbo

8. Banco Central do Brasil’s Foreign Exchange System . . . . . . . . 65Paulo Roberto Gonçalves

9. Regulatory and Supervisory Framework of Funds Transfers in Colombia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72Andres Arboleda Uribe

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10. Some Critical Issues on Informal Value Transfer Systems in Eastern and Southern Africa Anti–Money Laundering Group Member Countries . . . . . . . 80Charles Lengalenga

11. Somalia: The Experience of Hawala Receiving Countries . . . 87Mohamed Djirdeh Houssein

Annexes

1. Abu Dhabi Declaration on Hawala,made at the conclusion of the First International Conference on Hawala, 16 May 2002 . . . . . . . . . . . . . . . . . . . 94

2. Second International Conference on Hawala,Conference Statement, Abu Dhabi, 5 April 2004 . . . . . . . . . . . . 96

3. Interpretative Note to Special Recommendation VI:Alternative Remittance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

4. Combating the Abuse of Alternative Remittance Systems:International Best Practices, 20 June 2003 . . . . . . . . . . . . . . . 102

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Foreword

Hawala and other remittance systems have gained attention in pastyears with the substantial growth of remittance flows from countries

with large migrant labor forces and with increased focus on combatingboth money laundering and the financing of terrorism.

In May 2002, the government of the United Arab Emirates, under theleadership of the Central Bank of the U.A.E., pioneered this area with theFirst International Conference on Hawala. The International MonetaryFund welcomed that the government of the U.A.E., again with the leader-ship of the Central Bank, organized a second conference in April 2004, andthat the IMF has been able to collaborate with the U.A.E. in its organization.

The IMF and the World Bank have been researching hawala and otherremittance systems since 2002 to better understand the significance ofinformal remittance systems and the interplay of historical, cultural, andeconomic factors that promote such systems. The IMF especially has beenworking on developing operational guidance for regulating both the for-mal and informal remittance sectors.

The Second International Conference on Hawala resulted in a confer-ence statement that identified the challenges of implementing a regulatoryframework for remittance systems. The conference participants concludedthat there was a need to gather and analyze information on remittance sys-tems and their operations and to conduct outreach to raise the regulatedcommunity’s and the public’s awareness of remittance issues.

The Monetary and Financial Systems Department of the IMF developedthese proceedings of the Second International Conference on Hawala topromote outreach. Readers will find several articles on regulatory frame-works in remitting and receiving countries and some general articles on theproblems that can arise when regulating remittance systems. I hope thatthis collection of articles will function as a survey of regulatory practicesand an overview of experiences in different countries.

Stefan IngvesDirector

Monetary and Financial Systems Department, IMF

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1

Work of the IMF in Informal FundsTransfer Systems

R. BARRY JOHNSTON

Background

The First International Conference on Hawala, hosted by the govern-ment of the United Arab Emirates under the leadership of the Central

Bank of the U.A.E. in May 2002, was a groundbreaking event that producedthe Abu Dhabi Declaration on Hawala. The IMF was very pleased that thegovernment of the U.A.E., again with the leadership of the Central Bank,collaborated with the IMF to organize this second conference.

The IMF has been working on enhancing the integrity of the financialsystem for some time now. However, like many other organizations, wehave turned our attention to informal funds transfer (IFT) systems rela-tively recently. In 2002, we began a research project with the World Bank tobetter understand IFT systems. The results were published in early 2003 asInformal Funds Transfer Systems: An Analysis of the Informal Hawala Sys-tem.1 This work helped us to better understand the significance of the infor-mal hawala system and the complexity of historical, cultural, and economicfactors that promote such systems. The following are some highlights ofthat analysis.

1

R. Barry Johnston is assistant director in the Monetary and Financial Systems Departmentof the IMF.

1Mohammed El Qorchi, Samuel Munzele Maimbo, and John Wilson, 2003, Informal FundsTransfer Systems: An Analysis of the Informal Hawala System, IMF Occasional Paper No. 222(Washington: International Monetary Fund).


• In countries where financial capacity is limited, IFT systems fill a crit-ical gap.

• IFT systems can have economic implications. In countries where largevolumes of transactions are channeled through such systems, theycould have macroeconomic consequences.

• Certain characteristics of IFT systems, including anonymity and lackof official scrutiny, make them susceptible to use by criminals formoney laundering and terrorist financing.

These features make such systems relevant to the work of the IMF as partof our macroeconomic and financial sector surveillance, and as part oftechnical assistance to help strengthen countries’ economic systems. TheIMF is compiling additional information on the significance and operationof IFT systems to understand the systems better and to be ready to advisecountries, where needed, on how to upgrade and enhance regulatory andsupervisory frameworks for IFT systems.

IMF Goals

The Second International Hawala Conference provided a uniqueopportunity to document the regulatory practices and proceduresadopted by various countries, to discuss their merits, and to begin todevelop a statement of good regulatory practices for IFT systems. Fol-lowing broader consultation and outreach, the IMF will develop opera-tional guidance on regulating the informal sector, which will be used indiscussions with members and to inform our technical assistance andadvice. This publication of the hawala conference proceedings will pro-mote outreach and function as a survey on the regulatory practices in anumber of countries.

Important work in developing the approach to regulating IFT systemshas already been done. The Abu Dhabi Declaration on Hawala of May2002 provided a road map on how to proceed. The Financial Action TaskForce (FATF) on money laundering adopted a recommendation on alter-native remittance systems. Special Recommendation VI is one of the eightspecial recommendations on terrorist financing that were adopted inOctober 2001. The FATF subsequently developed an Interpretative Note toSpecial Recommendation VI: Alternative Remittance Systems (February2003) and a best practices paper, Combating the Abuse of Alternative Remit-tance Systems: International Best Practices (June 2003), based on the find-ings of the Asia/Pacific Group on Money Laundering. The Asia/PacificGroup also produced an implementation package for the regulation of

2 R. BARRY JOHNSTON�


alternative remittance systems. The IMF has adopted FATF’s 40 recom-mendations plus the 8 special recommendations as standards important toour operational work.

The IMF is aware that countries have adopted a variety of approachesto supervising and regulating informal funds transfer systems and that,in developing effective responses and advice, it must understand localcircumstances. In short, there is a very practical issue to confront: howto implement the international standards, which are to some extentaspirational, in ways that take account of local circumstances and canresult in more effective oversight. The 2002 Abu Dhabi Declaration onHawala highlighted the undesirable consequence of overregulation—that it could drive the IFT providers further underground. The taskbefore us is no mean challenge, made more difficult by the imperfectknowledge of the operation of the IFT systems. Therefore, the IMFplaces a high premium on consulting and cooperating with countries tolearn from their experiences, which can guide the implementing prac-tices and procedures.

Perspective on Regulation

From the IMF’s perspective, the following are some factors the interna-tional community should reflect on when designing regulatory and super-visory systems.

First, the regulatory structure should be appropriate and commensurateto the risks. These risks have been difficult to quantify in view of our lim-ited knowledge of IFT systems and the extent to which those systems areexploited by criminals.

Second, although in past years IFT systems have come under scrutiny forterrorist financing and money laundering, we must not lose sight of thereality that remittances are very important to migrant workers who sendmoney home and that IFT systems represent an important source ofincome for some countries.

Third, informal systems are very difficult to regulate without driving thesystems further underground. The international community will need todemonstrate to those who operate and participate in such systems that thebenefits of regulation will outweigh the costs. In the jargon of economics,the regulations will need to be incentive-compatible, and their design willrequire engagement with the private sector.

Fourth, the international community needs information to design goodsupervisory and regulatory practices that can take account of local circum-

WORK OF THE IMF IN INFORMAL FUNDS TRANSFER SYSTEMS 3�


stances. The regulatory frameworks that are already in place in some coun-tries should help generate such information.

Fifth, regulation should not be considered the panacea that will preventthe misuse of IFT systems. The international community will need to usemultiple approaches, including promoting the formal sector in fund trans-fers, as several countries have done successfully.

Sixth, we need to specifically acknowledge the difficulties of implement-ing effective regulation in conflict-afflicted countries.

Structure of the Conference Panels

At the Second International Conference on Hawala, we were very fortu-nate to have an internationally diverse and knowledgeable group of pan-elists: standard setters and representatives from the internationalorganizations, hawala remitting and hawala receiving countries, academia,law enforcement, and the private sector. In addition to the panelists, theaudience included many distinguished experts and practitioners fromwhose comments and questions we all learned.

Three panels discussed the experiences of countries that receive fundspredominantly by means of the IFT systems. In recipient countries, con-cerns over foreign exchange management, capital movements, and the qual-ity of the formal financial sector have been important influences on theregulatory attitude toward IFT systems. These countries’ experiences in reg-ulating and in promoting the formal sector were critical. In addition, it wasinteresting to hear views on the approach to regulation in conflict-afflictedcountries such as Afghanistan and Somalia.

One panel discussed the experience of hawala remitting countries. Suchcountries generally have fairly liberal foreign exchange policies and devel-oped financial sectors. In those countries, the regulatory and supervisoryinterest primarily stems from concerns about the funds’ potential criminalmisuse and about terrorist financing.

The conference also had panels for law enforcement and the private sec-tor. The private sector is in the best position to advise on the commercialeffects of different approaches to regulation and on the likely response ofthe IFT systems. It was interesting to hear that some business associationsrepresent the collective views of the hawaladars (hawala dealers) from cer-tain regions or ethnic communities and could be partners in future discus-sions. From law enforcement representatives, it was interesting to hear towhat extent hawala is used for criminal purposes in their own countries andtheir perspective on the effect of the regulations in place in their countries.



Elements That Will Need to Be Considered

The Abu Dhabi Declaration of the First International Conference onHawala and the best practices paper on FATF Special Recommendation VIalready outline the elements that need to be considered in designing a reg-ulatory framework for IFT systems. However, some issues remain to bestudied.

• Licensing or registration requirements. What is the rationale for choos-ing either a registration or a licensing regime, or for following a policyof prohibition of IFT systems? What are the practical experiencesrelating to the merits of choosing one regulatory regime over another?

• Due diligence of owners and managers. One of the goals of regulatingIFT systems is to ensure that criminals do not own or manage an IFTagency. A competent authority should be designated to perform afit-and-proper test. The question is, what should constitute the mini-mum elements of a fit-and-proper test that could have wide applica-tion for diverse country circumstances? For example, to what extentshould a registration system also involve elements of due diligence?

• Implementation of anti–money laundering regulations for customeridentification, record keeping, and reporting of suspicious transactionsand counterterrorist finance regulations. It is important to identifypractical approaches to implementing regulations to combat moneylaundering and the financing of terrorism in IFT systems, whetherdirect or phased in as a country’s overall anti–money launderingcapacity develops. What “second best” approaches could be followedthat address the critical risks while the broader capacity to implementthe international standards is being developed?

• Compliance monitoring and sanctions. How have countries gone aboutmonitoring compliance with IFT regulatory systems? What are themerits and costs of having continuous compliance monitoring com-pared with reactive monitoring when specific problems are identified?Are there any pointers on where it is best to locate the compliancemonitor (e.g., in the central bank or supervisory body or in lawenforcement)? What has been the experience with self-regulatorycompliance systems? Is there experience with adopting risk-basedapproaches to supervision of IFT systems? What has been the experi-ence with sanctioning IFT systems; have transactions been drivenunderground?

• Consumer protection. What are the public sector’s obligations to con-sumers once IFT systems are regulated, and how should those obliga-tions be discharged? Should the authorities require transparency with

WORK OF THE IMF IN INFORMAL FUNDS TRANSFER SYSTEMS 5�


regard to the list of licensed and registered IFT systems and to fees andexchange rates?

• Awareness-raising and training. What has been the experience in build-ing acceptance of the regulatory frameworks for IFT systems and increating the capacity to implement the regulation?

This conference identified the challenges in implementing a regulatoryframework for IFT systems and recommended steps to advance the work. Italso advanced the participants’ knowledge, the level of international collab-oration, and the way forward on regulating IFT systems, and began toanswer some of these and other questions.

The IMF already started developing operational guidance on how tosupervise and regulate IFT systems. However, this will be an ongoingprocess in which we will collaborate with regulatory agencies and the pri-vate sector to gather information and identify good practices for a regula-tory framework. Furthermore, the IMF will look into the specific problemsfacing developing countries in complying with supervisory and regulatoryrequirements for the IFT sector to combat money laundering and thefinancing of terrorism. We will present the results of our studies and hopeto reach consensus on operational guidance on the best ways to regulateremittances in a Third International Conference on Hawala.



2

Formalizing the Informal? Problems in the National andInternational Regulation of Hawala

NIKOS PASSAS

Hawala means “transfer” in Arabic and refers to a traditional informaland efficient funds transfer method used by millions of expatriates to

send remittances to their families around the world. Several studies empha-size hawala’s economic and humanitarian significance. In the midst of callsto shut down all potential means used by militants to finance their terror,the First International Conference on Hawala, held in 2002 in Abu Dhabi,was successful in offering an opportunity to examine hawala beyond mediasensationalism and rushed policy responses.

Nevertheless, any optimism that the conference would lead to appropri-ate and effective regulatory arrangements was soon frustrated by hurriedapproaches at both the national and international levels that seemed to bemore fitting for formal institutions than informal networks. Indeed, someof the measures introduced in the past two years have caused serious dam-age to ethnic communities dependent on their relatives’ remittances.

The argument of this chapter develops through the following mainpoints:

(1) hawala serves honest people as well as serious criminals;(2) financial controls of terrorism are critical but no panacea;(3) there has been a counterproductive overemphasis on hawala as

uniquely vulnerable to abuse;

7

Nikos Passas is professor at Northeastern University, College of Criminal Justice, Boston.


(4) current regulatory arrangements fail to meet stated objectives; and (5) careful consideration of sound empirical evidence and genuine dia-

logue with the sector are indispensable.These points will be addressed as we examine the appeal of hawala—and

the regulatory objectives, challenges, and risks. We conclude with implica-tions for a sensible and evidence-based policy.

The Appeal of Hawala

Hawala originated in the Indian subcontinent and constitutes one ofnumerous informal value transfer systems operating globally (El Qorchi,Maimbo, and Wilson, 2003; Passas, 1999). Deliveries are made in cashquickly, cheaply, and conveniently in places where banking services areunavailable, expensive, or unreliable.

Two main aspects can be distinguished in the hawala business: the send-ing and receiving of money (the relationships between a hawaladar and hisor her clients), and the settlement process (relationships among intermedi-aries).

The first part is relatively straightforward. Clients hand in their cash andrequest an equivalent amount to be delivered in local or, more rarely,another specified currency. Hawaladars (hawala operators) and those act-ing as their agents accept cash on their premises—usually some other busi-ness, such as a corner store, a delicatessen, a music or electronics business,a travel agency—or may go to their clients’ workplace or home for a cashpickup. In most cases, no fees are discussed. Rather, the transaction cost isfactored into the quoted exchange rate or the amount that will be deliveredoverseas in local currency for their U.S. dollars, pounds, dirhams, riyals, etc.

At the end of each day, hawaladars consolidate all deals into ledgers foreach agent and counterpart they do business with, including a running bal-ance. The funds transfer requests are organized into payment instructionsheets—containing the amounts and the name, address, and telephonenumber of the recipient—and faxed to counterparts in other parts of theworld. The serial number of a rupee or other note in the hands of theintended recipient is also faxed: it is often used for identification. Somecommunications may also be done by e-mail or telephone. Hawaladarsmaintain such records at least until accounts are settled; in labor importingcountries (e.g., United States, Europe, or U.A.E.), ledgers are often kept forseveral years.

The delivery takes from a few minutes to 48 hours, depending on theurgency and the destination of the funds. Cash may be handed over at the

8 NIKOS PASSAS�


recipients’ premises or taken to their doorstep. Each hawaladar keeps a poolof cash, which enables payments as soon as instructions arrive. Thus, localcash is typically used for payments on behalf of overseas clients. In this way,actual fund transfers are minimized (for more details, see Passas, 2003b,2003c, 2004b).

Hawala serves millions of immigrants from South Asia, Africa, the Mid-dle East, and elsewhere, whose remittances are often desperately needed asa means of survival. The funds also provide important support for eco-nomic development (Ratha, 2003). Formal financial institutions haverecently made strong efforts to increase their share of the remittance mar-ket by lowering fees, widening their networks, and using better technology.The law enforcement and regulatory attention drawn by hawala has alsoincreased operating costs in the informal sector. Nevertheless, hawala con-tinues to be the best option for most immigrants and the only one for thosecoming from regions devastated by civil conflict and disasters.

Data updated in November 2004 from the United Arab Emirates illus-trate the competitiveness of hawala. Table 2.1 contrasts the cost of sendingabout US$100 from the U.A.E. to South Asia, including exchange rates,charges for telegraphic transfers or drafts by banks and exchange houses,and Western Union fees. In short, hawala offers much better exchange ratesand no fees at all.

The financial benefits to remitters’ families become clearer in Table 2.2,which uses Pakistan as an example and compares the amounts received bybeneficiaries in local currency for about US$100 sent from Dubai. Hawalabeats all the competition by far. The amount received in cash is higher thanall other options. Moreover, all formal methods involve charges and feesrequiring the remitters to add from US$1.32 to US$27.22 to the cost. In short,better rates and lower costs make hawala the best option financially. Otheradvantages include having convenient home delivery or pickup, interactingwith people speaking the same language and from the same region, avoidingbureaucratic procedures and paperwork, preserving confidentiality, andachieving fast delivery even in the remotest villages. The relationship of trust

FORMALIZING THE INFORMAL? 9�

Table 2.1. Comparative Cost of Sending US$100 to South Asia from Dubai, U.A.E.

Charges (US$)Institution Draft Telegraphic Transfer Rate of Dh/US$

Exchange house 1.36–2.722 9.52–16.33 3.6735–3.68Bank 2.722–6.80 12.25–27.22 3.678–3.693Western Union 9.52 — 3.7Hawala 0 — 3.673–3.6736

Source: N. Passas.


and the mutual interests of hawaladars and their clients support the efficientglobal hawala networks. Finally, “cultural inertia” and the forces of old habitsadd to the hurdles faced by formal institutions seeking to capture a largershare of the multibillion-dollar (U.S. dollars) global remittance market.

Need for Regulation

At the same time, research clearly shows that hawala is vulnerable to crim-inal abuse, just like all other financial institutions. We know that hawalaclients include money launderers, militants, corrupt politicians, fraudsters,and tax evaders (Carroll, 1999; Howlett, 2001; Passas, 1999, 2003a, 2003b,2003c, 2004b, 2004c; FATF, 2001, 2003). Legitimate clients and funds areoccasionally commingled with illicit ones. As hawaladars use local cash poolsto pay for overseas remittances, the father of someone sending honestlyearned funds from the United States or U.A.E. could actually receive the cashthat a corrupt official or smuggler wishes to launder or secretly take out ofthe country.

Most vulnerable to abuse, however, is the process of settlement amonghawaladars. The cash pools on which they draw for payments are alwaysasymmetrical, as each operator transfers funds to and from multiple loca-tions every day. Apart from compensatory payments, other ways of balancingaccounts include formal transfers (check, wire, bank-to-bank, etc.), the use ofcouriers, and payments in kind, as well as commercial transactions, falsifiedinvoices, and third parties. Not being subject to the same rules as formal insti-tutions and operating frequently in parallel economies through not alwaysknown third parties make the whole process susceptible to illegal uses. Theproblem is not merely theoretical; there is evidence that money derived fromdrug trafficking, illegal arms sales, body part trade, corruption, tax evasion,and all kinds of fraud have indeed moved through hawala networks.

10 NIKOS PASSAS�

Table 2.2. Comparative Amounts Received in Pakistan for Remittance of US$100from Dubai, U.A.E.

Method of Remittance Charges Total Paid PK Rupees Received

Draft (exchange house) 1.36–2.722 101.36–102.722 5,901–5,910Draft (bank) 2.722–6.80 102.722–106.80 5,890Telegraphic transfer

(exchange house) 9.52–16.33 109.52–116.33 5,901–5,910Telegraphic transfer (bank) 12.25–27.22 112.25–127.22 5,890Western Union 9.52 109.52 5,858Hawala 0 100 5,920

Source: N. Passas.


In this light, leaving hawala completely unregulated, as was the case inmany parts of the world before 9/11, is no longer realistic. The question ishow to regulate it (Maimbo and others, 2005; Passas, 2003a, 2003b, 2003c).One important point to consider is that trust is a defining element ofhawala, which makes the system not only more efficient, but also reliable.Informal dispute-resolution mechanisms most often resolve issues amonghawaladars, and individual remitters have seldom lost their money evenafter law enforcement actions, accidents, or bankruptcy (Maimbo, 2003;Passas, 2004a, 2004b, 2004c). Hence, a consumer protection type of regula-tion is not as necessary as many a Westerner might think.

Regulatory Objectives and Challenges

The main task is to reconcile two sets of public policy priorities. On theone hand, we must counter terrorist financing, money laundering, andother financial crime. Labor exporting countries are also concerned aboutthe economic or other damage caused by hawala in local economies thirstyfor foreign currency.1 On the other hand, we need to reduce the hurdlesfaced by laborers remitting funds to their homeland and to avoid unneces-sary disruptions of capital flows and commerce, both of which are vital toeconomic development.

More specifically, the crime-control objectives are to (1) achieve moretransparency by identifying operators and clients and by enhancing thetraceability of transactions, (2) provide a measure of deterrence and pre-vent abuses of funds transfer networks, (3) prevent the financing of terror-ist operations, and (4) collect intelligence and monitor the activities ofcriminal groups and extremists.

The economic aims are to (1) lower the cost of remittances, (2) widenthe range and increase the speed of remittance options, (3) ensure compli-ance, (4) protect the consumer, and (5) ensure a level playing field for thevarious competitors in the remittance market.

The synchronization of these objectives is complicated by the dilemmasof undocumented immigrants, who may be earning legitimate funds with-out authorization to work, which means that they could not use formalinstitutions for remittances or other business. Another serious challenge isthe harmonization of controls internationally and regionally, as the con-texts vary dramatically and render some rules unenforceable or unrealistic.


1Because hawala draws on local cash pools for making remittance payments, it is fearedthat hawala deprives the country of valuable foreign exchange.


Challenges specific to hawala networks include the following:• There is often no uninterrupted transparent audit trail.• It may be hard or impossible to interpret idiosyncratic hawala records.• The fusion of hawala with other businesses makes it hard to disentan-

gle transactions and may easily hide illicit activities.• The interface with gray/black markets makes it harder to supervise

hawala and offers opportunities to obscure transactions.• Fine-tuning regulations and law enforcement targets to avoid harm to

innocent actors is particularly difficult and requires study and appre-ciation of ethnic, cultural, political, and socioeconomic specificities.

• Ensuring a balanced approach and proper regulation of the formalsector requires the conception and implementation of rules appropri-ate for very different actors, modi operandi, and traditions.

• Finally, assessing and measuring the effects of measures and policiesrelative to hawala are hard, given the availability of a wide range ofother informal methods that could be used by those determined toevade regulation. Thus, reduced illegal hawala activity may not neces-sarily be a positive development, to the extent that activities get dis-placed to less transparent and less understood informal value transfermethods (Passas, 2003c).

Shortcomings of Current Arrangements

No thorough and systematic effort has been attempted to assess the effectof policies that were introduced very shortly after the terrorist attacks ofSeptember 11, 2001. There are strong indications, however, that most of thepolicies—both national and international—are not producing the desiredeffects and may indeed be counterproductive.

In South Asia and other labor exporting countries, for example, hawalahas been and remains either criminalized or outlawed. This means that cer-tain large parts of hawala networks are by definition illegal, forcing opera-tors and clients to keep a low profile and hide their business as much as theycan. Some European countries, such as France and Spain, allow no IFToperations. Others require costly and burdensome procedures for de factolicensing, pushing a number of hawala operators underground.

The same applies to the United States, where federal efforts to increasecompliance and transparency through registration are completely under-mined by an uncoordinated patchwork of state regulations. With the excep-tion of a few U.S. states that do not regulate money transfers at all, theoverwhelming majority mandate licensing. In some of them, however, the

12 NIKOS PASSAS�


capitalization or bond requirements amount to hundreds of thousands ofU.S. dollars. If a hawaladar has clients in more than one jurisdiction, hewould need to comply with the rules of all states. This is an unaffordableand nonpragmatic arrangement that effectively seeks to formalize the infor-mal. Attempting to apply to hawala rules that are appropriate to formalfinancial institutions and corporations is unwise and unworkable. Hawal-adars are left with three options: to introduce or substantially raise fees andcharges to customers, to stop offering the funds transfer service to their eth-nic communities, or to operate without a license. However, operating with-out a required state license has become a federal offense. This has effectivelypushed many hawaladars out of business or underground. Judging bymedia and official reports of arrests and charges for this offense, hawala hasbeen largely criminalized in the United States.

Even in the liberal environment of the U.A.E., where hawala is legal andcompliance is affordable (simple registration), hawaladars shun the lime-light and would not come forward, even to attend the hawala conference.

Many countries are eager to heed calls by the Financial Action TaskForce and others to apply anti–money laundering and terrorist financerecommendations and rules. However, interviews with officials suggestthat despite formal compliance with such international standards,enforcement is problematic and impractical. Attempts to formalize theinformal equal efforts to alter the age-old traditional networks, whichsuccessfully resisted prohibitions and authoritarian regimes in the past.The chances of succeeding are slim, particularly if the informal sector isnot consulted.

The Risks of Unsuccessful Regulation

Financial controls are essential and necessary. They deter and preventserious crimes, offer investigative leads to detect and arrest offenders,reduce the harm of planned or committed crimes, and generate opportuni-ties for intelligence collection. However, if our aspirations get lofty, there isthe danger of causing more problems than we solve. All of the objectives setout above risk being frustrated, and we can expect the following responses:

• a reduction of the positive economic effects of labor remittances;• fewer, more expensive remittance options available to expatriates;• unnecessary criminalization of legitimate actors;• higher human costs to the families of immigrants;• alienation of large segments of the population which would be help-

ful in counterterror coalitions; and



• shifts to less well known informal value transfer methods and thus lesstransparency and traceability of transactions

Contrary to popular perception, there were no hawala transactions inthe 9/11 terrorist operations. Myths about huge amounts raised and madeavailable to al Qaeda and associated groups have been dispelled (NationalCommission on Terrorist Attacks upon the United States, 2004). Terrorismis inexpensive and financed through a wide range of methods. Hawala hascertainly been used to transfer militants’ funds, but it is not the most impor-tant vehicle. Assumptions about a centrally and rationally organized alQaeda have also been rejected, as evidence points to loose networks unifiedby ideas and beliefs rather than structures. Militants tend to raise theiroperational funds locally and through ordinary crime, such as credit cardfraud or tobacco smuggling.

Furthermore, because of the strong emphasis on naming, shaming,freezing, and seizing the assets of suspected supporters of terrorist groups,we may expect groups to use funds transfer methods and infrastructuresakin to money laundering. Thus, instead of hiding the illegal source ofmoney, people would now want to hide themselves as the source of fundsgiven to extremist groups.

Conclusion: The Way Forward

As we try to avoid “collateral damage” and undermine our own objec-tives, the fight against transnational crime could turn out to be a very use-ful counterterrorism approach. Infrastructures set up for one kind of secretfinance and smuggling can be employed by militants as well. Some of themmay also team up temporarily with criminal groups. Hot spots of financialcrime, which abound in all continents, must be investigated. Anticrime andcounterterrorism policies ought not to be regarded as conflicting or com-peting, but as complementary and mutually supportive.

The most promising approach to hawala regulation, and an efficient sep-arator of users from abusers, is through a dialogue and outreach to all stake-holders of this significant economic sector. By taking the views ofhawaladars into account and by building a consensus, future complianceand transparency, or traceability of transactions, is far more likely. Encour-aging further cost reductions and more convenient and accessible formalremittance avenues would ensure the continuation of vital services to needycommunities.

At the domestic level, countries would be wise to harmonize their federal,state, and local rules and responses on the basis of evidence, appreciation,

14 NIKOS PASSAS�


and understanding of the networks they seek to supervise and control. Inter-nationally, it may be useful to establish specific policy goals and urge coun-tries to meet them in their own way, consistent with local traditions, culture,and socioeconomic conditions. In that way, we would promote legal harmo-nization while allowing for the necessary diversity and flexibility.

Regulation will be most effective to the extent it becomes truly cross-agency and international. It must be emphasized, however, that financialcontrol will never work while trade remains nontransparent. Gigantic sec-tions of the world economy currently operate “under the radar” and consti-tute an enormous risk for proliferation of crime, terrorism, and weapons ofmass destruction. Precious stones and metals have received some attention,but it is all trade that needs to be better regulated (Passas, 2004d). Oncetrade transactions are transparent, they must also be connected with finan-cial transactions. This is the only way genuine transparency and account-ability may be achieved.

Finally, a demand-side approach to counterterrorism must supplementthe supply-side, law enforcement, and military approaches. Terrorism isalso a socioeconomic and political issue reflecting both local and globalproblems. Our policies must pay attention to new recruits and sympathiz-ers, who could use their illegal or legal businesses to facilitate fund raisingand transfers “for the cause.” Our long-term success will be founded onlong-term policies that address the fundamental problems underlyingextremism of all kinds.

Bibliography

Carroll, L., 1999, “Alternative Remittance Systems,” FOPAC Bulletin, Vol. 20.

El Qorchi, Mohammed, Samuel M. Maimbo, and John Wilson, 2003, Informal FundsTransfer Systems: An Analysis of the Informal Hawala System, IMF Occasional PaperNo. 222 (Washington: International Monetary Fund).

FATF (Financial Action Task Force), 2001, 2000–2001 Report on Money LaunderingTypologies (Paris: Financial Action Task Force, OECD).

———, 2003, Combating the Abuse of Alternative Remittance Systems: International BestPractices (Paris: Financial Action Task Force, OECD).

Howlett, C., 2001, Investigation and Control of Money Laundering via Alternative Remit-tance and Underground Banking Systems (Sydney: Churchill Fellowship).

Maimbo, Samuel M., 2003, The Money Exchange Dealers of Kabul: A Study of the Infor-mal Funds Transfer Market in Afghanistan (Washington: World Bank).

———, and others, 2005, Migrant Labor Remittances in the South Asia Region (Wash-ington: World Bank).



Maimbo, Samuel M., and Nikos Passas, 2004, “The Regulation and Supervision ofInformal Remittance Systems,” Small Enterprise Development, Vol. 15, No. 1, pp.53–62.

National Commission on Terrorist Attacks upon the United States, 2004, Monograph onTerrorist Financing (Staff Report to the Commission) (Washington: National Com-mission on Terrorist Attacks upon the United States).

Passas, Nikos, 1999, Informal Value Transfer Systems and Criminal Organizations: AStudy into So-Called Underground Banking Networks (The Hague: Ministry of Jus-tice, The Netherlands).

—— 2003a, “Financial Controls of Terrorism and Informal Value Transfer Methods,” inTransnational Organized Crime. Current Developments, ed. by H. van de Bunt, D.Siegel, and D. Zaitch (Dordrecht: Kluwer).

—— 2003b, “Hawala and Other Informal Value Transfer Systems: How to RegulateThem?” Journal of Risk Management, Vol. 5, Issue 2, pp. 39–49.

—— 2003c, Informal Value Transfer Systems, Money Laundering and Terrorism (Wash-ington: National Institute of Justice and Financial Crimes Enforcement Network).Available via the Internet: http://www.ncjrs.org/pdffiles1/nij/grants/208301.pdf.

—— 2004a, “Indicators of Hawala Operations and Criminal Abuse,” Journal of MoneyLaundering Control, Vol. 8, No. 2, pp. 168–172.

—— 2004b, Informal Value Transfer Systems and Criminal Activities (The Hague:WODC, Ministry of Justice, The Netherlands).

—— 2004c, “Law Enforcement Challenges in Hawala-related Investigations,” Journal ofFinancial Crime, Vol. 12, No. 2, pp. 112–119.

—— 2004d, The Trade in Diamonds: Vulnerabilities for Financial Crime and TerroristFinance (Vienna, Virginia: FinCEN, U.S. Treasury Department).

Ratha, Dilip, 2003, “Workers’ Remittances: An Important and Stable Source of ExternalDevelopment Finance,” in Global Development Finance (Washington: WorldBank).

16 NIKOS PASSAS�


http://www.ncjrs.org/pdffiles1/nij/grants/208301.pdf

3

Comparing Mature and NascentRemittance Corridors:U.S.-Mexico and Canada-Vietnam

RAÚL HERNÁNDEZ-COSS

In recent years, as remittance flows and funds transfer systems havebecome increasingly important for international policymakers, the

broad concepts of remittance phenomena have become well documented.This essay compares the key features of two remittance corridors, identify-ing two distinct stages for inducing a comprehensive shift from informal toformal channels. The main source of analytical information is work con-ducted by the World Bank in support of the Asia-Pacific Economic Coop-eration (APEC) Remittance Initiative. Additional research could explore inmore detail how the features of a given corridor should be addressed inimplementing regulations and how operators in the formal sector can bestreach remittance senders.

A research team of the Remittance Initiative applied the analyticalframework of APEC’s 2003 report on informal funds transfer systems to theremittance corridors between the United States and Mexico and betweenCanada and Vietnam. The results, which moved from broad principles tospecific lessons in funds transfer systems, revealed two stages—the“mature” and the “nascent”—at which a comprehensive shift from infor-mal to formal channels may be undertaken.

17

Raúl Hernández-Coss is a financial sector specialist in the World Bank’s Financial MarketIntegrity (FSEFI) unit. The author wishes to express his gratitude for research conducted byJuan Galarza and Paolo Ugolini for the preparation of this contribution.


The U.S.-Mexico corridor is a mature market for formal remittances; theCanada-Vietnam corridor is at a nascent stage in the shift to formal sys-tems. The distinction suggests that researchers and policymakers shouldacknowledge that different remittance corridors face different priorities(based on their stage of development and other factors) and, therefore,should focus on different policies when shifting to formal systems. Moreresearch will be needed to better understand the full implications of thedegree of development of different remittance corridors.

The two remittance corridors share some of the same challenges. Butwhereas a mature market has a “paved road” for remittances, one that mustbe maintained and expanded, policymakers in the nascent market must focusfirst on setting the conditions for efficient formal remittance mechanisms.

This paper consists of three sections. The first provides a comparison ofthe economic indicators for remittance flows in the two corridors. The sec-ond illustrates the different stages at which a comprehensive shift frominformal to formal channels in the two corridors may be induced. The lastsection offers conclusions and recommendations.

Comparative Indicators of Remittance Flows Through the Two Corridors

In the past few years, the importance of remittances for both Mexico andVietnam has increased with respect to other sources of foreign income.1 In2003, according to data from the Mexican central bank, remittances werethe second-largest source of external finance after crude oil exports, repre-senting 78 percent of crude oil exports, 124.2 percent of foreign directinvestment (FDI), and 138.9 percent of tourism revenues. For Vietnam,remittances in 2003 comprised almost 7.4 percent of GDP, up from 4.4 per-cent in 1999. Also, in 2003 remittances were approximately 160 percent ofFDI, up from 85 percent in 1999. In 2002, Mexico was the largest recipientof formal remittances flows in the world; Vietnam ranked 11th (Figure 3.1).In 1999, the difference between remittance flows into Vietnam and Mexicowas more than US$4.7 billion. Mexico’s rate of growth in workers’ remit-tances outpaced Vietnam’s between 1999 and 2003 (Figure 3.2).

18 RAÚL HERNÁNDEZ-COSS�

1This section analyzes remittance flows through formal and informal financial channels(including legal channels that are not part of the formal financial sector) using official dataprovided by the countries involved in this research.


COMPARING MATURE AND NASCENT REMITTANCE CORRIDORS 19�

Figure 3.1. Top 15 Remittance Receiving Countries in 2002 (Millions of U.S.dollars)

Source: World Bank data.

Figure 3.2. Workers’ Remittances to Mexico and Vietnam, 1999–2003(Millions of U.S. dollars)

Source: Banxico; Ministry of Foreign Affairs in Vietnam.


Impact of Remittances in the Recipient Economies

The Mexican economy is 17 times larger than Vietnam’s. Gross nationalincome (GNI) per capita in Mexico is more than 10 times that of Vietnam.Mexico has 20 million more people than Vietnam. In 2002, about 9.5 mil-lion people migrated from Mexico, and 2.8 million migrated from Vietnam.It is not surprising, therefore, that Mexico receives much more in remit-tances than does Vietnam (Table 3.1).

Although the total value of remittances entering Mexico is much higherthan in Vietnam, remittances play a relatively larger role in Vietnam’s econ-omy. In 2003 remittances represented 2.2 percent of Mexico’s GDP but were7.39 percent of Vietnam’s (Table 3.2).

With respect to other types of income, remittances equaled 13 percent ofVietnam’s exports and approximately 160 percent of FDI, compared with 8percent of exports and 123 percent of FDI in Mexico (Figure 3.3). More-over, remittances have played a relatively larger role in the Vietnamese econ-omy over the past five years, compared with FDI (Figure 3.4).

Both Mexico and Vietnam are committed to facilitating the transfer ofremittances through stronger and more accessible formal systems. How-ever, because the qualitative features of remittance flows into the two coun-tries are shaped by different economic, social, and cultural nuances, the


Table 3.1. Workers’ Remittances and Economic Indicators, 2002

Mexico Vietnam

GNI per capita (U.S. dollars) 5,920 430Migration (millions) 9.5 2.8Population (millions) 101 80.4Population growth (percent) 1.50 1.16GNI (billions of U.S. dollars) 597 35Remittances (billions of U.S. dollars) 13.4 2.6

Source: World Bank.

Table 3.2. Remittances to Mexico and Vietnam as a Share of GDP, Exports, andForeign Direct Investment, 2003(percent)

Mexico Vietnam

GDP 2.18 7.39Exports 8.00 13.24Foreign direct investment 124.20 159.45

Source: Banxico; Vietnam Investment and Trade Promotion Center.



Figure 3.3. Remittances to Mexico and Vietnam as a Share of GDP, Exports, andForeign Direct Investment, 2003(Percent)

Source: Banxico; Vietnam Investment and Trade Promotion Center.

Figure 3.4. Remittances to Mexico and Vietnam as a Share of FDI, 1999–2003 (Percent)

Source: Banxico, Ministry of Foreign Affairs in Vietnam.


effort to shift the remittances market from informal to formal systems callsfor different approaches in the two countries.

Estimating Informal Flows in the Two Corridors

The research team used the APEC analytical framework for IFT systems(APEC, 2003) to estimate the magnitude of remittances through both infor-mal and formal channels. The process of applying the framework posedmultiple challenges.

In a mature remittance corridor, data are available on the number ofmigrants sending money to the recipient country and on the frequency andaverage amount of their remittances. Some information on the channelsused may also be available. All this valuable information can be adapted toproject the volume of informal flows. However, large discrepancies in val-ues and methods complicate the process (Box 3.1).

In a nascent remittance corridor, there is a lack of data on the number ofmigrants and their remittance behavior. The absence of data leads to heavyreliance on anecdotal information. Thus, estimates of the total volume ofremittances, formal and informal, will not be statistically sound, althoughthey may trigger the interest of the private sector to tap into the corridor.

The research team working on the Canada-Vietnam remittance corri-dor faced a special challenge in estimating the total remittance volume.On one hand, presenting a figure larger than the US$2.6 billion that isrecorded by the central bank for formal transfers would help attract theprivate sector into the corridor to develop new products. On the otherhand, the team felt the need to highlight the need for more reliable toolsfor collecting data in the corridor and for gaining a better understandingof the remittance sender.

In the end, the team chose not to include in their estimates the marketplayers’ estimates of the total volume of remittances—in part, out of con-cern over the implications, for both the sender and the recipient remittancecountry, that a large but unreliable figure could have on developing the reg-ulatory and market incentives.2 Further research on remittance corridorsshould refrain from estimates that are not based on data and should dis-close the methods used to estimate total flows, taking into account that ashare of financial flows will always move through informal channels thatremain obscure.


2Interviews suggested an additional 40 percent of the total formal flows go to Vietnam byinformal channels.



Box 3.1. Estimating the Volume of Informal Remittances

In 2003, Banxico conducted a survey across the Mexican border to identifygeneral characteristics of remittances in Mexico. The survey concluded that 80percent of Mexicans living in the United States send money home on a regu-lar basis, with an average remittance of US$254 sent 10.4 times per year.

In that same year, the Multilateral Investment Fund of the Inter-AmericanDevelopment Bank (IADB) and the Pew Hispanic Center conducted similarresearch across the country and reached different conclusions. According tothe IADB–Pew survey, 88 percent of the Mexicans working in the United Statessend money home, with average remittances of US$190 being sent seven timesper year (see table).

Banxico and IADB Surveys on Imigration

Banxico Survey IADB SurveyDescription 2003 2003

Percentage of Mexican workers who sendmoney to Mexico 80 88

Number of times Mexican workers sendmoney home per year 10.4 7

Average value of remittance to Mexicoper transaction $254 $190

Source: Banxico and IADB.

From information gathered in the two surveys, two models were developedto calculate informal remittances from the amounts declared by the authori-ties. The methods used for Mexico were based on calculating the percentage ofworkers sending money to Mexico (80 or 88 percent) as a share of all Mexicansliving in the United States (estimated by CONAPO at more than 10 million)and multiplying it by the annual frequency (10.4 or 7) and average value ofremittances sent (US$254 or US$190). Finally, we estimated the value of infor-mal remittances by subtracting the official value of remittances declared byBanxico.

Because of a large discrepancy in the values and methods of the two surveys,the results obtained were not considered significant.

To get a better estimate of the informal flow of remittances in Mexico,future research should be conducted to determine the following:• the number of Mexican workers in the United States employed in the dif-

ferent sectors of the economy;• average Mexican workers’ skills;• average income levels for the different sectors;• average remittances sent to Mexico, broken down by income levels; and• number of times remittances are sent to Mexico, broken down by income

level.


Stages for Inducing a Shift from Informal to Formal Channels

Identifying perceived incentives that lead remitters to choose informalfunds transfer systems over formal funds transfer systems requires analy-sis of both the sending and recipient economies. Although many incen-tives are unique to a particular remittance corridor, some apply to everysender in every remittance corridor at some point in the decision-makingprocess.

Grouping incentives illustrates how remittance senders in the first stageof the remittance process—the “first mile”—perceive the channels availableto them and how distribution of remittances at the last stage—the “lastmile”—is determined by the channel chosen (the intermediary stage). Ouranalysis of the perceived incentives that shape the two corridors was basedon the APEC Framework’s list (APEC, 2003) of perceived incentives forboth the first and the last mile. The relevance of various incentives was dif-ferent for each corridor (Table 3.3).

It is impossible to determine whether any single factor is most impor-tant in provoking a shift to formal systems, but several factors, no doubt,work together. In each corridor, the factors and incentives commonly pre-sent at the first mile are cultural familiarity, personal contacts, speed, cost,and the regulatory environment. In the last mile, the commonly perceivedincentives are personal contacts, accessibility, and the regulatory environ-ment. These incentives have specific features that define each corridor(Table 3.4).


Table 3.3. Perceived Incentives in the Remittance Process in Two Corridors

U.S.-Mexico Canada-VietnamAPEC Framework Perceived Incentives First mile Last mile First mile Last mile

Personal incentives Anonymity/secrecy * *Cultural familiarity * *Personal contacts * * * *

Customer service Dispute resolutionincentives Accessibility * * *

Class discriminationVersatility/resilience

Economic incentives Speed * *Cost * *Secondary benefits *Legal/regulatory

environment * * * *

Source: World Bank.


The U.S.-Mexico Remittance Corridor

Migrants have shifted to formal systems in the first mile—or the firststage of the remittance process—because of better access to, and awarenessof, formal channels. Competition has been generated by market trans-parency and information. Furthermore, bilateral initiatives between theUnited States and Mexico have helped facilitate the shift. From these find-ings, it appears that certain aspects of the formal remittances market couldbe strengthened by appropriate regulatory adjustments.

In the intermediary stage of the remittance process, prices have beenreduced by increased competition spurred by the development and prolif-eration of technology. New competitors are continuously innovating theirservices and products. Although IFT systems compete as a market player,they appear to have a declining role in the market.3 On the other hand,because the formal remittances industry may require large investments intechnology, marketing, and operations, oligopolies continue in the marketamong intermediaries.


Table 3.4. Key Features in the Operational Stages in Two Remittance Corridors

Operational Stages U.S.-Mexico Canada-Vietnam

First Mile Increased accessibility to formal Regulated and supervised financial channels institutions (relatively limited role)

Financial awareness among Viet Kieu (see footnote 4, main text) migrants and sending habits from Canada

Market information Role of ethnicity Bilateral initiatives Need for licensing/registrationHarmonization of regulations

Intermediary Greater competition Widespread use of IFT systemsTechnology Development of the Vietnamese Innovative services and products marketDecline of IFT services Technological imperativeTendency to oligopoly Potential impediments for regulated

financial institutions

Last Mile More distribution channels Flow distribution and geography in Links between sender and recipient Vietnam

communities Anonymity as a last mile incentiveGradual approach of regulators Data and recording issuesBanks’ approach to recipients Lack of distribution channelsNegative effects of remittances Government policy and remittancesCreation of rural distribution

networks

Source: World Bank.

3According to field interviews with the public and private sector and some World Bankestimates, IFT systems could be in a range of 3 percent to 5 percent of the recorded flows.


In the last mile, remittance flows reflect long-established migration pat-terns between Mexico and the United States. Distribution channels haveincreased, creating a “paved road” for remittances between the United Statesand Mexico’s urban and regional centers. Within those distribution chan-nels, the market growth for distribution of remittances has outpaced theapplication of regulations to the market. The distribution channels andbanks also have developed products that familiarize recipients with accountholding. Unfortunately, the paved road tends to end at Mexico’s urban andregional centers, since the distribution networks for formal remittanceshave not yet adequately penetrated rural regions.

The Canada-Vietnam Remittance Corridor

In the first mile, banks and credit unions are regulated financial institu-tions that have a substantial opportunity to become bigger competitors in theCanada-Vietnam corridor. Formal operators should explore ways to marketremittance services to different types of senders, since there are two distinctclasses of senders to Vietnam: temporary migrant workers and Viet Kieu.4

The latter are the main senders from Canada. It is apparent that ethnicityplays an important role in the corridor. There is also a need for licensing orregistration requirements for money services businesses at the first mile.

At the intermediary stage, IFT systems are widely used. The main incentivesfor doing so are cost, speed, and cultural familiarity. The growth of the remit-tances market in Vietnam is evident, although comprehensive data are lacking.Technological advances have yet to substantially affect the Canada-Vietnamcorridor. A present challenge for regulated financial institutions at the firstmile is to develop banking relationships with counterparts at the last mile.

At the last mile, remittance flows in Vietnam are influenced by geogra-phy, given the fact that different types of senders send to different areas.Recipients at the last mile value anonymity and try to avoid interactionwith local officials. Because of the lack of technological advances, there is alack of comprehensive data, and authorities are exploring how to organizerecords of remittance flows. Also, particularly in rural areas, distributionthrough formal channels in Vietnam is limited. Finally, the behavior andpolicies of the Vietnamese government and regulations also play a criticalrole in influencing whether senders transmit funds formally or informally.


4Viet Kieu, a term used by the Vietnamese to refer generally to overseas Vietnamese, orig-inally referred to refugees who fled Vietnam during the socioeconomic transformation ofthe 1970s.


Conclusions and Recommendations

The U.S.-Mexico corridor is a “mature” market for formal remittances,whereas the Canada-Vietnam corridor is at a “nascent” stage in the shift toformal systems. Both face some of the same challenges. Some sequencing ofpolicy actions may be appropriate.

The U.S.-Mexico remittance corridor has changed radically in the pasteight years, from one in which IFT systems were prevalent to one domi-nated by formal mechanisms. Formal mechanisms have created the possi-bility for users to access new financial services offered by banks and creditunions and allow them to build a credit history in the United States. At thesame time, the volume of transactions and the value that they representhave encouraged banks to design new products for these potential cus-tomers. Remittances that are conducted through the formal financial sectoralso are subject to heavier regulation that eventually could protect theintegrity of these flows.

The Canada-Vietnam remittance corridor, though at a nascent stage inthe shift from informal to formal systems, is poised for tremendous growth.

Policymakers should acknowledge that different remittance corridorsface different priorities (based on their stage of development and other fac-tors) and, therefore, should focus on different policies when shifting to for-mal systems. Whereas a mature market already has a paved road forremittances, one that must be maintained and expanded, the nascent mar-ket must focus first on setting the conditions for efficient formal remittancemechanisms. These conditions include providing market players, both inthe sending and recipient economy, with more information on the magni-tude of the corridor, the potential networks available for origination (firstmile) and distribution (last mile), a better understanding of the informalchannels used in the corridor, their possible links with illicit proceeds, and,most important, a deeper analysis of the demand for financial services bysenders in the first mile. This final condition could facilitate the creation ofnew products that support the use of multiplatform schemes to conductremittance transactions.

Recommendations for a Nascent Market

Recommendations for a nascent market are geared toward establishing acompetitive market and electronic avenues for remittances between send-ing and recipient economies.

Authorities should promote the use of economies of scale among privatefinancial institutions and work closely with the sending economies to



develop bilateral initiatives that widen access to the formal financial sectorin the sending country and that promote financial literacy among migrantsenders. Continuous research on the characteristics and potential of theremittances corridor, which would bring market transparency and infor-mation on critical features and challenges of the corridor, could be thebeginning of the shift to the formal sector. Coordination among differentgovernment agencies, in both the sending and recipient countries, will beneeded.

In a nascent market, an initial description of the corridor should includethe following:

• information on the size and location of remitting communities;• the sending habits of potential customers;• the degree of financial intermediation (such as the number of bank-

ing networks, postal offices, and other potential points of distributionfor the remittances in the last mile);

• the degree of access to financial services in the sending and receivingcountries (including the framework for microfinance institutions inthe last mile).

• the remittance mechanisms in use and the incentives that make thempopular;

• the regulations that apply to the industry and their impact on themarket; and

• data on general levels and frequency of remittances and the associatedcosts of those services.

In addition, regulations in both jurisdictions (sending and recipient)should be applied transparently and consistently to create a level playingfield for market competitors, predictable government behavior, and clarityin the market.

Recommendations for a Mature Market

With the ultimate goal of moving remittances to the formal financialsector, policymakers should strive to create transparency that can producemarket information and trigger incentives for private sector investment inthe market. In a mature market, many of the issues addressed in a nascentmarket remain relevant. However, where a “paved road” for remittances hasbeen laid, a greater focus can be given to the details of maintaining, fine-tuning, and leveraging the benefits of a mature market.

Authorities should institute detailed and well-organized mechanismsand standards for systematic information gathering. Providing informationto a market can help it expand, as consumers become better educated and



businesses develop new strategies and services. As the remittances marketbecomes established, it will have greater implications for capital flows andthe overall financial sector. Authorities can stay apprised of market eventsand be better prepared to respond to shocks if detailed information is col-lected and organized regularly and efficiently. Information may also beshared with other countries. Regulations can be issued in a nonthreateningmanner to collect and organize data.

Cost and speed are critical factors for a remittance system. But oncecompetitive prices and efficient channels are in place, competitors shouldexplore other factors, such as cultural factors and accessibility, that may alsoprevent remitters from choosing formal channels. Formal channels shouldrecognize that informal systems develop and stay popular for social as wellas economic reasons. Tailoring remittance products and services tomigrants’ specific needs can take competition to another level.

Bibliography

APEC (Asia-Pacific Economic Cooperation), 2003, Informal Fund Transfer Systems inthe APEC Region: Initial Findings and a Framework for Further Analysis, AlternativeRemittance Systems Working Group Report (Washington: World Bank).

———, 2004a, Informal Funds Transfer Systems: Lessons from the Policy Dialogue andBilateral Case Studies on Shifting to the Formal Sector, Remittances Initiative Reportto Finance Ministers and Deputies (Washington: World Bank).

———, 2004b, Shaping the Remittances Market by Shifting to Formal Systems, Sympo-sium on Alternative Remittance Systems, Tokyo, Japan, June 3–4.

G-8 Action Plan: Applying the Power of Entrepreneurship to the Eradication of Poverty, 2004,G8 Summit, Sea Island, Georgia.

Second International Conference on Hawala, 2004, “Conference Statement,” AbuDhabi, April 5.



4

Hawala: A U.A.E. Perspective

SAEED AL-HAMIZ

Definition

Hawala can be simply defined as an alternative or parallel remittance sys-tem that exists and operates outside the traditional banking system. Typ-

ically, a hawala transaction transfers the value of money from one country toanother without the corresponding movement of cash or cover across bor-ders. Another way of looking at the transaction is that it is a transfer of debt.

Hawala has existed a long time and actually predates bank transfersby hundreds of years. During the twelfth and thirteenth centuries, the devel-opment of trade between regions called for the establishment of reliable andtrustworthy instruments to finance those transactions. The instruments pre-date the conventional banking system and have contributed to the develop-ment of trade and the exchange of goods between nations and regions.

Hawala transactions operate essentially on principles similar to the pay-ment systems that were in use with the appearance of hundis, or bills ofexchange).1

The original objective of hawala was to facilitate all aspects of long-distance trade, whether by ship down the Red Sea and across the IndianOcean or by camel through Mesopotamia and Iran to Central Asia and

30

Saeed Al-Hamiz is Executive Director of the Banking Supervision and ExaminationDepartment of the Central Bank of the U.A.E.

1C.L. Aggarwal, The Law of Hundis and Negotiable Instruments (Lucknow, India: EasternsBook Co., 1989).


China. Financial security was a major problem for such traders, as it wasdifficult for them to protect their bullion (as a means of payment) frommarauding thieves. Hence, traders created hawala. Hawala is based purelyon a system of trust and originally operated within tight-knit extendedfamilies that were based in two or more major trading centers.

What is called hawala in Arabic is also known as hundi in India and Pak-istan and as havala in Iran. The word hawala comes from the Arabic roothawal, meaning to “to change” or “to transfer.” A traveler’s check is called ahawala safir. The Arabic word hawala has been adopted into both Hindiand Urdu. The alternative term, hundi, comes from the Sanskrit root mean-ing “to collect.” A hawala operator or dealer is called a “hawaladar.”

Examples

Hawala was the usual mode of money transmission in many regions ofAsia up until the mid-twentieth century. Thereafter, banks took over, andmany countries also enacted foreign exchange controls. This did not reducethe popularity of hawala in South Asia, however; quite to the contrary, itthrives in currency control environments.

Migrant workers who started coming to the United Arab Emirates in theearly 1960s sent and continue to send money using banks, money changers(who are well regulated in the U.A.E.), and hawala, which is also regulated.

An example of a typical hawala transaction is as follows: a foreign workergets paid in U.A.E. dirhams cash. He wants to send money to his family out-side the U.A.E., so he goes to a hawaladar in the U.A.E. and gives the hawal-adar the amount he wants to transfer. The hawaladar calls or sends ane-mail or fax to an associate in, for example, India and passes on the infor-mation about the amount to be transferred. The worker’s family in Indiareceives the equivalent in rupees (always better than bank rate) in cash fromthe original hawaladar’s associate.

This transaction can be completed very fast, sometimes in 15 minutes,and in almost all cases the hawaladar back home sends the money directlyto the worker’s house. In this case, the originating hawaladar will have acredit balance of the transferred amount and the associate in the recipients’country will have a debit balance of equivalent currency (less fees).

This transaction is simple and efficient in comparison to most alterna-tives. The worker pays the hawaladar and his family picks up the money thesame day. The worker does not need a bank account, and no one asks himto fill out elaborate forms or show an ID number. Nor does he need to dealwith an official exchange rate.

HAWALA: A U.A.E. PERSPECTIVE 31�


We in the U.A.E. consider that hawala has regained its popularity for thefollowing reasons:

• it is often faster and more reliable in reaching the beneficiary;• transmission charges are cheaper compared to banks and money

exchanges;• the hawala rate is better than the official banking exchange rate; and• it can be used in rural areas, which in some countries lack formal

banking facilities.Therefore, hawala is used by many people and organizations worldwide,

such as individuals who do not have bank accounts and low-salariedmigrant workers who wish to transfer funds to their families overseas andat the same time benefit from a better exchange rate, no commission orother charges, and fast and convenient home delivery of funds.

Initiatives Taken by the Central Bank of the U.A.E.

The Central Bank of the U.A.E. has offered to participate in any forum todiscuss the ramifications of hawala. We took the lead by arranging the“International Conference on Hawala” on May 15–16, 2002, in Abu Dhabi.Three hundred delegates from 58 countries attended, and the conferenceresulted in the Abu Dhabi Declaration on Hawala.

The declaration stated,“The international community should continue towork individually and collectively to regulate the hawala system for legitimatecommerce and to prevent its exploitation or misuse by criminals and others.”

The declaration also acknowledged that hawala has many positiveaspects and that much of the activity conducted by hawaladars is for legiti-mate business, but it also noted the system’s lack of transparency andaccountability.

We believe that hawala transactions originating in the U.A.E. are innocentand reflect migrant workers’ remittances to their home country. However, theCentral Bank of the U.A.E. has a responsibility to ensure that criminals,money launderers, and terrorists do not misuse this system of hawala.

To that end, the central bank actively encourages hawaladars operatingin the U.A.E. to register and follow a very simple set of rules.

Regulation of Hawala—Steps Already Taken in the U.A.E.

As a result of the Abu Dhabi Declaration on Hawala, in November 2002a public notice placed in local newspapers invited hawaladars to register

32 SAEED AL-HAMIZ�


with the Central Bank of the U.A.E. The notice outlined the followingconditions.

• A simple certificate will be issued, free of charge, to hawaladars whocome to register with the Central Bank of the U.A.E. The Central Bankof the U.A.E. will assure hawaladars that their names and details willbe kept safe at the bank.

• A hawaladar must maintain a record of each transaction; the recordsmust include details of the remitter. The hawaladar must also give fullparticulars of his or her bank account.

• Full details of reverse transactions (inward remittances) should also beregistered.

• Hawaladars must report transfers they suspect may be related tomoney laundering.

• Hawaladars must submit returns to the Central Bank on forms pro-vided by the bank.

The system is in the infant stage. All those who have applied have beengiven certificates to carry out hawala business. So far, 124 hawaladars haveregistered.

International Cooperation—Regulation

Both the First and Second International Conference on Hawala pro-duced a consensus that hawala needs to be generally understood on aworldwide basis. Internationally, hawala has many variants, which are bestdescribed as informal funds transfer (IFT) systems.

One example of an IFT system describes the “first mile” (collection offunds to the point of consolidation) and “last mile” (deconsolidation anddelivery at the destination), with the intermediary transfer of funds madeby SWIFT or telegraphic transfer (TT) using the “formal” system offered byeither banks or exchange houses.

The majority of participants in the conference also agreed that, given thelarge sums passing through IFT systems, the issue of regulation could notbe avoided. Regulation is needed to do the following:

• protect the rights and interests of retail customers;• prevent the evasion of taxes, excise duties, and so forth;• underwrite the reliability and creditworthiness of public companies

operating in the financial marketplace;• prevent drug money launderers and other criminals from laundering

their profits; and• prevent the financing of terrorist activities.

HAWALA: A U.A.E. PERSPECTIVE 33�


The Financial Action Task Force is also deliberating on the issue and maysuggest certain best practices in this area.

The Way Forward

The Second International Conference on Hawala was organized by theCentral Bank of the U.A.E. and the IMF and took place on April 3–5, 2004.Four hundred delegates attended. The conference statement reflected a gen-eral agreement that, despite issues of global security, hawala will continueto grow in volume and needs to be better understood.

It must also be understood that hawala is steeped in history; care must betaken not to overregulate it, which would likely drive the hawaladars under-ground.

As a regulator, the Central Bank of the U.A.E. has taken a first step byencouraging hawaladars to register. At present, more than 100 hawaladarshave registered, which is very encouraging.

Although formal funds transferors, such as banks and exchange houses,might find it a difficult proposition, they must become more competitiveby reducing their fees and operating more efficiently. Then, at least, themigrant workers and other innocent users of hawala would have a viablealternative. In time, there will be international standards; but reaching thatpoint will require a great deal of hard work.

34 SAEED AL-HAMIZ�


5

The Netherlands—Supervision of MoneyRemittance Offices

MAUD J. BÖKKERINK

Given the large turnover in the money remittance sector, money remit-tance offices are considered a significant part of the Dutch financial

system. In addition, because it has emerged that money remittances can bemisused for money laundering and terrorist financing, the Netherlands hasfound it necessary to regulate the money remittance providers.

Money remittance offices in the Netherlands are governed by four laws: theMoney Transaction Offices Act, the Identification of Services Act, the Disclo-sure of Unusual Transactions Act, and the Sanctions Act. These laws are part ofthe Dutch legal framework to protect the integrity of the financial system andto prevent money laundering and the financing of terrorism. Part of the Dutchcentral bank’s supervisory task is to inspect compliance with these laws formoney remittance providers. In case of breaches of these laws, the centralbank, De Nederlandsche Bank (DNB), has its own enforcement powers. TheDNB also has specific mechanisms to cooperate with the public prosecutorand law enforcement agencies to ensure that the objectives of the laws are met.

Legal Framework

Informal money remittance services, such as hawala, are prohibited inthe Netherlands, unless the service providers are registered with the DNB in

35

Maud Bökkerink is a financial sector expert in the Monetary and Financial SystemsDepartment of the IMF. Before that she worked for the Dutch Ministries of Finance and ofJustice on combating money laundering and the financing of terrorism.


accordance with the Money Transaction Offices Act, the law on the regis-tration and supervision of money transaction offices. This law, which cameinto force in July 2002, regulates currency exchange and money remittanceoffices and places service providers under the supervision of the DNB.1 Itimposes requirements on the integrity of persons involved in money trans-action offices and on the sound management and administrative organiza-tion of those offices. The Dutch government chose a registration systembecause it perceived that the full range of supervisory tools applicable tocredit institutions was too rigorous for institutions that perform onlymoney remittances.

Money remittance providers also are required, in accordance with theIdentification of Services Act, to identify their customers, as well as personsacting on behalf of customers, before entering into a business relationship.Identification is obligatory for all money remittances, regardless of theamount.2

Since August 1998, money remittance providers have been obliged toreport unusual transactions to the Office for the Disclosure of UnusualTransactions (Meldpunt Ongebruikelijke Transacties—MOT, the Dutchfinancial intelligence unit).3 In accordance with articles 8 and 9 of the Dis-closure of Unusual Transactions Act, both executed and intended transac-tions have to be reported on the basis of the three main “indicators” formoney remittance offices. First, money remittance offices have to reporttransactions when they have reason to believe that the transaction is relatedto money laundering. Second, they have to report all cash transactions over€2,000. Third, they have to report a transaction when it is believed that acustomer prefers to keep the transaction amount below the threshold toavoid reporting (“smurfing”).4

36 MAUD J. BÖKKERINK�

1The Money Transaction Offices Act replaced the Exchange Offices Act of 1995, whichgoverned the registration and supervision of exchange offices.

2Article 1(1)(a) sub 7 and 1(1)(b) sub 9 Identification of Services Act, and article 1(g),article 2(1)(g) of the combined decree of the Identification of Services Act and the Disclo-sure of Unusual Transactions Act, Decree of February 24, 2003.

3Article 1(1)(a) sub 10 Disclosure of Unusual Transactions Act, and article 4(1)(b) and4(1)(c) of the combined decree of the Identification of Services Act and the Disclosure ofUnusual Transactions Act, Decree of February 24, 2003.

4Indicator T9810211: transactions where there is reason to believe that the transaction isconnected with money laundering, indicator T9810141: transactions over €2,000 wherefunds are provided in cash, in checks, or by means of a credit or debit card, or where fundsare paid out in cash, in checks, or by transfer into an account, and indicator T9810231: pref-erence of the customer for transactions below the threshold, presumably to avoid reporting.


In 2002, money remittance offices reported 95,000 unusual transactionsto the MOT, and in 2003 almost 124,000; 95 percent of those transactionsconsisted of transactions over €2,000. Of the unusual money remittancetransactions that were reported in 2002, the MOT turned over 13,420 trans-actions to law enforcement authorities as suspicious; in 2003 they turnedover 27,300 transactions. According to the 2003 report of the Office for Dis-closure of Unusual Transactions, the total value of suspicious transactionswas €52.6 million in 2002, and in 2003 the value was €99 million. Of thereported unusual transactions, approximately 80 percent were remittedfrom the Netherlands to other countries and 20 percent were received fromother countries. In 2003 the three most popular countries of destination—for both unusual and suspicious transactions—were Colombia, the DutchAntilles, and Turkey. Suspicious money transfers sent to the Netherlandscame mostly from Austria, Germany, Italy, and the United States. Finally,money remittance offices have to comply with the requirements of theSanctions Act. This act is an important instrument in countering thefinancing of terrorism. In accordance with the act, money remittance officeshave to freeze terrorist funds and are prohibited from providing financialservices to terrorists and terrorist organizations.

Registration

Under the Money Transaction Offices Act, operating a money remit-tance office is prohibited unless the office is registered with DNB. Whenapplying for a registration as a money remittance office, the office has tofurnish, inter alia, information on the identity and criminal records of thedirectors, owners, and managers, as well as on the envisaged operationalmanagement. Applications for registration as a money remittance officecan be refused if the central bank is of the opinion that the integrity of thefinancial system would be impaired or if the management or administrativeorganization is not adequate to ensure the proper conduct of business orcompliance with other statutory obligations to which the office is subject.5

A money remittance office must also provide a bank guarantee. Thisrequirement is important for consumer protection and guarantees cus-tomers that the cash (or cash equivalent) that has been paid by the cus-tomers, but not yet paid out to the beneficiary, can be refunded, for instance,in the case of bankruptcy. The total amount received but not yet paid may

THE NETHERLANDS—SUPERVISION OF MONEY REMITTANCE OFFICES 37�

5Money Transaction Offices Act, Article 2(1).


never exceed the amount of the bank guarantee.6 In addition, money remit-tance providers have to pay a fee to register and an annual fee to cover thecost of supervision. The cost for both is €3,000. In addition, money transac-tion offices are also charged an annual fee as a percentage of their annualrevenues. The fees are intended to fully recover the costs of supervision.

When processing applications, the central bank assesses the fitness andpropriety of the applicants. The supervisor looks into property agreements,shareholders’ registers, the institution’s Articles of Association or coopera-tion agreement, the latest available annual accounts, and other informa-tion. The supervisor also tests the reliability of the person or persons whowill determine the policy of the money remittance office, holders andprospective holders of qualifying holdings in the money remittance office,the provided policy plan, the description of the administrative organizationand internal controls, and the bank guarantee.

Since the Money Transaction Offices Act came into force in July 2002,approximately half of the applications for registration have been refused.The main reasons were that the trustworthiness of managers, owners, anddirectors was not beyond any doubt, and that the administrative organiza-tion did not comply with the act. As of September 15, 2004, 31 money trans-action offices had been registered; for several offices the decision waspending.7

Some of the applicants that were refused registration lodged a notice ofobjection with the central bank. In a majority of those cases, the objectionshave been considered unsustainable. In a very few cases, the applicants havelodged an appeal with the district court.

In several cases where the registration was refused, the central bank fol-lowed up to see if the offices had stopped their money remittance business.Of those investigations, some cases led to a cease and desist order, and othercases were referred to the public prosecutor.

Supervision and Enforcement

The central bank has adopted a zero tolerance policy in enforcing theobligations of the supervisory laws. The policy applies to all legal and illegalfinancial institutions that are active in the financial markets in the Nether-


6Money Transaction Offices Act, Articles 1(d) and 2(2).7Of the 31 registered offices, 18 are registered to perform money remittances. Some offices

perform only currency exchange transactions and no money remittances. A list of registeredoffices can be found at http://www.dnb.nl.


http://www.dnb.nl

lands. The policy can also be recognized in the organizational structure ofthe Supervisory Directorate of the central bank. This directorate has threetypes of units: a unit that handles applications, supervisory units, and aspecial enforcement unit for illegally operating institutions.

An inspection team of about six staff members performs onsite inspec-tions of registered money remittance offices two to four times a year. Inaddition, money remittance offices are required to send a monthly financialreport, draw up annual accounts, and write an annual report.

The supervisor’s enforcement powers include giving specific instructions,imposing cease and desist orders under penalty, and imposing administra-tive fines. The supervisor also can report an offense to the public prosecutoror cancel an office’s registration. The enforcement powers to be used dependon the concrete aspects of a case. Aspects that are taken into account are, forinstance, the level of intent or the degree of recidivism. The underpinningfor the central bank’s enforcement policy is that offenses against the lawscannot be tolerated; the goal is to reach conformity with the rules and regu-lations. To attain that goal, supervisory measures are proportional, and insti-tutions are given a chance to change their behavior. Repressive measures aretaken only if no change occurs. Furthermore, if there are reasonable groundsto suspect that an institution is involved in criminal activities, the centralbank will always report it to the public prosecutor.

The enforcement unit of the central bank is taking a proactive attitude inmonitoring the market. To see if money remittance offices are operatingwithout a registration, the unit visits certain locations, checks the Internetwith dedicated software, and checks national and regional publications andnewspapers. The central bank follows up on all signals, usually starting withan onsite visit to gather information. Violations of the registration require-ment are discussed with the public prosecutor in regular meetings, duringwhich decisions are made on administrative or criminal actions.

Financial Expertise Center

The central bank maintains regular contact with the public prosecutorand law enforcement authorities to share information and cooperate incase of breaches of the relevant laws. One mechanism for this cooperationis the so-called Financial Expertise Center (FEC). The FEC is an interagencycoordinating body for the exchange of information on financial crime. Itwas established in 1998 by covenant of the participating agencies under theguidance of the Ministries of Finance and of Justice. Participants in the FECinclude all organizations that have a mandate relative to the financial sec-



tor: the financial supervisors, the financial intelligence unit, tax authorities,the intelligence and security service, law enforcement authorities, and pros-ecutorial authorities. The function of the FEC is to enable the participantsto strengthen the way their respective organizations perform their tasks bysharing information to ensure that they recognize offenses more easily.

The FEC has two consultative bodies for information sharing and coop-eration: a research group and an investigation group. In the research group,interagency project teams conduct surveys and study trends and develop-ments in the financial sector with respect to money laundering, financingof terrorism, and other financial crimes. Information is shared anony-mously. The project teams make recommendations, for instance, on thelegislation in force, on improvements with respect to the enforcement ofsupervisory rules, or on reporting procedures to the financial intelligenceunit. The reports of the research group are published on the FEC’s website(http://www.fecinfo.nl).

The investigation group discusses concrete cases. The objective of thisgroup is to bring together participants who have only a piece of informa-tion on a certain case, such as a piece of information that by itself seemsstrange but does not present grounds for suspicion. By sharing all pieces ofinformation from different organizations, often an illegal activity can berevealed. By using this coordinated approach, and by combining informa-tion from relevant participants, members of the investigation group decideon the best course of action, that is, administrative or criminal investigationand sanctions.

In a project that the FEC completed on money transaction offices, thesurvey performed by the research group revealed that registered moneytransaction offices play an important role in detecting underground cur-rency exchange and money remittance offices, especially through the report-ing of unusual transactions. The project team found from analyzing 50,000reported unusual transactions that a relatively small group of customers wasresponsible for more than 50 percent of the transactions (approximately€500 million). Police information revealed that part of this group consistedof professional money-changers for criminal organizations.

On the basis of this analysis, the FEC’s investigation group did a follow-up project to enable authorities to adequately enforce all applicable laws.The project team collected information not only on registered offices butalso on illegal offices. The project team analyzed and prioritized signalsemerging from all the available information and made proposals for addi-tional investigations. Signals that were taken into account were, for instance,concurrence of administrative, criminal, or tax offenses; the amounts



http://www.fecinfo.nl

involved in transactions; and the number of occurrences. In 2004, the pub-lic prosecutor will investigate six cases proposed by the project team.

The central bank has found that the collaboration of several organiza-tions through the FEC has been a significant vehicle for assessing the risksof money remittance and currency exchange transactions to the financialsector. It has also been valuable in enhancing information-sharing andinteragency cooperation.

Conclusion

As mentioned in the preamble of the Money Transaction Offices Act aswell as in the explanatory note to this law, the Dutch regulatory system hasbeen designed to protect the integrity of the financial system and to preventmoney laundering and the financing of terrorism. In conjunction with thelaws described above and with the enforcement and cooperation tools avail-able to the authorities, the system functions very well in safeguarding theDutch financial system from misuse by illegal money transaction offices.



6

U.K. Regulation of Money ServiceBusinesses

DAVID FAULKNER

This paper describes both how the United Kingdom regulates its moneyservice businesses and how, in doing so, it fulfills the requirements of

Financial Action Task Force (FATF) Special Recommendation VI. Recom-mendation VI calls on countries to take measures to ensure that informalmoney or value transfer systems are licensed or registered and subject to allthe FATF recommendations that apply to banks and nonbank financialinstitutions.

I. Background

The United Kingdom’s approach to the regulation of money servicebusinesses has evolved considerably over the past decade and has includedthe introduction of a formal regulatory regime. The United Kingdomdefines money service businesses as businesses falling within the followingcategories:

• third-party check cashers• bureaux de change, and• money transmitters, including those engaged in informal value transfers.The United Kingdom has adopted a two-pronged approach to the regu-

lation of such businesses, depending on whether they operate in the formal

42

David Faulkner is senior policy adviser for Financial Systems and International Standards,H.M. Treasury.


or informal realms. Those in the formal sector, such as the bureaux dechange located in main commercial banks, are regulated like the banksthemselves, by the Financial Services Authority. However, businesses in theinformal sector, which are stand-alone and independent, are regulated andsupervised by H.M. Customs.

In terms of scale, the United Kingdom has over 2,500 registered moneyservice operators carrying out their business in over 32,000 premises, halfof which are post offices. There are more than 40 so-called significanttraders such as Western Union. The remainder, therefore, are largely self-standing, independent, and individual businesses, 90 percent of which havefewer than five employees. They offer check cashing, currency exchange,and money transmission facilities, including some 800 specifically regis-tered as providing informal money transmission services. All services, irre-spective of the size and nature of the business, are subject to the regulatoryregime and must comply with its requirements.

The U.K. Approach

By the time FATF’s Special Recommendation VI emerged, the UnitedKingdom was already exploring how this broad informal sector could bemost effectively regulated. The introduction of the regulatory regime in 2001had its origins in a number of factors. The Cabinet Office Performance andInnovation Unit, in its June 2000 report Recovering the Proceeds of Crime, firstset out a proposal to establish a domestic regulatory framework for thesebusinesses. The report examined the recovery of the proceeds of crime acrossa range of criminal activities. It noted that the money service transmissionsector was potentially vulnerable to significant financial abuse. To addresssuch risks, the report recommended a balanced approach, one that wouldboth “incentivise” and involve all communities while being equally rigorousin scrutiny, tough in enforcement, and effective in sanctions imposed fornoncompliance.

On this basis, the report recommended what it called a light touchapproach, although the term “light touch” does not imply any sense ofunwillingness to address abuse of the system. On the contrary, the aim ofthe U.K. regulatory regime has been to avoid introducing burdensome,overly intrusive regulation that could be counterproductive, potentiallydriving many businesses away from compliance, undermining trans-parency, and obscuring traceability. One of the key aspects of effectivelyregulating this sector in the United Kingdom has been to ensure that thoseproviding money service facilities, for example to our ethnic communities,

U.K. REGULATION OF MONEY SERVICE BUSINESSES 43�


are not discouraged by overly complex and disproportionate regulationsbut rather are encouraged to work in partnership and cooperation with theauthorities. In short, the U.K. approach is one that aims to maximize con-trols on areas that are subject to the highest risk while minimizing theadministrative burden on industry, consumers, and communities.

Registration of U.K. Money Service Businesses

In operational terms, the U.K. regime requires that money service busi-nesses register with Customs. That is, to operate as a money service businessin one or all of the three categories indicated above (third-party check cash-ers, bureaux de change, or money transmitters), businesses must completeand submit a registration notice, which is available from various sources,including the Internet. Those registering are also required to pay a fee of£60—about €85/US$113—for each premises from which they operate. Thisfee has in fact been reduced in the past year to ensure that the levy imposedis proportionate to the type of business covered. In short, the process placesthe requirement to register directly on the regulated entity. Any business thatoperates these sorts of money services but fails to register is in breach of theUnited Kingdom’s money laundering regulations and subject to financialpenalties of up to £5,000 or €7,000/US$9,500.

In registering, businesses receive a certificate showing a specific andunique registration number and a video explaining the system and itsrequirements. Businesses must notify Customs of where they intend tocarry out their operations. Once a business is registered, it will be visited bya customs officer. The visit is central to the due diligence process, since itprovides officials with the opportunity to monitor how the business is beingrun and whether the money laundering regulations are fully understoodand complied with, and to ensure that customers provide sufficient evi-dence of their identity and that proper records are kept.

Penalties

The scope to issue penalties was recently widened considerably to allowfor the imposition of civil penalties for failures in registration andanti–money laundering systems failures. Customs has adopted a steppedapproach for imposing penalties for noncompliance. Any money servicebusiness found in breach of its responsibilities receives a warning letterand a subsequent visit to ensure that satisfactory controls have been put in

44 DAVID FAULKNER�


place. This process continues in an increasingly rigorous manner untilcompliance is achieved. Noncompliance is met by penalties and ultimatelyby prosecution.

Customs sums up the requirements that businesses need to meet in thephrase CATCH—that is, businesses must do the following:

• Confirm the identity of their customers;• Appoint a money laundering reporting officer;• Train their staff;• Control their business by having anti–money laundering systems in

place; and • Hold all records for at least five years.In short, the U.K. system places responsibility on the business rather

than on the regulator—a potentially significant distinction in the debateabout the merits of registration and licensing. The FATF best practicespaper on Special Recommendation VI (Combating the Abuse of AlternativeRemittance Systems: International Best Practices) indicates: “The key differ-ence between the two is that licensing implies that a regulatory body hasinspected and sanctioned the particular operator to conduct such a busi-ness; whereas registration means that the operator has been entered intothe regulator’s list of operators.”

The U.K. experience suggests that this distinction may be too finely drawn.Despite having a registration regime, the follow-up visits made by Customsinvolve a clear degree of inspection and approval, together with scrutiny ofthe application. This approach can be defined as “risk-based and intelligence-led”—risk-based because, having made a risk assessment, those passing judg-ment still have to base it on proportionality and potential impact;intelligence-led because knowledge, information, and data provide assurancethat the system is properly and effectively controlled. That means, in short,that Customs is operating intelligently and in ways designed to promote aculture of compliance and is bringing in those who might otherwise remainbeyond scrutiny. The supervisory effort is directed by intelligence that focusesattention on the most vulnerable areas. Finally, the arrangements are ulti-mately underpinned by a sequence of increasingly stringent sanctions andpenalties. As in any effective regulatory regime, the key should be to ensurequality of supervision, compliance, and enforcement through transparencyand traceability—an approach that has been termed “registration-plus.”

However, all regulatory systems need to be kept under regular review,and the U.K. continues to review its own systems and procedures. There iscertainly no one-size-fits-all solution, and circumstances and systems ofmoney transmission vary significantly across jurisdictions. The declarationissued at the Second International Conference on Hawala in April 2004

U.K. REGULATION OF MONEY SERVICE BUSINESSES 45�


acknowledged the need to understand different systems against the diver-sity of sociocultural, legal, and economic contexts.

Conclusion

By promoting the understanding of different money transmission sys-tems, the international community can foster enhanced regulation, reducevulnerabilities to money laundering and terrorist financing, and effectivelysupport those communities whose livelihood often crucially depends onsuch systems. The U.K. will continue to play its full part in these efforts.

46 DAVID FAULKNER�


7

Challenges of Regulating and Supervisingthe Hawaladars of Kabul

SAMUEL MUNZELE MAIMBO

In September 2004, Da Afghanistan Bank, the country’s central bank,introduced legislation to regulate and supervise the activities of money

service providers in Afghanistan. This regulation applies to all individualsand legal entities that provide money services in Afghanistan, whether ornot the individuals and legal entities are domiciled in Afghanistan. For thepurposes of the regulation, money services are defined to include safe-keeping, money transmission, check cashing, and currency exchange. Alicensed money service provider is entitled to engage in all of the activitiesof a foreign exchange dealer, but a licensed foreign exchange dealer may notengage in safekeeping, money transmission, or check cashing withoutupgrading its license to that of a money service provider.1

Da Afghanistan Bank faces significant challenges in its efforts to regulateand supervise the informal financial hawala transactions of the hawaladarsof Kabul under the recently introduced Money Exchange Dealers Regula-tions.2 Reforming the formal financial sector immediately after active con-

47

Samuel Munzele Maimbo is a financial sector specialist in the South Asia Region of theWorld Bank. Since March 2002, he has led the Bank’s work on informal remittance systems.The author wishes to acknowledge the research assistance provided by Katrina Karaan inpreparing this paper.

1This regulation shall not apply to commercial banks licensed by Da Afghanistan Bank,their branches, and foreign bank branches permitted by the bank. Money services providedby these banking organizations are regulated and supervised as part of their overall opera-tions, under the regulations issued pursuant to the Law of Banking in Afghanistan.2In Arabic, hawala simply means “transfer.” For analytical purposes, the term is used to referbroadly to money transfer mechanisms that exist in the absence of, or in parallel to, formal


flict is difficult enough; undertaking to regulate the informal sector undersuch circumstances is doubly daunting.

Further compounding the problem, increasing opium production inAfghanistan and an emerging nexus of drug trafficking with terrorist andmilitant groups are exerting a very strong effect on the informal financialsector. Much needs to be done to ensure that the successful reforms under-taken to date are not undone.

Implementing the new regulations will be challenging for the centralbank because of three specific issues. First, the informal financial systemhas a long history of independence and self-regulation. Second, incentivesfor compliance are undermined by the weakness of the legal and judicialframework for the prosecution of financial crimes. Third, investigatingmoney laundering and terrorist financing is complex, given the size of thedrug economy and the emerging risk of a nexus of drug trafficking with ter-rorist or militant groups.

This paper commences with a brief discussion of the rationale for regu-lating informal financial services then outlines the special challenges thecentral bank faces in Afghanistan. It concludes with two modest recom-mendations: the need to continue strengthening the legal and judicial sys-tem, and the need to continue working in partnership with the associationof hawaladars.

The Rationale for Regulating Informal Financial Services

In a conflict-afflicted country, conventional assumptions about financialrisk and abuse do not necessarily apply, at least not everywhere or in everycase. In an environment where increasing opium production and occa-sional terrorist acts have increased the incentives to conceal and obscure the

48 SAMUEL MUNZELE MAIMBO�

banking channels. In some countries, commercial banks use the term hawala to refer to for-mal-sector money transfers. That definition is not used here. A hawala transaction, as definedhere, encompasses financial transfers made by principals or by customers located in coun-tries A and B (Customers CA and CB in examples below), through hawala service providersin their respective countries. Those providers (designated hawaladars HA and HB) operateoutside the formal financial sector, regardless of the use or purpose of the transaction andthe country of remittance or destination. Typically, HA receives funds from CA and asks HBto advance the amount to CB in the local-currency equivalent. In a prototype hawala trans-action, an expatriate worker (CA) uses a hawaladar (HA) to arrange a remittance to his homecountry. CA makes payment in dollars or another convertible currency to HA, who contactsa hawaladar counterpart (HB) in the receiving country to arrange payment in local currencyto the remitter’s family or other beneficiary (CB) (El Qorchi, Maimbo, and Wilson, 2003).


origins and destinations of illicit financial transactions, it will not be possi-ble to accumulate the same breadth and depth of understanding of theinformal financial sector that regulators have for formal commercial banksin stable developed economies. That being so, why bother to attempt regu-lation at all?

The financial sector, and banks in particular, are subject to heavier regu-lation than virtually any other industry. The reasons for this lie in the com-bination of several factors. First, banks are vulnerable to failure—and bankfailures entail serious negative externalities. Second, there are significantproblems of imperfect information between bank owners and depositors.Third, optimal regulation of the market—just enough regulation to mini-mize failure—is often difficult to achieve, forcing regulators to err on theside of caution with additional regulations. Although none of these factorsis unique to banks, their combination is shared by few other industries.

By association, nonbank financial institutions, including informal finan-cial institutions, attract similar regulatory interest and concern. The riskthat nonbank financial institutions might create negative externalities forclients by engaging in unsafe and unsound financial practices compels reg-ulators to periodically examine the need for action. Their interest is oftenspurred by an event such as a bank failure, financial fraud, or, occasionally,a broader economic or political event.

In the specific case of the hawala system, renewed regulatory interest wasstimulated by press and law enforcement investigations into the September11, 2001, terrorist attacks in New York and Washington, D.C. By pointing to aconnection between informal remittance systems and terrorist financing,those investigations raised officials’ concerns about informal remittance sys-tems’ susceptibility to abuse. Hitherto, most financial regulators had assumedthat the amounts transferred through hawala-type remittance systems weresmall and did not pose significant systemic risks to the financial system.

On October 10, 2001, the international Financial Action Task Force(FATF) against money laundering responded to those concerns by issuingeight special recommendations aimed at combating terrorist financing.Those recommendations supplemented FATF’s 40 earlier recommendationsfor fighting money laundering, which quickly became and have remainedthe world standard for preventing criminal abuse of financial systems.

Arguing that money and value transfer systems had shown themselvesvulnerable to misuse for money laundering and terrorist financing, FATFurged in Special Recommendation VI that all jurisdictions contribute to thetransparency of payment flows by imposing on all types of money and valuetransfer systems consistent measures, including either licensing or registra-tion, against money laundering and terrorist financing.

CHALLENGES OF REGULATING AND SUPERVISING THE HAWALADARS 49�


The recommendation called on countries to license or register formaland informal remittance businesses and subject them to all FATF recom-mendations that apply to banks and nonbank financial institutions. FATFstated in Special Recommendation VI:

Each country should take measures to ensure that persons or legal entities,including agents, that provide a service for the transmission of money or value,including transmission through an informal money or value transfer system ornetwork, should be licensed or registered and subject to all the FATF Recom-mendations that apply to banks and nonbank financial institutions. Each coun-try should ensure that persons or legal entities that carry out this service illegallyare subject to administrative, civil or criminal sanctions.

Special Recommendation VI is considered to be the minimum effectivelevel that a money transfer business should be required to fulfill to complywith international know-your-customer requirements.3 According to therecommendation, it is important to the credibility of the system that busi-nesses reject clients and refuse to conduct business—and under specific cir-cumstances, report the transaction to authorities—if that client fails toproduce an acceptable form of identification. In a subsequent interpretivenote on Special Recommendation VI, FATF focused on three core points:

• Jurisdictions should ensure that money and value transmission ser-vices, including informal systems, are subject to all applicable FATFrecommendations (in particular, 4–16 and 21–25).4

• Jurisdictions should require licensing or registration of persons (nat-ural or legal) who provide money or value transfer services throughformal or informal systems.

• Jurisdictions should have the power to impose sanctions on moneyand value transfer services, including informal systems, that fail toobtain a license or register and that fail to comply with relevant FATFrecommendations, including that pertaining to record keeping.5


3The recommendation states that the institution should be “identifying the customer andverifying that customer’s identity using reliable, independent source documents, data orinformation.” The documents commonly acknowledged and accepted for identificationpurposes are identity card, passport, driver’s license, and social security card.

4FATF recommends that jurisdictions should introduce transaction reporting in line withtheir current reporting requirements for financial institutions. Thus, jurisdictions may con-sider issuing to the money-transfer sector specific guidance as to what may constitute a sus-picious transaction. Some currently used indicators of suspicious financial activity, such asthose found in the FATF’s “Guidance for Financial Institutions in Detecting TerroristFinancing,” are likely to be relevant for money and value transfer activities. However, par-ticular activities and indicators unique to this sector should be developed further.

5The FATF’s Recommendation 10 called for financial institutions to maintain records forat least five years. The FATF recommends that jurisdictions consider setting some minimumrequirements for the form in which those records should be kept.


In Afghanistan, the call to regulate informal remittance systems came at atime when development agencies were highly dependent on hawaladars fortheir financial transactions. No private financial institutions were operatingin the country, and the remaining state banks were plagued by significantweaknesses, among them, weak corporate governance and managementstructures, unskilled human resources, outdated technological capacity andaccounting systems, and grave problems of liquidity and solvency.

During the Taliban period, the country’s formal banking system was notoperational. The then six licensed state banks did not provide commercialbanking services, nor did they have the capacity to offer international ordomestic remittance services. Short of physically moving cash around thecountry, hawala transactions were the only reliable, efficient, and safe meansof transferring funds into Afghanistan and within its provinces.

In fact, the hawaladars of Kabul were the only active financial operators.They offered a diverse range of financial and nonfinancial services stratifiedinto local, regional, and international markets. More than 300 registeredhawaladars organized themselves into an impressive open market offeringforeign-currency exchange, funds transfers, microfinance, trade finance,and deposit-taking activities. Nonfinancial activities included telephoneand fax services, regional and international trade, and, more recently, Inter-net services.

The hawala system was praised by foreign and local aid agencies for itsefficiency.6 Transferring funds to Kabul from Peshawar, Dubai, and Londontook an average of 6 to 12 hours. Most transfers between Kabul and any ofthe regional centers were completed within 24 hours. Slightly more timewas required for payments to more remote regions or villages where themoney exchange dealer did not have a local office or representative. Thecost of transferring funds into and around Afghanistan was low, averaging1 to 2 percent. The price depended on the volume of the transaction, therelationship between the client and the hawala dealer, the currency ofexchange, the security environment in Kabul and at the destination for thefunds, and the negotiating skills of the client. Nearly all nongovernmental


6From 1980 to 1986 official development assistance to Afghanistan never exceeded US$20million a year. Between 1988 and 1998, official development assistance averaged a little morethan US$200 million a year, and during the years of the Taliban rule, external aid fell to a lit-tle more than US$130 million a year. From 1992 to 2001, the United Nations provided a totalof US$160 million in aid. At the 2002 International Conference on Reconstruction Assis-tance for Afghanistan in Tokyo, the international community pledged more than US$4.5 bil-lion toward the US$15 billion that international organizations estimated it would cost todevelop the economy (Rondinelli, 2004, pp. 11–15).


organizations, aid donors, and development agencies used the hawala sys-tem to deliver humanitarian relief and developmental aid to Afghanistanand to move funds around the country. There was no limit to the volume offunds the hawaladars of Kabul could process, either individually or sever-ally. Single transactions in excess of US$500,000, especially betweenPeshawar and Kabul, were not uncommon. Smaller organizations regularlyremitted US$20,000–30,000 through the system to meet expenses.

The role of hawaladars in facilitating remittances is important. About 15percent of the rural population receives remittances, which representsabout 20 percent of the rural population’s expenditure on average (WorldBank, 2004, p. 19). During the past 25 years, more than 30 percent of theAfghan population has been externally or internally displaced (with over 3million in Pakistan and 2.3 million in Iran). Remittances from Pakistan,Iran, North America, Europe, and parts of Australasia remain a central ele-ment of Afghan households (World Bank, 2004, p. 27).

At the same time, the use of the hawala system raised concern, particu-larly among the international financial institutions. The inaccessibility ofthe customer records of hawaladars and ambiguities in the settlementprocess made the system vulnerable to abuse. There were no standard doc-umentary requirements for conducting business in the market. Neither thecentral bank nor the hawala dealers’ association required dealers to opentheir books for external inspection, nor did they require periodic financialreports. Standardized documentation and reporting were consideredunnecessary because of the high level of trust upon which the informal sys-tem is founded. There were no standard requirements for keeping recordsof completed transactions and no regulatory requirement for customeridentification. Consequently, hawala transactions were unlikely to leaveaudit trails for law enforcement agencies investigating money laundering,tax evasion, corruption, or other related activity.

In early 2002, when Da Afghanistan Bank commenced financial sectorreforms, it had four regulatory options regarding the informal sector(Maimbo, 2003): (1) adopt no regulatory or supervisory standard pertain-ing to the informal money transfer sector; (2) extend formal banking sectorregulations to the money-exchange market and establish formal on- andoffsite supervisory mechanisms; (3) allow self-regulation and supervisionamong dealers; or (4) establish special regulatory and supervisory stan-dards for the informal sector.

Each approach presented its own administrative and institutional chal-lenges. The fundamental question facing the central bank was whetherhawaladars posed systemic risks serious enough to require formal regula-tory and supervisory regimes similar to those being developed for the bank-



ing sector. Or could the hawaladars be left alone without endangering thelong-term stability of the financial sector and monetary policy?

In view of intense international efforts to combat money laundering andterrorist financing, the first option had to be ruled out—it was not feasibleto forgo regulatory standards altogether. Therefore, regulators began con-sidering how hawala practices could be brought into closer compliancewith international regulatory and supervisory standards.

The following were some of the key questions:• could the registration process in force at the time be strengthened? • could client information collected by hawaladars be standardized?• could hawaladars be induced to report suspicious activity to the cen-

tral bank? • could hawaladars be made to keep appropriate records? • could an agreement be reached about external oversight and access to

those records?Nearly three years later, the same questions apply. But in the meantime,

Afghanistan has made progress in reforming its financial system.7 Com-pared with conditions in December 2001—an outdated legal framework,no functioning commercial banks, a handful of nongovernmental organi-zations competing with a vibrant informal financial sector—a basic formalfinancial system has emerged.

Now the bank relicensing process of the state banks has been completed.Following the enactment of a new commercial banking law in September2003, the central bank agreed to decide which banks would be allowed tosubmit applications for relicensing (by March 2004) and which would berelicensed (September 2004). A new central banking law now guaranteesthe autonomy of Da Afghanistan Bank. After the successful issuance of anew currency, a rudimentary monetary policy regime is emerging. A newbanking supervision department has commenced onsite inspections ofbanks. The central bank’s SWIFT connection is functional, and one-thirdof central bank branches are now connected electronically for domestic


7When reforming their financial sectors, conflict-afflicted countries face many challenges,among them damaged physical infrastructures, staff with outdated skills, and absent or out-dated technology. Because properly functioning financial systems enhance economic devel-opment, reduce transaction costs in the economy, promote the efficient use of financialresources, and improve financial market liquidity, it is vital that those conditions be read-dressed. Experience from Bosnia-Herzegovina, the Democratic Republic of Congo, and EastTimor shows that the challenges are not insurmountable. Buildings can be rebuilt, staffretrained, and technology upgraded. Comprehensive, well-sequenced, and well-coordinatedfinancial sector reforms can restore basic services in the short term, and the financial sectorcan return to long-term growth and vitality.


payments. Overall, the central bank’s operational capacity has improveddramatically.

Banking services in Afghanistan, however, remain limited. The passageof the Central Banking Law and the Commercial Banking Laws in Septem-ber 2003 and the entry of several commercial banks mark significantprogress. But there is much to be done before financial services are restoredto the level required for meaningful trade and investment activities. Statefinancial institutions are largely nonfunctional. The new private banks havenot yet started lending to industry, and it appears that at least some of themwill not be inclined to do so in the near future (World Bank, 2004, p. 57).

In light of the experience of other conflict-afflicted countries,Afghanistan’s central bank has fared reasonably well. However, thoughreforms in the formal financial sector have progressed at an impressive rate,much remains to be done in harnessing the positive aspects of the informalfinancial system while tempering the risks that it presents.

Special Challenges of Regulating Informal Money Services in Afghanistan

To protect the progress made to date in the formal financial sector, thegovernment must now rise to the challenges of (1) implementing therecently introduced regulations and supervision requirements in a sector ofthe financial system that has a long history of self-regulation, (2) strength-ening the legal and judicial framework for the prosecution of financialcrimes, and (3) building its capacity to investigate complex money laun-dering and terrorist financing transactions. The last is a particularly serioustask given the size and rate of growth of the drug economy and the emerg-ing risk of a nexus of drug-trafficking and terrorist-militant groups.

The Hawaladars’ Long History of Self-Regulation

The history of foreign exchange dealers in Kabul dates back to the erawhen the great overland trade routes between the Mediterranean and theOrient passed through Afghanistan (Nyrop and Seekins, 1986). From the1930s, when the first banks were established, to present-day Afghanistan,hawaladars have played a central role in financial intermediation, with littleor no regulatory oversight.

Before 1930, all foreign exchange transactions were handled by privatedealers located primarily in Kabul and Qandahar. Even the Afghan govern-ment’s foreign exchange was purchased from these dealers. Through Bank-



i-Melli and later the central bank, the government tried to assert a monop-oly of its own over foreign exchange transactions between 1930 and 1960.Despite exchange-surrender regulations and occasional prohibitions offree-market dealings, the bazaars survived so successfully that Bank-i-Melliand the central bank had to keep their own dealers in the money bazaars.

The 1960s were a period of renaissance for the money bazaars, even asthe formal banking system stagnated. The volume of business and the num-ber of dealers grew; technological improvements, such as electronic calcu-lators, appeared. Among the money traders, specialization began to emerge.

By the 1970s, dealers normally traded in either rupees or other convert-ible currencies. The money bazaars maintained close telecommunicationslinks with correspondent banks around the world and handled foreign bankdrafts as well as currency. By the 1970s, they could provide nearly all the ser-vices of a commercial bank, making trade-finance loans, consumer loans(notably for weddings), working capital loans for farmers and entrepre-neurs, housing loans, and loans for long-term industrial undertakings.Because of the bazaars’ high interest rates, businessmen saw them as a lastresort for credit. Because bank loans were largely unavailable outside Kabul,the prominence of the rural provincial bazaars continued to grow. Right upuntil 2002, the authorities continued to follow a policy of noninterferencewith operations in the money bazaars.

The market has had such a long history of operational and regulatoryindependence that external oversight is not likely to be welcomed, espe-cially if it is overly burdensome.

A Weak Legal and Regulatory Framework

To its credit, the central bank has not implemented regulations for theinformal financial sector in haste. Rather, its new money exchange regula-tions are the product of months of consultation and discussion. As drafted,they provide detailed eligibility criteria for licensing, minimum prudentialrequirements, and requirements for compliance with anti–money launder-ing standards.

Licensing. The proposed regulations specify that licensed hawaladarsmust maintain, during the entire duration of their operations, the mini-mum required capital and a standby letter of credit or other guarantee.They must employ at least two fit-and-proper persons to manage the busi-ness. If the business is a legal entity, some or all of whose owners possess aqualifying holding, those owners must be fit-and-proper persons or legalentities whose managers are fit-and-proper persons. The business plan of



the licensed firm must specify a proper organizational structure with effec-tive internal control mechanisms, an appropriate accounting system forrecording transactions, and the financial means to attract and retain quali-fied staff. The firm must agree to apply the appropriate procedures for theprevention of money laundering and terrorist financing.8 Once a license isgranted, the money service business is permitted to engage in any or all ofthe following activities: money transmission, safekeeping, and check cash-ing. It is not, however, permitted to accept deposits, make loans, exchangecurrency, or offer securities services as enumerated in Article 94 of theBanking Law.

Capital. Under the proposed regulations, every money service businessis required to meet a graduated minimum capital requirement that isdependent on the volume of money transmitted during the year.9 The low-est requirement is AFN 1 million if the applicant has not previously pro-vided money services in Afghanistan, or if the licensee and its authorizedagents had a volume of money transmissions of less than AFN 50 million(or equivalent),10 for the previous 12 months. The highest requirement isAFN 5 million if the licensee and its authorized agents had a volume ofmoney transmissions of AFN 200 million (or equivalent) or more over theprevious 12 months.11

Guarantees. Every money service business is required to maintain astandby letter of credit or guarantee for the sum of at least AFN 5 millionfrom a licensed credit institution or other institution specified by the central


8The proposed prudential regulatory process is consistent with standard bank licensingprocedures, which commence with the screening of license applicants to exclude those withinappropriate professional qualifications, banking experience, financial capacity, and ethicalbackgrounds. At a minimum, regulators generally assess three issues: the sufficiency of abank’s initial capital, the suitability of major shareholders and management, and the trans-parency of its corporate and organizational structure. In the case of foreign banks, the bankreceives adequate supervision in its home country, and the home-country regulatorapproves the establishment of the branch.

9The rationale for a minimum capital requirement for hawaladars may be questionable,given that that equity might not be the most important concern for regulators of money-transfer operations. Instead, a minimum liquidity ratio might be a more prudent measure offinancial soundness.

10Average rate in 2004: US$1=AFN 50.11In choosing to define a minimum capital standard for money-service providers, regula-

tors in Afghanistan have opened themselves up to the same issues that the banking sectorhas been contending with for years. How should capital be defined? What level of capital isadequate for money service businesses to remain safe and sound? What criteria should beused to assess the adequacy of capital?


bank. The security must cover up to five service units or authorized agents.For each additional unit or authorized agent, the business must increase thesecurity by AFN 500,000, up to a maximum of AFN 25 million. The securitymust be in a form satisfactory to the central bank and issued for the benefitof customers of the licensee. By enabling customers to seek compensation,the regulations intend to secure the good performance of the licensee’s oblig-ations with respect to receipt, handling, transfer, and payment.

Anti–money laundering requirements. In collaboration with the IMF andUnited Nations Office on Drugs and Crimes (UNODC), Afghanistan’s cen-tral bank has been working to improve the country’s anti–money launder-ing regime.12 The government recently completed the process of legislatingagainst money laundering and terrorist financing activities. The new lawmeets current international standards. The proposed legislation deals prin-cipally with the criminalization of money laundering and terrorist financ-ing, customer due diligence, establishment of a financial intelligence unit(FIU), international cooperation, extradition, confiscation of funds andproperties connected to the crimes of money laundering and terroristfinancing, and similar provisions.13 When the legislation is adopted, everymoney service business will be obliged to take measures for the preventionof money laundering.14

To effectively implement the prudential and anti–money launderingstandards described above, the central bank will need to further strengthenits legal and judicial framework. Currently, if hawala dealers were to complywith the proposed suspicious activity reporting requirements, it is unlikely


12For the purpose of compliance with UN Security Council Resolution 1373, the govern-ment has become a party to all relevant UN conventions and protocols relating to terroristfinancing and laundering of funds and properties.

13Provisions from the following legislation were also used as the basis for Afghanistan’sdraft legislation: UNDCP Model Legislation on Laundering, Confiscation and InternationalCooperation in Relation to Proceeds of Crime; the IMF Draft Model Financial TransactionsReporting Act; EU Directives 2001/97/EC of the European Parliament and the EuropeanCouncil dated December 4, 2001; the Law on Prevention of Money Laundering of Slovenia;and the Belgian Royal Decree of June 11, 1993, on the composition, organization, operation,and independence of Belgium’s FIU.

14Some of those measures are an appropriate customer-acceptance policy that identifiescircumstances under which customers will be rejected; an appropriate customer-identification policy that includes identification of the beneficial owner of the transmittedfunds when such owner may differ from the customer; continuous training of staff so thatthey are able to recognize transactions that might be related to money laundering; instruc-tions as to what action the staff should take in such circumstances; effective internal con-trol and communication procedures; submission of reports to the FIU or another authorityas required by the laws of Afghanistan; and retention of records on transactions.


that successful prosecutions could be mounted in the Afghan legal system.A hawala dealer would be challenged to find corroborating evidence thatone of his clients was financing a terrorist activity or laundering the pro-ceeds of opium. The prosecution would be faced with the task of buildingits case from anecdotal evidence. Furthermore, to ensure compliance byhawala dealers, the authorities would have to be able to sanction those whodid not comply. At present, it is questionable that such sanctions could beenforced.

This problem is not unique to Afghanistan. Even in developedeconomies, anti–money laundering and counterterrorism programs arehampered by an inability to develop an endgame. Agents of law enforce-ment agencies in developed economies often gather intelligence with littlehope that they will be able to make a criminal case or otherwise disrupt theoperation. In Afghanistan, the problems of preparing a firm case are com-pounded by a very weak judiciary. Years of conflict have resulted in exten-sive damage to buildings, office records, and essential equipment. Manylawyers and judges have left the country, and the number of law students islow. Many judges lack adequate legal training. Significantly, there is little orno interaction among the judiciary, the police, and prosecutors.

The Complexity of Investigating Financial Crimes

Documenting the degree to which hawala is used to launder money inAfghanistan remains a difficult task. It is equally difficult to trace illegalmoney flows, to separate legal flows from illicit flows, and to establish thefinancial links to criminal activities. Law enforcement agencies are oftenunable to penetrate informal financial systems because of the close businessor kinship ties of the participants. Additional constraints in Afghanistaninclude poor monitoring of cross-border currency movements, no report-ing requirements for large cash transactions, lack of uniform guidelines foridentifying suspicious transactions, large parallel black-market economies,and ineffective information procedures and systems for sharing informa-tion with foreign law enforcement authorities.

In addition to the legal constraints, law enforcement agencies face theconsiderable challenge of investigating financial crimes committed in a lessthan transparent sector. The legal and regulatory framework, particularlythe reporting requirements, merely provides techniques for improving thebasis of knowledge. Reports may not have evidentiary value and can be dis-appointingly weak if their limitations are not recognized.

Financial reporting requirements are generally designed to help trans-form the raw material provided by financial institutions so that regulators



and law enforcement officers can assimilate it as they do the other informa-tion they receive. To be effective, the recently established financial intelli-gence unit in Da Afghanistan Bank and law enforcement authorities mustbe able to identify and define data that will be useful for investigative pur-poses; they also must be able to demonstrate to the sector how these datawill in fact be used. Law enforcement and the financial sector need to haveand understand typologies they can use in flagging data to be reported.

The data also need to be validated to remove information that is unreli-able (including reporting that has been deliberately inserted to mislead offi-cials). Detailed analysis should assemble fragmentary intelligence intocoherent, meaningful accounts. Assessment should then put intelligenceinto a sensible real-world context and identify how it can affect specificinvestigations and relate to regulatory and law enforcement policy. Butthere are limitations, some inherent and some practical, on the scope ofinformation reported by hawaladars—indeed, as with informationreported by any financial institution. Those limitations must be recognizedby the authorities responsible for receiving and using reported data.

The most important limitation on financial intelligence is its incom-pleteness. Much ingenuity and effort is expended by money launderers andterrorist financiers on making secret information difficult to acquire andhard to analyze. Although the financial intelligence process may overcomesuch barriers, it seldom yields the full story. In fact, when first acquired, theintelligence is often sporadic and patchy; even after analysis, substantialinferences often must be made and then proved.

The way that financial intelligence is presented can contribute to mis-perceptions. The security procedures with which financial intelligence isnecessarily handled can reinforce a mystique of omniscience and omnipo-tence that can discourage compliance. In fact, financial intelligence is notonly obviously incomplete; it also can be incomplete in undetectable ways.There is always pressure, at the assessment stage if not before, to create aninternally consistent and intellectually satisfying picture. When financialintelligence becomes the dominant, or even the only, source of law enforce-ment information, it can become difficult for those responsible for theassessment process to establish a context and recognize that there may begaps in that picture. Furthermore, to ensure full cooperation and compli-ance from the sector, law enforcement needs to be able to show that finan-cial intelligence is in fact used in legitimate and valuable investigations.Without that verification, the credibility of reporting requirements can eas-ily be lost.

These limitations are best offset by ensuring that the ultimate users offinancial intelligence, decision makers at all levels, properly understand its



strengths and limitations and have the opportunity to acquire experience inhandling it. It is not easy to do this while preserving the security of sensitivesources and methods. But unless financial intelligence is properly handled,the effort made to gather it is wasted.

Unfortunately, in Afghanistan, two specific factors further threaten thelegal process for investigating and prosecuting financial crimes: the size ofthe drug economy and the emerging risk of a nexus of drug trafficking withterrorist and militant groups.

• Size of the drug industry. In 2003 the total area under opium poppycultivation in Afghanistan increased by 8 percent—from 74,000hectares in 2002 to 80,000 hectares in 2003 (UN Office of Drugs andCrime, 2004, p. 7). There has been a clear and accelerating extensionof opium cultivation to previously unaffected and marginally affectedareas. The number of provinces where opium poppy cultivation isreported has steadily increased from 18 of 32 provinces in 1999, to 23in 2000, 24 in 2002, and a staggering 28 provinces in 2003. Potentialopium production amounted to 3,600 tons in 2003, an increase of 6percent compared with 3,400 tons the year before. The area under cul-tivation in 2003 ranks third in the country’s recent history, and theharvest is the second highest recorded so far in Afghanistan. Eventhough the 2003 opium price of US$283 per kilogram represents a 19percent decrease from last year’s price of US$350, the resulting rev-enue flows15 from this level of opium output remain high, with signif-icant implications for the financial sector, particularly the hawaladars.The pressure to launder funds is high—and will remain so for a sig-nificant while.

• The emerging risk of a nexus of drug trafficking with terrorist/militantgroups. The greatest threat to Afghanistan’s economic development isthe growing risk of a nexus of drug trafficking and terrorist/militantgroups—often referred to as narcoterrorism.16 The presence of opiumand terrorism in Afghanistan poses significant risks of abuse of the


15The aggregate value of the Afghan opium harvest (at farm-gate prices) declined toUS$1.02 billion in 2003 from US$1.2 billion in 2002 (–15 percent). The 2003 harvest repre-sents, on average, a potential income of about US$3,900 per opium-growing family. Thepotential opium income per capita for 1.7 million growers averaged US$594. In comparison,on the basis of a population estimated at 24 million and a GDP estimated at US$4.4 billion,Afghanistan had a GDP per capita of about US$184 in 2002.

16A subset of terrorism in which terrorist groups, or individuals, participate directly orindirectly in the cultivation, manufacture, transportation, and distribution of controlledsubstances and the monies derived from those activities. Narcoterrorism may be character-ized by the participation of groups or associated individuals taxing, providing security for,or otherwise aiding or abetting drug trafficking efforts to further or fund terrorist activities.


financial system—formal and informal—regardless of the legislationor regulations enacted. Historically, terrorists have played a significantrole in sustained conflicts in numerous countries—among themBolivia, Colombia, and Peru (coca), Kosovo (primarily opium),Lebanon (opium), and Myanmar (opium) (Winer and Roule, 2003,p. 19). The simultaneous presence of opium and terrorism imposessignificant financial and ideological pressure on financial intermedi-aries to side with money launderers and terrorist financiers, extendingthe criminalization of the economy. While drugs pose the highest riskto Afghanistan, given the level of opium produced, we cannot ignorethe risks (often related to the opium trade) of arms trafficking, smug-gling of humans and goods, or other serious crime.

Afghanistan’s Council of Ulemas has stated that cultivation, processing,trafficking, and consumption of drugs must be prevented. “Even if it is notconsumed by Muslims or if it is done out of poverty, [narcotics-relatedactivity] is illegal,” stresses the statement, which was endorsed by the UNOffice on Drugs and Crime. Despite the statement, however, the trade con-tinues to grow, and more remains to be done.

Conclusion and Recommendations

Many of the regulatory and supervisory challenges of the hawala systemin Afghanistan are unique. In assessing the success of the country’s centralbank in regulating the hawaladars, analysts, the press, and the public mustavoid the risk of “mirror imaging”—believing that experience with infor-mal financial systems gained elsewhere is universal. Increases in opium pro-duction and terrorism have compounded the incentives for concealingillicit financial transactions; thus, it is not possible to accumulate the samelevel of knowledge about the informal financial sector that we have aboutformal systems (commercial banks) in developed economies.

In a conflict-afflicted country, it is critical that observers and regulatorsalike appreciate that the conventional assumptions about financial risk andabuse may not necessarily apply. The striking feature of Afghanistan’s eco-nomic structure is the dominance of the informal sector—not only in agri-culture and in the drug economy, but also in other sectors of the economy. Itis inherently difficult to estimate the size of the informal economy, except insectors where it is dominant, such as agriculture and drugs. The World Bankestimates that as much as 80 percent to 90 percent of the economic activityin Afghanistan occurs in the informal sector (World Bank, 2004, p. 5). Thesize of the informal economy represents a self-reinforcing equilibrium



inherited from the past, involving failed governments, competing powerbases, insecurity, a lack of rule of law, and a very poor investment climate forformal activities. For this reason more than any other, it is essential that thecentral bank sustain its pragmatic consultative approach to regulation.

In the long term, an effective strategy for isolating illicit funds beingtransferred through the hawala system is to encourage legal transfers tomigrate to conventional financial instruments. The effectiveness of thisstrategy depends on the ability of formal financial instruments to competewith the hawala dealers with respect to exchange rates, speedy service, andcoverage of areas that now lack banking services. The entry of new banks inAfghanistan is a first step toward such a transition. The rate at which banksopen regional and provincial branches, offer services at attractive rates, andreach out to local customers will determine the long-term success of thatfirst step.

Although the informal sector is dynamic, a recent World Bank studyconcluded that the sector cannot be the “engine” for sustained long-termgrowth. The study rightly observed that international experience suggeststhat development beyond a certain point is accompanied by a decrease inthe share of the informal sector. Informality does not protect propertyrights and reduces the possibility of formalizing and enforcing contracts,weakens incentives to invest, and diminishes opportunities for division oflabor and trade (World Bank, 2004, p. 8).

Despite improvements in policies and in conventional financial institu-tions, hawaladars will continue to represent an important and often neces-sary element of Afghanistan’s financial architecture. The market’ssimplicity, cost-effectiveness, and convenience will ensure its survival formany years to come. It is therefore advisable that oversight policies focusprimarily on regulation rather than on eradication. Cost-effectiveness andspeediness are virtues that cannot be regulated away. Only competitive mar-ket forces can replace the hawaladars.

Meanwhile, Afghanistan’s central bank should, as it has already, continueworking with the hawaladars of Kabul. Their association has an executivecommittee responsible for enforcing the tacit rules and business conduct ofthe market. Under the committee’s leadership, code violations bring seriousconsequences.17 The shaming and stigmatizing associated with committeecondemnation often curtail dealers’ critical ability to collaborate with otherdealers to facilitate large transactions. Being limited to one’s own funds in this


17At periodic meetings the money exchangers select 10 individuals to serve as members ofthe executive committee.


business may force one out of the market. The committee is also responsiblefor the amicable settlement of disputes. It charges no fees for its services, andits appointed members are not salaried or otherwise compensated.

Forming partnerships with the hawaladars is in line with the WorldBank’s recommendation that the government generate economic growthby harnessing the dynamism of the informal sector. Strategies for doing soinclude facilitating further growth of the informal sector, to the extent thatit is legitimate—for example, by using microcredit and by gradually shift-ing informal activities to the formal sector (World Bank, 2004, p. xiii).

Coordinated efforts to strengthen legal and regulatory frameworks mustalso include engagement of the sector itself. This will help regulators under-stand and implement measures that address vulnerabilities without inad-vertently affecting dealers who work outside criminal circles. Outreach alsowill help to separate at least some legitimate dealers from those working inillicit finance. Any external oversight of the market will require the activecollaboration of the hawaladars’ association. Indeed, subcontracting somebasic supervisory measures to the association in the interim may serve thecentral bank’s objective of opening up the market to greater transparency.

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www.unodc.org/unodc/en/crop_monitoring.html

Winer, Jonathan M., and Trifin J. Roule, 2003, “Follow the Money: The Finance of IllicitResource Extraction,” in Natural Resources and Violent Conflicts: Actions andOptions, ed. by Ian Bannon and Paul Collier (Washington: World Bank),pp. 170–71.

World Bank, 2004, The Financial Sector in Afghanistan (Washington: World Bank, SouthAsia Finance and Private Sector Unit).



8

Banco Central do Brasil’s ForeignExchange System

PAULO ROBERTO GONÇALVES

The purpose of this paper is to comment on the Brazilian foreignexchange system and to show why informal money transfers are not

allowed. The sections that follow briefly describe Brazil’s financial systemand its foreign exchange system and discuss the most important aspects oftheir regulation. The section “Monitoring of the Foreign Exchange System”comments on the surveillance procedure, which aims to maintain the reg-ular operation of the system. The last part of this paper describes the treat-ment of informal money transfers.

The Brazilian Financial System

The Brazilian financial system has 16 public banks, 104 national privatebanks, and 71 banks under foreign capital control, with 16,866 bankbranches. In addition, it has many other kinds of entities, such as securitiesdealers, securities brokers, credit unions, consumer finance companies, andsavings and loan companies (see Table 8.1).

Banco Central’s Information System (Sisbacen)

Banco Central’s information system, Sisbacen, performs the processing,storing, and online recovery of data, as well as real-time information updat-

65

Paulo Roberto Gonçalves is head of the Foreign Exchange Surveillance Division of theDepartment of Surveillance of Illegal Activities in the central bank of Brazil.


ing. Sisbacen is a tool designed to make rational use of computer resourcesto provide Banco Central with the instrumental assistance required to ful-fill its legally defined activities.

Sisbacen incorporates a sophisticated network that connects nationalfinancial institutions, federal and state government agencies, and legislativeand judiciary branches with Banco Central. Sisbacen is equipped with a

66 PAULO ROBERTO GONÇALVES�

Table 8.1. Number of Institutions in Operation (Selected months)

2001 2002 2003 2004 2004 2004 2004 2004 Type Abbr. (Dec) (Dec) (Dec) (Jan) (Feb) (Mar) (Apr) (May)

Multiple bank BM 153 143 141 141 141 141 139 138Commercial

bank1 BC 28 23 23 23 23 23 23 24Development

bank BD 4 4 4 4 4 4 4 4Savings bank CE 1 1 1 1 1 1 1 1Investment bank BI 20 23 21 21 21 21 21 21Consumer finance

company SCFI 42 46 47 47 47 47 47 46Security

brokerage company SCTVM 177 161 147 147 144 145 145 144

Exchange brokerage company SCC 43 42 43 43 43 44 44 44

Security distribution company SDTVM 159 151 146 146 145 144 145 143

Leasing company SAM 72 65 58 55 54 54 54 54Real estate credit

company2

and savings and loan SCI e association APE 18 18 18 18 18 18 18 18

Mortgage company CH 7 6 6 6 6 5 5 5

Development agency AG FOM 9 10 11 11 11 11 11 12

Subtotal 1 756 693 666 663 658 658 657 654

Credit union COOP 1,379 1,430 1,454 1,453 1,451 1,451 1,450 1,448Microfinancing

institution SCM 23 37 49 49 48 49 48 48

Subtotal 2 2,135 2,160 2,170 2,165 2,157 2,158 2,155 2,150

Consortium manager CONS 399 376 365 367 367 367 367 366

Total 2,534 2,536 2,535 2,532 2,524 2,525 2,522 2,516

Source: UNICAD.1Includes foreign banks’ full branches.2Includes 15 real estate credit companies that cannot accept deposits from the public.


public access feature that allows any interested party to consult genericinformation.

In accordance with the rules and procedures established by Banco Cen-tral, all foreign exchange operations done in Brazil by the authorized insti-tutions, and all operations involving bank deposits above 10,000 reias (R$)that are maintained in Brazilian banks by nonresidents, must be recordeddaily. Approximately 300 international transfers in Brazilian currency and15,000 foreign exchange transactions are recorded in Sisbacen daily.

The Brazilian Foreign Exchange System

The free floating of the market determines the rate in the Brazilian for-eign exchange regime. Banco Central’s interventions occur only to smoothhigh volatility in low-liquidity scenarios, providing market liquidity andregulating the availability of dollar-indexed assets.

To operate with foreign exchange in Brazil, banks and other businessesmust be authorized by Banco Central. Currently, 120 banks, 11 securitiesdealers, 33 securities brokers, and 262 travel agencies and hotels are autho-rized to operate with foreign exchange. The travel agencies and hotels arelicensed only to buy and sell traveler’s checks and exchange cash for tourists.Only banks can carry out financial transfers with foreign countries.

The authorized institutions buy and sell foreign currency for natural per-sons and legal entities. Foreign currency can only be exchanged against thenational currency. These transactions are formalized by standardized foreignexchange buy-sell contracts registered in Sisbacen. Each of the contracts is anautonomous, legally enforceable instrument. The contract registers mustcontain the identification of the sender and of the receiver in Brazil andabroad, the amount, the exchange rate, the purpose (investments, loans, ser-vices, imports, exports, or interbanking operations), the country of originand of destination, the form of payment, and other kinds of information.

The authorized institutions record the data related to each transaction inSisbacen, which generates the foreign exchange contract that must besigned by the parties (the buyer and the seller of the foreign exchange cur-rency). Each transaction is classified in accordance with the IMF’s Balanceof Payments Manual, Fifth Edition.

At the end of each day, Banco Central obtains all foreign exchange con-tracts, which will be available for monitoring. Foreign exchange contractsare the main source of information for the balance of payments. Exchangecontracts related to exports or imports are linked with the data from theCustoms Department’s computational system (Siscomex).

BANCO CENTRAL DO BRASIL’S FOREIGN EXCHANGE SYSTEM 67�


International Transfers in National Currency

Another way to receive or transfer money is by means of the system“International Transfers in National Currency.” With this system, a Brazil-ian individual or company can make a remittance by depositing Brazilianreais into an account at any bank in Brazil. The account owner must be aninternational bank nonresident in Brazil. That bank will then transfer thefunds to an indicated account abroad in the recipient country’s currency.

The Brazilian bank where the account is maintained must register everyaccount movement above R$10,000 (about US$3,450) in Sisbacen. Thesame occurs for debts of the account.

The nonresident international bank must be a correspondent of thebank where its account is opened. Deposits or withdrawals from thisaccount are made using the normal forms established in the financial sys-tem. Transactions in cash are allowed only for values up to R$10,000.

The registers must contain the identification of the sender in Brazil andof the receiver, abroad, the amount, the purpose (investments, loans, ser-vices, or interbanking operations), the depositor account in the country,and the account where the funds will be deposited abroad.

Brazilian Foreign Exchange System Regulation

Banco Central’s regulation obliges the financial institution to maintain,for five years, a dossier with documents that identify the party in Brazil andconfirm the reason for the money transfer.

Law No. 4595 of December 31, 1964, established that Banco Central canrequire financial institutions, or individuals or legal entities, to provide itwith documents, papers, and accounting records. The law considers non-compliance an impediment to Banco Central’s inspection, which may resultin an administrative proceeding with a penalty of R$100,000 (aboutUS$34,500).

Under Law No. 4131 of September 3, 1962, the financial institutions areresponsible for correctly identifying their customers and for recording theforeign exchange transactions (including their correct classification) inaccordance with the information supplied by their customers. If BancoCentral verifies an intentionally incorrect classification, the institution canbe charged under an administrative proceeding with a penalty of between5 percent and 100 percent of the value of the operation. Also, the financialinstitutions are obliged to report suspicious transactions and situationsunder the regulations to control money laundering and terrorist financing



(Law No. 9613, of March 3, 1998). Acts against the Brazilian financial sys-tem (Law No. 7492, of June 16, 1986) are included in the range of predicateoffenses to the crime of money laundering.

Monitoring of the Foreign Exchange System

Banco Central’s supervision maintains a dedicated unit in charge of ver-ifying the authorized institutions and of analyzing operations that presentsigns of a crime against the financial system, money laundering, or illegalforeign exchange transactions. Those actions involve the review of financialtransfers from or to foreign countries in foreign or national currency. Basi-cally, the actions focus on the identification of the parties involved in Braziland abroad and on the analysis of documentary compliance and of the legaland economic bases of operations.

Banco Central performs the monitoring activities described in the previ-ous paragraph, in addition to the internal monitoring that will be developedby the institutions. Banco Central is also responsible for auditing the identi-fication and control procedures conducted by financial institutions. Theidentification of illegal foreign exchange or illegal financial activities duringthe monitoring conducted by Banco Central may indicate that the institu-tion’s internal control and compliance system has failed or is not adequatelydesigned or fitted to detect the illegal activities. An exception is complex ille-gal schemes that can only be detected from a macro view of the system.

For its review, Banco Central selects a sample of operations from theitems listed below:

• amount involved in each transaction;• types of companies that perform activities to facilitate the manage-

ment of suspicious operations;• atypical operations with purposes and amounts that are incompatible

with the principal purpose of the company;• customers with no tradition or companies that were recently set up;• operations with gold (loan contracts, purchase and sale, arbitrage, and

BM&F—the Brazilian mercantile and futures exchange);• operations in cash settled in national or foreign currency;• frequent private unilateral transfers or transfers of large amounts

(donation, support of residents, assets);• operations that, when added up, amount to significant sums;• operations involving tax havens;• transfers between companies related by capital, by association, or by

common attorneys;



• transactions with atypical contractual clauses (payments withoutdefined due dates or with zero interest);

• occurrences at bank branches located in border regions, airports,ports, or highways; and

• occurrences involving individuals and legal entities with previous his-tory of examinations by Banco Central.

The analysis of the selected operations considers the following:• other foreign exchange operations and international transfers in

Brazilian reais performed by the parties involved;• inquiries to banking files, checking account statements, and docu-

ments supporting income;• the review of financial statements, the charter, and respective amend-

ments;• the tracking of financial operations;• surveys by electronic media;• contacts with the compliance area of the institution that conducted

the operation; and• other procedures necessary to characterize illegal transactions or signs

of such transactions, including contact with other agencies involved incounteracting and preventing illegal financial transactions.

Along with this process, Banco Central will seek the complete qualifica-tion of the parties involved and the identification of the origin, destination,and legitimacy of transferred funds.

Informal Transfers

Informal money transfers are not allowed in Brazil. Only authorizedbanks can conduct financial transfers from and to foreign countries. Moneytransfer or remittance entities, such as Western Union or MoneyGram,must have a formal agreement with a bank that operates in Brazil. The bankreceives the payment order in Brazil, pays the beneficiary, and registers theoperation on Sisbacen. The bank is responsible for the transfer.

An individual who engages in an unauthorized foreign exchange trans-action can be imprisoned for two to six years (Law 7492/1986, clause 16 and22). The same rule applies to the representative of an entity that engages inunauthorized transactions. Offenders also can be punished in a Banco Cen-tral administrative proceeding. The charge can reach 200 percent of theamount involved.

To identify customers performing unauthorized transactions, financialinstitutions should have strict know-your-customer procedures, which are



evaluated by Banco Central in its onsite supervision program. If a suspi-cious transaction is detected, the financial institution must report it to thefinancial intelligence unit (COAF), which may report it to the public pros-ecutor’s office. In Brazil, anyone may transfer his or her savings to othercountries, provided that the transfer is registered in Banco Central and sub-mitted to the Brazilian revenue authority. Similarly, transfers to hawaladarsare illicit operations (foreign exchange black market) and are normally theresult of a criminal activity. Participants in illegal activities, such as smug-gling, corruption, tax evasion, illegal drugs, and weapons trafficking, do notwant to be identified, so they use illegal money changers to send moneyabroad. Part of this money returns to Brazil in the black market or throughthe regular system disguised as legal transactions (loans or investments).

The Brazilian federal police department is responsible for combating theforeign exchange black market. In August 2004 it launched a large opera-tion against money changers. In eight states, 74 money changers werearrested, and many other arrest warrants were served. Now, the police wantto identify money changers’ clients through confiscated documents.

The foreign exchange primary market in Brazil raises some US$300 bil-lion a year. The black market is considered to be much smaller than thelegal market, but there are no reliable estimates of its size. Included in theUS$300 billion a year are the remittances sent by Brazilian workers abroad.Most of those transfers are done in the legal market, where the cost runs1 percent to 3 percent of the amount remitted. What sometimes occurs inthose operations is that one person living in another country uses a legalremittance company abroad, but that company works with an illegal corre-spondent in Brazil.



9

Regulatory and Supervisory Frameworkof Funds Transfers in Colombia

ANDRES ARBOLEDA URIBE

This paper discusses Colombia’s experience of implementing a regula-tory framework for money transfers that is capable of attracting money

remitters to cross the line to a formal system. It also describes the supervi-sory practices and procedures the country designed and has applied for thepast 12 years to enforce those regulations.

After a background section that briefly explains why Colombia adopteda new regulation on foreign exchange in 1991, the paper describes the char-acteristics of funds transfers in Colombia, the requirements for obtaining alicense, the challenges and results of the supervision model that wasadopted, and the consequences for providers who opt to work illegally.Finally, it presents some concluding thoughts.

Background

Hawala, or informal funds transfer systems, are illegal in Colombia.Colombia’s Foreign Exchange Statute defines money transfers from or toColombia as foreign exchange operations that must be channelledthrough licensed money remitters. Therefore, anyone wanting to transferfunds to Colombia, regardless of the funds’ source or destination, needsto use the services of a money remitter in the sending country. That entity

72

Andres Arboleda Uribe was Director de Regulación in the Superintendencia Bancaria deColombia.


will, at the same time, need to have an agent, branch, franchise, or otherlegal relation with a licensed money remitter in Colombia to pay the orderto its beneficiary.

Transfer means the operation by which a professional institution, calleda money remitter, following an order of a sender, delivers funds to anotherperson (or to the same sender), called a beneficiary, in a foreign jurisdiction,using for that purpose the services of a correspondent money remittercalled payer.1

The same statute requires anyone wanting to provide money remittanceservices to be licensed by the Colombian Banking Superintendence or theSecurities Exchange Commission (Securities Superintendence), dependingon the type of institution created for that purpose. Any attempt to transferfunds through any different channel is considered a violation of both theForeign Exchange Statute and the Financial System Statute and is severelypunished.

The question is, has prohibition under these statutes been enough to dis-courage illegal funds transfer systems?

History

Until the beginning of the 1990s, we had in Colombia a very rigid systemof foreign exchange control. Between 1967 and 1991, monetary authoritiesdetermined the price of foreign currency and severely restricted the posses-sion of foreign exchange. Obviously, since money transfers involved foreigncurrency, they were administered (at a high cost) by the governmentthrough Colombia’s central bank (Banco de la República) and were sub-jected to excessive scrutiny.

Restrictive systems always bring with them very active black markets,and money transfers were no exception. They moved in a sort of penum-bra, in most cases without the use of formal institutions. During the 1980sand previous years, what really prevailed in country-to-country moneytransfers was the use of trustees, underground hawalas, which were alreadyconsidered illegal, and ordinary mailing services. The central bank’s fundstransfer service was mandatory and designed for sophisticated operations,not for ordinary people. It was very common for people to use alternativemethods to move funds.

REGULATORY AND SUPERVISORY FRAMEWORK OF FUNDS TRANSFERS 73�

1Besides transfers, the Colombian Foreign Exchange Statute allows physical carrying offunds into the territory with no limits in terms of amount. Currency exceeding US$10,000or its equivalent have to be declared and, in any case, if required, be properly accounted for.


Our experience showed us that prohibition was not effective. Informalor alternative ways of transferring funds would continue to exist and wouldlead the business unless we designed a regulatory scheme fair enough topromote the use of formal channels and to modernize the sector.

In 1991, Colombia made huge steps toward that goal. That year Congresspassed Law 9-912 that helped to clear away the fog surrounding the moneytransfer business in Colombia.

The new rules set by Law 9-91 promoted the expansion of the fundstransferring business in a country that, for sociopolitical reasons, had begunto experience in that decade an increase in emigration to North Americaand Europe. Since then, emigration in Colombia has been greater than inmost of the Latin American countries. It is estimated that the number ofColombians living in foreign countries is growing at a rate of 5.5 percentannually, which is more than the whole planet’s rate of population growth.For obvious reasons, the growing emigration rate has tremendouslyincreased the number of money transfers to Colombia.

Characteristics of Funds Transfers in Colombia

As a result of Law 9-91 and other regulations issued later, the fundstransferring business in Colombia has the structure described below.

First, since 1991, the government no longer maintains a monopoly onthe administration of foreign exchange; the market determines the price offoreign currency. The central bank preserves enough powers to apply mon-etary measures or to intervene in the market in order to keep the foreignexchange rate within adequate levels.

Second, with some exceptions, the foreign exchange market is liberalized.Third, foreign exchange market operations, including money transfers,

are explicitly defined in the law, resulting in transparency and confidence inthe sector.

Fourth, financial institutions, security brokers, and foreign exchangehouses (casas de cambio) are allowed to intermediate in money transfers.Analysts have considered this simple provision to be crucial in understand-ing the huge development and expansion that the money remittance busi-ness experienced during the past decade, after the activity was widelyopened to competition. The chart in Figure 9.1 shows the amount of moneycoming into Colombia through money remitters from 1992 to 2001.

74 ANDRES ARBOLEDA URIBE�

2Law 9-91 is available online at http://www.banrep.gov.co (juriscol icon).


http://www.banrep.gov.co

Fifth, money transfer providers need to be licensed by the ColombianBanking Superintendence or the Securities Exchange Commission, depend-ing on whether they are banks, casas de cambio, or security brokers.

Sixth, money transfer providers are subject to permanent onsite and off-site governmental supervision.

Seventh, illegal providers are subject to a severe sanctioning regime (dis-cussed below).

The decision made in the 1990s to liberalize the market opened new andinteresting opportunities for legal businesses. For the first time in years, thelaw allowed people to compete in the market by creating institutions dedi-cated primarily to money transfers. At the same time, illegal providers real-ized that they did not have to keep hiding, because suddenly their businesswas no longer a crime.

However, this liberalization came with a whole new set of rules, soundpractices, and standards that providers needed to align themselves with to beaccepted as “club members.” In other words, to do business legally, someonewanting to operate as a money remitter must obtain a license and follow someprudential rules that are enforced by a highly professional supervisory body.

How to Obtain a License

To obtain a license, applicants must file with the Colombian BankingSuperintendence or the Securities Exchange Commission. Applicants must


Figure 9.1. Amount of Money Entering Colombia through Money Remitters,U.S. Dollars (1992–2001)


pass a “fit-and-proper” test and provide information related to the busi-ness, such as the following:

• all the documents supporting the legal source of the funds that will beused to create the institution;

• investors’ equity in financial and nonfinancial institutions;• a list of investors’ debt;• each investor’s income tax declaration;• a business feasibility study;• descriptions of the business’s administrative and financial infrastruc-

ture;• a description of its technical infrastructure, including all computers

and connectivity systems;• identification of any foreign investors in the new institution, plus

proper authorization to invest, from the investor’s home countryauthority;3

• a draft of the contract and other information regarding the corre-spondent money remitters or agents the institution will work with inother countries;

• a draft of the applicant’s money laundering prevention manual.To obtain a license, the money remitter must certify a minimum capital

of US$1.3 million. Minimum capital requirements have been graduallyraised since 1991. Before issuing a license, the Superintendence checks withadministrative, criminal, and tax authorities to find out if investors haveany prior violation record (fit-and-proper test).

Although the law gives the Superintendence six months to complete thewhole process, an authorization takes an average of three months from thetime the application is filed.

Constant Supervision

The issuing of a license means that, on one hand, the money remitter isauthorized to operate and that, on the other hand, the Colombian BankingSuperintendence or the Securities Exchange Commission will subject themoney remitter’s activities to permanent supervision and examination toensure compliance with several prudential rules.


3 Following the Basel Committee recommendations, the Colombian Banking Superinten-dence and the foreign authority usually draft a memorandum of understanding that allowsColombian authorities to obtain the documents faster and to confirm other informationrelated to the investors.


Money remitters are under the supervision of the governmental bodyin charge of examining banks, insurance companies, and pension funds.The supervision follows the same procedures and has a similar focus forall of them.

The Colombian Banking Superintendence has a special division formoney remitters’ supervision. A team of inspectors undertakes an ongoingonsite and offsite examination of the money remitters chartered in Colom-bia. Money remitters have to be visited at least once a year.

Under prudential regulation, money remitters must comply with the fol-lowing conditions, among others:

• full disclosure to the market and customers of their operations andcosts;

• advertising under Colombian Banking Superintendence parameters;• accounting records under Financial Accounting Standards;• monthly reporting to authorities;• minimum capital requirements;• liquidity gap analysis;• foreign exchange risk management; and• money laundering prevention and control.For money laundering prevention, money remitters must adopt the fol-

lowing structure. Money remitters must implement an internal systemdevoted to preventing and controlling any attempt by a customer to usethem for money laundering purposes. Under a know-your-customermodel, money remitters must appoint a compliance officer who is respon-sible for keeping track of operations in order to detect money launderingcases and to audit the whole system. Money remitters have to report anysuspicious activity to the Superintendence’s financial intelligence unit andalso submit a monthly report showing all funds transfers.

For offsite supervision, money remitters are obliged to periodically sendthe following information to the Superintendence:

• call reports related to their general situation;• monthly financial statements;• end-of-year financial statements;• monthly reports of money transferring operations;• statistical reports of customers’ complaints (number and types of

complaints);• investment portfolio report;• contingent accounts report; and• external auditor’s report.In addition, the Superintendence has the power to require any other

information necessary for the purposes of supervision.



For onsite supervision, the Superintendence visits money remitters’office at least once a year. It performs what is basically a risk-focused exam-ination. It analyzes their capital standards, their liquidity risk exposure,their credit risk exposure (in terms of owned receivable accounts), and forobvious reasons, their foreign exchange rate risk and money launderingexposure. It also examines their compliance with the Foreign ExchangeStatute, according to which, money remitters must keep records and trackeach transfer. For this purpose, the Colombian Banking Superintendencehas signed several Memorandums of Understanding with colleagues fromother countries in order to check correspondents’ accounts and records.

An examiner’s report is written with the conclusions of the onsite exam-ination and then sent to the money remitter for comment.

In many cases, the report contains a list of the legal provisions that,according to the examination team, the money remitter was not following.Again, special care is given to their compliance with regulations on moneylaundering, including special examinations to exclusively evaluate thistopic.

In cases in which a violation was not excusable according to torts law, orthe Superintendence finds an excessive, overall exposure to risk that canaffect the money remitter’s financial stability, the law gives the Superinten-dence the power to adopt one or more of the following decisions, dependingon internal guidelines, policies, and the gravity of each case: cease and desistorders, pecuniary sanctions to both the institution and its administrators;special surveillance status, capitalization orders, fiduciary administrationorders, mandatory transferring of assets and liabilities, merger orders, spe-cial recovery programs, receiverships, and liquidation (license removal).

In short, we have a very straightforward regulation that not only pro-hibits unlicensed operation but also promotes the business on a legal basis,giving enough incentives for providers to cross the line and become part ofthe formal sector. For this reason, and thanks to our proactive and strictsupervision, hawala is not common in Colombia.

It is true that every now and then we find hawaladars in Colombia. Butwe believe that an adequate regulatory and supervisory framework hasmade money remitters more interested in formalizing their business.

What Happens to an Illegal Provider in Colombia?

It is the Superintendence’s duty to impose one or several of the followingmeasures on those pursuing money transfers without a license:

• cease-and-desist orders compelled by daily fines of US$1,000;



• the liquidation of the institution; and• the liquidation of all illegal operations, through an expedited admin-

istrative process.For the purpose of determining if a nonlicensed institution is pursuing

illegal money transferring activities, the Financial System Statute (Decree663-93) empowers the Superintendence to inspect accounting books, files,and records. For such inspections, we sometimes mount undercover operations.

Conclusion—Why This Scheme?

Countries that apply extreme controls, so that residents are not free tomove their funds, are extremely susceptible to the development of blackmarkets. A better system is liberalized markets combined with good pru-dential regulation and supervision of funds transfer providers.

A scheme requiring applicants to have minimum qualifications to belicensed as money remitters, combined with full-disclosure standards, per-manent onsite and offsite supervision, zero tolerance to illegality, and coop-eration among authorities, both national and overseas, brings confidenceand helps promote an above-board business of enormous importance to acountry’s economy.

That is our case, and we believe it has worked properly.



10

Some Critical Issues on Informal ValueTransfer Systems in Eastern andSouthern Africa Anti–Money LaunderingGroup Member Countries

CHARLES LENGALENGA

The Eastern and Southern Africa Anti–Money Laundering Group(ESAAMLG) was conceived in 1999 and is a Financial Action Task

Force–style (FATF-style) regional body with a membership of 14 countries—Botswana, Kenya, Lesotho, Malawi, Mauritius, Mozambique, Namibia, Sey-chelles, South Africa, Swaziland, Tanzania, Uganda, Zambia, and Zimbabwe.

This article examines the overall historical development of informalvalue transfer systems (IVTSs) in the ESAAMLG region and also looks athow the lack of formal banking facilities (or their cost, where available) hasaffected the evolution of the IVTS. This article also looks at a number ofpossible interventions by ESAAMLG member countries that could mini-mize the possibility of an IVTS being used as a vehicle for financing of ille-gal activities, including terrorist financing. In addition, this article examinesthe possible challenges that may be inherent in the available interventions.

Background

As a starting point, one needs to appreciate that most of the membercountries, save for a few, are classified in the very poor economic brackets.

80

Charles Lengalenga is the executive secretary of the Eastern and Southern AfricaAnti–Money Laundering Group.


In addition, it is appropriate to highlight the historical perspective. Fromthe late 1950s through the early 1960s, most of the member countriesembarked on extensive educational reform, which resulted in a lot of theircitizens passing through formal education systems and enabled them toacquire vocational and professional skills. However, given the imbalances inindustrial development, which saw few countries making advancements intheir economic setups, the migration of skilled and unskilled workersbecame very common. Frequently, skilled and unskilled workers migratedfarther south to South Africa or to then Southern Rhodesia, both of whichhad relatively well-developed capitalist systems with the capacity to employlarge numbers of both skilled and unskilled laborers.

It was common to have large numbers of Malawian, Mozambican, andZambian skilled and unskilled laborers working in the South African indus-tries and the Southern Rhodesian mines. However, because of the austereliving and working conditions, the migrant workers left their families anddependents in their home countries. As the migrants were the primaryproviders for their families, an informal value transfer system emerged. Themigrant workers remitted money to their kin through unofficial means,using bus drivers and long-distance truck drivers that were traveling theextensive road network as their couriers.

To date, the existing plethora of regional bodies, such as the SouthernAfrica Development Community (SADC), Common Market for Easternand Southern Africa (COMESA), and East African Community (EAC), hasgiven an added dimension to the informal value transfer systems. The exist-ing need for regional integration has led to the construction of networks ofall-weather roads throughout eastern and southern Africa. Currently, thereis a modern, well-established passenger bus transport system as well as aheavy-duty overland-vehicle system all the way from South Africa, throughZimbabwe, Zambia, Tanzania, and Uganda. With the increased regionalintegration that allows the local citizenry to work or conduct commercialbusiness in other countries, it is very common to see income earners,whether they are unskilled or skilled laborers, consigning cash on the exten-sive road network to their home countries.

To use the well-established road transport, all the remitter needs to dois give the cash to the bus crew or trucker, along with the name of therecipient and the pickup point, at very minimal cost. This system ofinformal value transfer is advantageous because it is relatively inexpen-sive, timely, and reliable. This is distinct from the formal value transfersystem, which has prohibitively expensive transfer charges and is plaguedby stories of cash shortages at the value destination point. In one casestudy, to send the equivalent of US$150 by bus from the city to a rural

SOME CRITICAL ISSUES ON INFORMAL VALUE TRANSFER SYSTEMS 81�


outpost cost US$3, compared with US$22 for sending the same amountby postal bank.

Undeveloped Banking and Formal Value Remittance Systems

One of the critical factors in the use of the unconventional and unregu-lated IVTS is the lack of banking facilities and other modern amenities formanaging money, which has left many rural communities without anyalternative but to use the person-to-person method of delivering value.

A recent evaluation of the region’s efforts to combat money launderingand the financing of terrorism has shown that less than 40 percent of thepopulations of some countries have access to banking facilities. This meansthat close to 60 percent have to find alternative means to conduct com-merce or transfer their income between points. The available anecdotalinformation indicates that the ratios of people without access to bankingfacilities are even higher among the poorer members of the groups evalu-ated. This state of affairs leaves the informal value transfer system as theautomatic stopgap and is seen as a natural feature of the cash-basedeconomies of the region.

Cost of Banking Facilities

The use of alternative systems is encouraged by the cost of using the for-mal remittance system. In some documented cases, a remitter is charged asmuch as 20 percent to 30 percent of the principal amount being remitted.To the majority of the people in the region, whose very survival is ham-pered by extreme poverty and the lack of the basic resources to sustain life,having to pay such comparatively large remittance charges is a choice theycannot entertain. Thus, in the circumstances, most people would prefer thecheaper IVTS, which in some instances has the added advantage of havingsomeone known to the remitter transport or deliver the funds. However,from the standpoint of recouping the value in the event the remittance islost in transit, the informal value transfer system has its risks.

Although some governments have attempted to regulate such transna-tional transactions at borders by restricting the amounts that can beimported or exported, the system remains porous, and it is largely left at themercy of the IVTS users. The border regulatory mechanisms in such casesare very weak. Also, where the border control officers come across such atransaction, which may be in excess of what is permitted, corruption by the

82 CHARLES LENGALENGA�


very public officers charged with the policing duties portends another prob-lem. Generally, government law enforcement officers, like other civilauthorities, are not well compensated. Thus, the risk of the law enforcementofficers taking a little “tip” from the remitted funds is great.

Possible Intervention in the Use of the Informal ValueTransfer System

To ensure that the use of informal value transfer systems is kept in checkto minimize its potential for various abuses, the responsible authoritieshave a number of options open to them.

Make more banking services available to remote areas. This is a more aca-demic than practical solution in that most of the communities in the mem-ber countries cannot sustain a banking facility. In many countries, as mostrural populations live at 70 percent to 80 percent below the poverty levels,the setting up of banking facilities would be doomed to failure right fromthe start. In a number of countries in the region, the ambitious setting upof banking facilities has often been followed by subsequent bank closures.Most banks, particularly the more risk-sensitive foreign-owned banks, haveoutright shunned setting up branches, preferring to remain in the metro-politan centers.

Increase awareness that people can lose their money in the event of an acci-dent. While the citizenry is well aware of the risks of loss through accidents,this possibility is apparently largely seen as remote and is usually acceptedas an unavoidable twist of fate when it does occur. There have been inci-dents of fire and other road traffic accidents involving the transport vehi-cles carrying these types of uninsured valuables.

Tighten border controls. Although this tool has always been available tocombat illicit imports or exports of foreign currency, the propensity of civilservice authorities to connive with errant IVTS operators creates ratherthan solves a problem. The attitudes and corruption of some public officialshave tended to consign this approach to the backstage of civil rhetoric,notwithstanding the good intentions of prospective reformers.

Develop a mechanism of regulating such remittances. Currently, there areno watertight mechanisms to regulate informal value transfer systems. Onlyrecently has ESAAMLG been exploring ways of having the member coun-



tries place IVTSs in their scope of monitoring and control. With the lack ofresearch findings and proper documentation of the patterns and existenceof IVTSs, it will be a long time before any noticeable monitoring and con-trol mechanisms are brought to bear.

Make formal banking services such as remitting funds cheaper and considerestablishing maximum threshold figures on commission charges. Althoughthis is an attractive proposition, it may be seen as going against the generalwind of economic liberalization—embraced by most member countries—which encourages individual business entities to determine their ownvalue-generation parameters.

Define and name the system, as a starting point, because as it is, the systemhas no name. Naming and defining a system is a good starting point for anyactions meant to bring the monitoring and control of IVTSs into the scopeof ESAAMLG member states. Whereas in the eastern member countriesthe informal money transfer system has been conceptualized and aname—hawala—ascribed to it, that is not the case farther south. If anyuniversal policy decisions and actions regarding IVTSs were to be under-taken in the region, it would be necessary to ascribe a regionally recog-nized conceptual name to the system. Perhaps hawala, a word that isalready widely used in East Africa, could be considered for adoption in thewider regional circle.

Obtain political commitment. In taking any actions meant to monitor orregulate IVTSs, political commitment is essential. However, such a commit-ment does not come cheaply because the member countries have other per-ceived national priorities. Thus, the problems of IVTSs, as with moneylaundering in general, are largely seen as secondary to the more pressinghealth, education, and poverty issues. The lack of documentation and reg-ulation of IVTS in the region has not helped the situation, because there isno authoritative basis on which policy decisions can be made.

Other Challenges of Monitoring and Regulating IVTSs

Although the 14 member countries of ESAAMLG have agreed to adoptand implement FATF’s eight special recommendations, very few countrieshave made any real progress in adapting them to their financial institutionregulatory frameworks. By and large, most member countries are stillengaged in political debate on the necessity of what some quarters see as



largely intrusive and liberty-thwarting principles. A few jurisdictions havedrafted legislation to combat the financing of terrorism but, as may beexpected, promulgation has not come automatically because of varioussensitivities relating to religion and perceived infringements of personalliberties. The following are impediments to implementing the eight specialrecommendations.

• Currently there are no documented authoritative studies on IVTSs.This is a major stumbling block, as any meaningful policy decisions oractions have to draw on documented and recognized typologies ofIVTSs. Going forward, there is obviously a lot of scope for researchinto the subject and documentation of IVTS characteristics.

• IVTSs are considered normal and part of the commercial and socio-economic setup of the member countries. In short, a very good caseneeds to be established for the citizenry to appreciate why IVTSs reg-ulation is needed.

• In some jurisdictions, the existing banking systems encourage IVTSs;for example, in some countries, persons can only remit so much at atime—US$1,000 a day—so a remitter has to find a convenient alter-native means to beat the official threshold. In some countries, a severeforeign exchange shortage has necessitated austere exchange controls,which in turn have forced people to opt for IVTS to avoid the atten-dant penalty charges or to circumvent the red tape associated with theformal process of handling foreign currency.

Conclusion

Some countries in the group have yet to come to terms with the needto play an active role in ensuring that IVTSs are not left open to possibleuse by terrorism financiers. Indeed, it will take a lot of persuasion by allconcerned international stakeholders to get some member countries torealize the need to move with the rest of the international communitytoward focusing on informal value transfer systems as possible terrorfinancing avenues. Probably the very nature and economic compositionof most member countries will necessitate a “softly-softly” approach, rec-ognizing the cash-based feature of our economies. Taking a prescriptiveapproach without properly unraveling the key issues related to the use ofIVTSs could just worsen the situation by causing the involved players todrive their activities underground. This is where the setting up ofESAAMLG comes in handy. The group brings together the key multidis-ciplinary cadre needed to work through issues and advise the member



governments on what realistic and balanced actions they can take toensure that the IVTSs are not abused.

Although all 14 ESAAMLG member countries have signed up to adoptand implement the 8 FATF special recommendations on terrorist financ-ing, the authorities have yet to fully explore and understand the problem.Indeed, most of the jurisdictions are still in the process of implementing thefirst stages of the FATF 40 recommendations on anti–money launderingpractices. Therefore, it is going to be a while before member countries makeany meaningful progress in putting IVTSs into the scope for appropriateregulation. Although acts of terrorism have occurred at various places inthe region, there is little or no firm, documented evidence that an IVTS hasbeen the conduit of the money used in the terrorist activities. However, wecan safely conclude that an IVTS presents a possible and serious avenue forfinancing of terrorism.

Clearly, the larger part of the population may not be aware of the poten-tial for IVTSs to be used for the financing of terrorism. Some ESAAMLGcountries have considered themselves out of harm’s way insofar as interna-tional terrorism is concerned. Thus, our initial impression is that, up to acertain point, it will require considerable effort to get such jurisdictions—at some levels within the member countries—to consider monitoring andregulating IVTSs.



11

Somalia: The Experience of HawalaReceiving Countries

MOHAMED DJIRDEH HOUSSEIN

On behalf of the Somali people, I would like to take this occasion tothank H.H. Sheikh Zayed bin Sultan Al Nahyan, the President of the

United Arab Emirates (U.A.E.); Their Highnesses, the members of theSupreme Council; and the government and the people of the U.A.E. fortheir generous hospitality in accommodating such a big community ofSomalis who live and work in their country. The U.A.E. has been our sec-ond home for a long time and especially during the past 14 years since thestate of Somalia collapsed.

I want to thank the Governor of the Central Bank of the U.A.E., H.E.Sultan bin Nasser Al Suwaidi, and the central bank for holding the SecondInternational Conference on Hawala—as well as for holding the First Inter-national Conference on Hawala on May 15–16, 2002—and for inviting meto participate in this conference.

History of Somalia

In 1960, two colonies, British Somaliland and Italian Somaliland,received their independence and united to form the Somali Republic. Dur-ing 1960–69, a democratic parliamentary system existed. Then a militarycoup took power in 1969. After decades of civil war, the government was

87

Mohamed Djirdeh Houssein has been Chairman of the Somali Financial Services Associ-ation since August 2004.


toppled on the night of January 26, 1991. Since then, no one has ruledSomalia. It disintegrated into several parts. Some set up viable stable admin-istrations like Somaliland and Puntland, while others were characterized bytotal anarchy. Meanwhile, a creeping civil war continues.

Somalia is unique; it is not a failed state, although there are many. Soma-lia is simply a state that ceased to exist. There is no central government;none of the organs of government exist, such as police or military forces,central or commercial banks, hospital or schools, or any other public entity,physical or otherwise. The Mogadishu International Airport and the Port ofMogadishu state facilities are not functioning, while a few kilometers fromeach there are dirt-runway airports and open-ocean ports that are func-tioning and are run by militias.

That is dangerous, because what happened in Somalia could happen toother states, and the vision of life without a government might become log-ical or acceptable. There is a German saying: “No one should feel comfort-able with a fire engulfing his neighbor’s house.” It is essential to appreciatethis reality and to understand the Somali context as we envisage variouspolicies and regulatory arrangements. It will not be possible to make sepa-rate regulations for Somalia only, but at the same time, it will be difficult toapply the normal international regulations to a state that does not exist in anormal sense.

Somalis are nomadic, and though the Somali language has a rich litera-ture, it was an oral language until 1973, when it was written in the Latinalphabet. As such, personal identification and documentation were neverwidely used except in the capital, Mogadishu.

Hawala System in Somalia

Hawala is an efficient, practical, and cost-effective system of transferringfunds from one country or area to another. It has been used for millennia.Unfortunately, these days, the name hawala conjures images of dark forcesand underground activities. We had major problems using the name whenwe were forming the Somali Financial Services Association late last year.

Hawala serves more than half of the world, far more than conventionalbanking, and serves it well. We should not overregulate the hawala business.If we do so, we might make it an underground business. In the case ofSomalia after 1991, when the civil war reached the capital, Mogadishu, andthe government collapsed, more than 25 percent of the urban populationmigrated to Gulf Cooperation Council countries, East and South Africa,Australia, Canada, Europe, and the United States. It is estimated that about

88 MOHAMED DJIRDEH HOUSSEIN�


half a million Somalis live in the Gulf Cooperation Council countries. Theyall transfer funds to Somalia as family support, as investment, and for busi-ness transactions. Since there are no banks, there is no other financial trans-fer system except the hawala system. United Nations DevelopmentProgramme (UNDP) studies have shown that 26 percent of the total popu-lation of Somalia depend totally on transfers, and up to 66 percent dependon it for 50 percent of their basic needs.1 This system serves an importanthumanitarian need. Hawala is the only mechanism businesses have fortransferring funds out of Somalia to purchase imports. Within Somali ter-ritories, because of the insecurity caused by the civil strife and the physicalbulkiness of local currencies, all fund transfers are by the hawala service.Hawala repatriates all the export earnings back to Somalia. In a countrywhere unemployment is about 80 percent, the hawala industry is a majoremployer. As there are no banks, many of the hawala companies serve asdeposit takers for their customers.

Where hawala services are provided, there are other beneficial aspects.Communication links are set up with satellite connections and with tele-phone and Internet service or high-frequency radio services. Electric sup-plies are also set up. These can then be offered commercially to thesurrounding communities. Thus, there are communication links with allmajor and minor towns of Somalia.

The process of hawala funds transfer is simple and straightforward. Aperson in Columbus, Ohio, who wants to transfer US$100 to a relative inMerca, Somalia, will contact an agent in Columbus. Either the funds will bepaid in cash or credited to the agent’s account. Once this is confirmed, theagent will send the instruction to either the company’s regional office in theUnited States or the company’s headquarters. Within the same working day,the main office will instruct either their regional office in Somalia or theirpaying agent directly. Charges are 5 percent, which are split between thecollecting agent or branch (30 percent), the main company (50 percent),and the paying agent or branch (20 percent). Literally every town is served.No banking service in Somalia in the past has ever achieved this scale offunds transfer and covered such a wide area. In fact, some companies offerpayments within two hours. One company has set up a server-based, live-data system whereby all agents and company offices are connected to thelive transaction. On this, all regulatory requirements are built in; the systemwill process neither illegal transactions nor those that have further formal-

SOMALIA: THE EXPERIENCE OF HAWALA RECEIVING COUNTRIES 89�

1Report on Supporting Systems and Procedures for the Effective Regulation and Monitoringof Somali Remittance Companies (Hawala), prepared for UNDP Somalia by AbdusalamOmer, 2002.


ities to be taken care of. It will send copies of transactions automatically togovernment authorities when mandated. It is also linked to the blockedpersons list of the U.S. Treasury and cross-checks names.

The following is an example of one transfer using hawala that took placeon March 29, 2004. A customer transferred US$1,000 from Hargeisa, Soma-lia, to a Somali businessman in Guangzhou, China. The hawala company inHargeisa could only transfer to Dubai. They charged a transfer fee of US$10and used an exchange rate of AED 3.67 to the U.S. dollar. From Dubai, oneof the big exchange houses was used, with a rate of AED 3.676 to the U.S. dol-lar, and a transfer fee of US$52 was paid. The total amount paid for fees wasUS$64 ($52 plus $10 transfer fees and AED 6, which is the difference betweenthe exchange rates used by the hawala company and the exchange house). Ifthe hawala company had an agent in Guangzhou, I don’t think more than atotal of US$30, i.e., 3 percent, would have been charged.

The total funds transferred by Somalis are estimated at around US$1 bil-lion per year.2 Somalis are not necessarily known as good savers, but thereality of a huge migration in such a short period and the serious unem-ployment and famine at home make everyone wish to assist, even if the sav-ing is from the welfare assistance of the refugees.

Settlement in hard currency is also very attractive. The hawala compa-nies pay either local currency or hard currency, especially in U.S. dollars, themain international currency that is used. This serves as a hedge againstinflation and is also an element of security. As the Somali shilling devalued,the physical handling and safekeeping of cash, especially in the civil waratmosphere, became a serious problem (see Table 11.1). As such, U.S. dol-lars are more conveniently handled and securely stored.


2Ibid.

Table 11.1. Devaluation of the Somali Shilling to the U.S. Dollar, 1982 to 2003

Year Shillings

1982 6.31985 5001989 8001990 3,0001993 5,5002003 21,000


Self-Regulation

No governmental regulations control financial transactions withinSomali territories. In Somaliland, the Bank of Somaliland registers hawalacompanies. The bank issues a Certificate of Authorized Exchange Dealer fora fee and a deposit of US$3,000. With this, the municipality issues a licenseto operate. Beyond that, no other regulation exists.

The UNDP Somalia and EU Somalia organized a workshop in Dubai inJuly 2003 and a conference in London in December 2003. As a result, theSomali hawala companies have set up the Somali Financial Services Associ-ation (SFSA). We are in the process of building up the organization. TheSFSA is the first attempt at self-regulation and needs to be professionallymanaged. The UNDP Somalia and EU Somalia offices are assisting. TheSFSA also needs training and capacity building.

Challenges of the Somali Hawala Business

Somalia is a country that has to function without a central government,and the challenge is how to deal with that and how to address the followingissues.

• Regulation within Somalia should not be expected until a recognizedgovernment is formed.

• Regulation of the hawala system at the source of the transfer should bedeveloped.

• Disruption of this humanitarian service that provides a livelihood tomany should be avoided.

• Overregulation, which could drive this needed service underground,should also be avoided.

• Concerns as to how to nurture, guide, regulate, and integrate thehawala into the mainstream industry should be addressed.

• Appreciation should be encouraged for a service that is efficient, iscost-effective, and serves rural areas.

• Hawaladars need technical assistance to understand complicated anddiverse regulations. In the United States many of the 50 states havetheir own regulations.

• Collaboration between the formal financial institutions and hawalashould be developed.

• Discussion should be had as to ways to apply the know-your-customer requirement in Somalia.



• Accommodation should be considered for small businesses that donot need much capital or training but operate in niche markets thatdepend on other traditional methods.

Special Challenges of the Central Bank of the U.A.E.

The Central Bank of the U.A.E. can play a pivotal role in implementingthe achievements and agreements of this conference in Somalia. It can playa bridging role between the hawala sending and receiving countries, espe-cially Somalia. This is easier, given that the U.A.E. is the second home toSomali businesses, and that there are cultural similarities between Somaliaand the U.A.E. Most of the exports and imports come through the U.A.E.All the financial transactions are done through the U.A.E. Moreover, the seaand air transport to and from Somalia are with the U.A.E. Somalis considerthe U.A.E. the financial capital of Somalia.

Achievements

The First International Conference on Hawala opened the discussionand formally addressed the hawala issue. For the first time it was shown thatthe hawala money transfer system is a genuine, working, efficient, cost-effective system that is here to stay. The conference, in reality, has broughtthe hawala industry in out of the cold. The Central Bank of the U.A.E.,under the leadership of its Governor, H.E. Sultan bin Nasser Al Suwaidi, hastaken a drastic, novel, and courageous stand to acknowledge the existenceof the hawala money transfer system and has supported the need for itsexistence. The Abu Dhabi Declaration on Hawala has accommodated thissignificant international financial service and has also encouraged the inter-national financial industry to do so and live with it. The Abu Dhabi Decla-ration set guidelines and the first mechanism to integrate the hawala systeminto the mainstream financial system. The declaration was groundbreaking.

Conclusion

The Somali hawala companies feel they are misunderstood. They do notwant to be prosecuted for adopting an old, traditional mechanism and forhaving developed it into an efficient funds transfer system. The need tooffer efficient, cost-effective, and instant service is making financial services



use the latest communications technologies, which creates an atmospherefor more transparency and accountability. This is where the hawala compa-nies and the public authorities can converge, and both could do their jobwell. The need for modern, online services has advantages for both thecompanies and the regulators.

As we are today participating in the Second International Conference onHawala, we should not only build on the first conference’s achievementsand guidelines but also try to set solid and fundamental procedures to legal-ize, regulate, integrate, and develop the hawala money transfer industry,keeping in mind all the above needs and challenges.

More studies are needed, and more discussions between the main par-ticipant groups at the conference that will help us reach a consensus thatwill cater to all our basic needs. We should expect more scrutiny by allauthorities concerned about abuses and hawala’s potential to facilitatecrime. The need for more transparency by hawaladars is also clear. At thesame time, the activity of hawaladars must be clearly distinguished fromnormal banking services, which include taking deposits, issuing checks, ormaking loans. The process by which hawala funds are transmitted andhawala’s interface with banking channels are still not well or widely known.

We feel that Somalis have been singled out too unevenly for control since9/11, and public authorities should be more aware of the collateral damagethis continues to inflict. We should also work toward setting affordable,transparent, and reasonable regulations of Somali and other hawala net-works. Continuous outreach and active dialogue are essential.



Annex 1

Abu Dhabi Declaration on Hawala,Made at the Conclusion of the FirstInternational Conference on Hawala,16 May 2002

Participants at the First International Conference on Hawala in theU.A.E., in May 2002, drafted and agreed upon the Abu Dhabi Declara-

tion on Hawala, which set forth the following principles:1. Recognizing the need to better understand Hawala and other alter-

native remittance systems and to ensure that these systems are notabused by money launderers and terrorist financiers, the Govern-ment of the United Arab Emirates brought together experts andrepresentatives of international and regional bodies and regulatoryand law enforcement agencies, as well as bankers and money chang-ers, in Abu Dhabi on May 15–16, 2002.

2. The word “Hawala” comes originally from the Arabic language andmeans transfer or remittance, but in this context refers specificallyto informal money or value transfer systems or networks outsidethe formal financial sector.

3. The Conference participants agreed that Hawala and other alterna-tive remittance systems have many positive aspects and that most ofthe activities conducted by Hawaladars (Hawala Operators) relateto legitimate business. Hawala provides a fast and cost-effectivemethod for worldwide remittance of money or value, particularlyfor persons who may be outside the reach of the financial sector.

4. However, the participants also raised concerns about Hawala andother alternative remittance systems, noting that a lack of trans-

94


parency and accountability, as well as the absence of governmentalsupervision, presents the potential for abuse by criminal elements.

5. In light of these concerns, the participants agreed:• Countries should adopt the 40 Recommendations of the Financial

Action Task Force (FATF) on Money Laundering and the 8 SpecialRecommendations on Terrorist Financing in relation to remitters,including Hawaladars and other alternative remittance providers.

• Countries should designate competent supervisory authorities tomonitor and enforce the application of these recommendations toHawaladars and other alternative remittance providers.

• Regulations should be effective but not overly restrictive.• The continued success in strengthening the international financial

system and combating money laundering and terrorist financingrequires the close support and unwavering commitment of theinternational community.

• The international community should remain seized with the issueand should continue to work individually and collectively to reg-ulate the Hawala system for legitimate commerce and to preventits exploitation or misuse by criminals and others.

6. The participants wish to express their deep appreciation to the Gov-ernment of the United Arab Emirates and particularly the CentralBank for their leadership in hosting this groundbreaking Conference.

ABU DHABI DECLARATION ON HAWALA 95�


Annex 2

Second International Conference onHawala, Conference Statement,Abu Dhabi, 5 April 2004

The Conference acknowledged and reaffirmed the important achieve-ments of the First International Conference on Hawala as set out in the

Abu Dhabi Declaration on Hawala (May 2002).The Conference recognized the key role that hawala and other informal

funds transfer (IFT) systems play in facilitating remittances, particularlythose of migrant workers. It noted, as well, the significance of IFT systemsas an integral part of the international financial system.

A major outcome of the Conference was its contribution in increasingawareness of the role of IFT systems. Participants emphasized that IFT sys-tems need to be understood against the diversity of socio-cultural, legal,and economic contexts. Nevertheless, IFT systems, like other parts of thefinancial system, can also be misused for illegal purposes, and participantstherefore re-emphasized the need for transparency and traceability offinancial transactions. Furthermore, acknowledging the work of the Finan-cial Action Task Force (FATF) in developing standards and best practices inthis area, the Conference highlighted the range of experiences, practices,and approaches that could apply.

The Conference identified the following challenges in implementing IFTregulatory regimes:

• Overcoming imperfect information on the functioning of IFT sys-tems;

• Ensuring authorities have adequate resources in dealing with thisissue;

• Designing regulatory solutions that are proportionate to the risks andsensitive to possible unintended consequences;

96


• Avoiding over-regulation that might drive IFT operations under-ground; and

• Demonstrating to the participants in IFT systems that the benefits ofregulation outweigh the costs.

With the aim of addressing these challenges, the Conference concludedthat there was a need to:

• Gather and analyze information on IFT systems and their operations;• Engage in a dialogue with IFT providers and users to develop con-

structive solutions;• Conduct outreach to raise the awareness of the regulated community

and public to IFT issues; and• Remove any impediments to cost-effective, reliable, and convenient

transmission of funds in the regulated financial sector.Where IFT systems are permitted, countries should as a first step register

and/or license IFT operators. Further anti–money laundering and combat-ing the financing of terrorism (AML/CFT) requirements should then beimplemented in the IFT sector by countries according to their capacity.

Finally, the Conference encouraged the FATF and the internationalfinancial institutions to take note of the conclusions of this Conference andwork to develop further guidance.

The Conference expressed its gratitude to the Government and CentralBank of the United Arab Emirates, and the International Monetary Fundfor organizing this Conference.

SECOND INTERNATIONAL CONFERENCE ON HAWALA 97�


Annex 3

Interpretative Note to SpecialRecommendation VI:Alternative Remittance

General

1. Money or value transfer systems have shown themselves vulnerableto misuse for money laundering and terrorist financing purposes.The objective of Special Recommendation VI is to increase thetransparency of payment flows by ensuring that jurisdictionsimpose consistent anti–money laundering and counter-terroristfinancing measures on all forms of money/value transfer systems,particularly those traditionally operating outside the conventionalfinancial sector and not currently subject to the FATF Recommen-dations. This Recommendation and Interpretative Note underscorethe need to bring all money or value transfer services, whether for-mal or informal, within the ambit of certain minimum legal andregulatory requirements in accordance with the relevant FATF Rec-ommendations.

2. Special Recommendation VI consists of three core elements:a. Jurisdictions should require licensing or registration of persons

(natural or legal) that provide money/value transfer services,including through informal systems;

b. Jurisdictions should ensure that money/value transmission ser-vices, including informal systems (as described in paragraph 5below), are subject to applicable FATF Forty Recommendations

98


(2003) (in particular, Recommendations 4–16 and 21–25)1 andthe Eight Special Recommendations (in particular SR VII); and

c. Jurisdictions should be able to impose sanctions on money/valuetransfer services, including informal systems, that operate with-out a license or registration and that fail to comply with relevantFATF Recommendations.

Scope and Application

3. For the purposes of this Recommendation, the following definitionsare used.

4. Money or value transfer service refers to a financial service thataccepts cash, cheques, other monetary instruments or other storesof value in one location and pays a corresponding sum in cash orother form to a beneficiary in another location by means of a com-munication, message, transfer or through a clearing network towhich the money/value transfer service belongs. Transactions per-formed by such services can involve one or more intermediaries anda third party final payment.

5. A money or value transfer service may be provided by persons (naturalor legal) formally through the regulated financial system or informallythrough non-bank financial institutions or other business entities orany other mechanism either through the regulated financial system (forexample, use of bank accounts) or through a network or mechanismthat operates outside the regulated system. In some jurisdictions, infor-mal systems are frequently referred to as alternative remittance servicesor underground (or parallel) banking systems. Often these systems haveties to particular geographic regions and are therefore described usinga variety of specific terms. Some examples of these terms includehawala, hundi, fei-chien, and the black market peso exchange.2

6. Licensing means a requirement to obtain permission from a desig-nated competent authority in order to operate a money/value trans-fer service legally.

INTERPRETATIVE NOTE TO SPECIAL RECOMMENDATION VI 99�

1When this Interpretative Note was originally issued, these references were to the 1996FATF Forty Recommendations. Subsequent to the publication of the revised FATF FortyRecommendations in June 2003, this text was updated accordingly. All references are now tothe 2003 FATF Forty Recommendations.

2The inclusion of these examples does not suggest that such systems are legal in any par-ticular jurisdiction.


7. Registration in this Recommendation means a requirement to regis-ter with or declare to a designated competent authority the exis-tence of a money/value transfer service in order for the business tooperate legally.

8. The obligation of licensing or registration applies to agents. At aminimum, the principal business must maintain a current list ofagents, which must be made available to the designated competentauthority. An agent is any person who provides money or valuetransfer service under the direction of or by contract with a legallyregistered or licensed remitter (for example, licensees, franchisees,concessionaires).

Applicability of Special Recommendation VI

9. Special Recommendation VI should apply to all persons (natural orlegal), which conduct for or on behalf of another person (natural orlegal) the types of activity described in paragraphs 4 and 5 above asa primary or substantial part of their business or when such activ-ity is undertaken on a regular or recurring basis, including as anancillary part of a separate business enterprise.

10. Jurisdictions need not impose a separate licensing/registration sys-tem or designate another competent authority in respect to persons(natural or legal) already licensed or registered as financial institu-tions (as defined by the FATF Forty Recommendations (2003)within a particular jurisdiction, which under such license or regis-tration are permitted to perform activities indicated in paragraphs4 and 5 above and which are already subject to the full range ofapplicable obligations under the FATF Forty Recommendations(2003) (in particular, Recommendations 4–16 and 21–25) and theEight Special Recommendations (in particular SR VII).

Licensing or Registration and Compliance

11. Jurisdictions should designate an authority to grant licences and/orcarry out registration and ensure that the requirement is observed.There should be an authority responsible for ensuring complianceby money/value transfer services with the FATF Recommendations(including the Eight Special Recommendations). There should alsobe effective systems in place for monitoring and ensuring such com-

100 ANNEX 3�


pliance. This interpretation of Special Recommendation VI (i.e., theneed for designation of competent authorities) is consistent withFATF Recommendation 23.

Sanctions

12. Persons providing money/value transfer services without a licenseor registration should be subject to appropriate administrative, civilor criminal sanctions.3 Licensed or registered money/value transferservices which fail to comply fully with the relevant measures calledfor in the FATF Forty Recommendations (2003) or the Eight SpecialRecommendations should also be subject to appropriate sanctions.

INTERPRETATIVE NOTE TO SPECIAL RECOMMENDATION VI 101�

3Jurisdictions may authorise temporary or provisional operation of money/value transferservices that are already in existence at the time of implementing this Special Recommen-dation to permit such services to obtain a license or to register.


Annex 4

Combating the Abuse of AlternativeRemittance Systems: International BestPractices,1 20 June 2003

Financial Action Task Force on Money Laundering

Introduction

Alternative remittance systems are financial services, traditionally oper-ating outside the conventional financial sector, where value or funds aremoved from one geographic location to another.

Special Recommendation VI: Alternative Remittance2

Each country should take measures to ensure that persons or legal entities,including agents, that provide a service for the transmission of money or value,including transmission through an informal money or value transfer system ornetwork, should be licensed or registered and subject to all the FATF Recom-mendations that apply to banks and non-bank financial institutions. Each

102

1The content of this paper is taken primarily from APG’s Draft Alternative RemittanceRegulation Implementation Package (October 2002). This Best Practices Paper is intendedto draw on the work of the APG Working Group on Underground Banking and AlternativeRemittance Systems, guided by Mark Butler and Rachelle Boyle, into international best prac-tices.

2See also the FATF Interpretative Note to Special Recommendation VI: Alternative Remit-tance.


country should ensure that persons or legal entities that carry out this serviceillegally are subject to administrative, civil or criminal sanctions.

While the Interpretative Note is intended to further explain Special Rec-ommendation VI, the Best Practices Paper is intended to give additionaldetails (including some examples), to offer jurisdictions suggestions inimplementing Special Recommendation VI and to give them guidance onhow to detect alternative remittance systems outside the conventionalfinancial sector. It focuses on many practical issues, such as the identifica-tion of money/value transfer services, the procedures for licensing or regis-tering such services and their customer due diligence procedures. This BestPractices Paper addresses the following topics:

• Definition of money or value transfer service• Statement of Problem• Principles• Areas of Focus

(i) Licensing/Registrationa. Requirement to Register or Licenseb. Applications for Licencec. Business Addressd. Accounts

(ii) Identification and Awareness Raisinga. Identification Strategiesb. Awareness Raising Campaigns

(iii)Anti–Money Laundering Regulationsa. Customer Identificationb. Record Keeping Requirementc. Suspicious Transaction Reporting

(iv)Compliance Monitoring(v) Sanctions.

Definition

Throughout this Best Practices Paper, the following definition from theInterpretative Note to SR VI is used.

Money or value transfer service (MVT service) refers to a financial servicethat accepts cash, cheques, other monetary instruments or other stores ofvalue in one location and pays a corresponding sum in cash or other formto a beneficiary in another location by means of a communication, mes-sage, transfer or through a clearing network to which the MVT service

COMBATING THE ABUSE OF ALTERNATIVE REMITTANCE SYSTEMS 103�


belongs. Transactions performed by such services can involve one or moreintermediaries and a third party final payment.

A MVT service may be provided by persons (natural or legal) formallythrough the regulated financial system or informally through entities thatoperate outside the regulated system. In some jurisdictions, informal sys-tems are frequently referred to as alternative remittance services or under-ground (or parallel) banking systems. Often these systems have ties toparticular geographic regions and are therefore described using a variety ofspecific terms. Some examples of these terms include hawala, hundi, fei-chien, and the black market peso exchange.

Statement of Problem

As ‘Know Your Customer’ and other anti-money laundering strategiescome into operation in the formal financial sector, money laundering activ-ity may be displaced to other sectors. Jurisdictions have reported increasedmoney laundering activity using the non-bank sector and non-financialbusinesses. Measures should therefore be taken to obviate any increasedabuse of the unregulated sector. MVT services are increasingly vulnerableto abuse by money launderers and the financiers of terrorism, particularlywhen their operations are conducted through informal systems involvingnon-bank financial institutions or other business entities not subject to theapplicable obligations under the FATF Recommendations.

In addition to their use by legitimate clients, criminals have launderedthe proceeds of various criminal activities using MVT services. Primarily,unregulated MVT services permit funds to be sent anonymously, allowingthe money launderer or terrorist financier to freely send funds without hav-ing to identify himself or herself. In some cases, few or no records are kept.In other cases, records may be kept, but are inaccessible to authorities. Thelack of adequate records makes it extremely difficult, if not impossible, totrace the funds after the transaction has been completed.

From recent research, it is suspected that the principal criminal activ-ities engaged in by those who utilise MVT services are the illicit traffick-ing in narcotic drugs and psychotropic substances, illicit armstrafficking, corruption, evasion of government taxes and duties, traffick-ing in human beings and migrant smuggling. Recent reports indicatethat international terrorist groups have used MVT services to transmitfunds for the purpose of funding terrorist activities. (For example, inves-tigation of the September 11, 2001 terrorist attacks has found that boththe formal financial sector and informal MVT services were used totransfer money to the terrorists.)

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Principles

The following principles guide the establishment of these best practices:• In certain jurisdictions, informal MVT services provide a legitimate

and efficient service. Their services are particularly relevant whereaccess to the formal financial sector is difficult or prohibitivelyexpensive. Informal MVT services are available outside the normalbanking business hours. Furthermore, money can be sent to andfrom locations where the formal banking system does not operate.

• Informal MVT services are more entrenched in some regions than othersfor cultural and other reasons. Underground banking is a long-standingtradition in many countries and pre-dates the spread of Western bankingsystems in the 19th and 20th centuries. These services operate primarilyto provide transfer facilities to neighbouring jurisdictions for expatriateworkers repatriating funds. However, the staging posts of undergroundbanking are no longer confined to those regions where they have their his-torical roots. Accordingly, informal MVT services are no longer usedsolely by persons from specific ethnic or cultural backgrounds.

• MVT services can take on a variety of forms which, in addition to theadoption of a risk-based approach to the problem, points to the needto take a functional, rather than a legalistic definition. Accordingly, theFATF has developed suggested practices that would best aid authori-ties to reduce the likelihood that MVT services will be misused orexploited by money launderers and the financiers of terrorism.

• Government oversight should be flexible, effective, and proportionalto the risk of abuse. Mechanisms that minimise the compliance bur-den, without creating loopholes for money launderers and terroristfinanciers and without being so burdensome that it in effect causesMVT services to go “underground” making them even harder todetect, should be given due consideration.

• It is acknowledged that in some jurisdictions informal MVT serviceshave been banned. Special Recommendation VI does not seek legit-imisation of informal MVT services in those jurisdictions. The identi-fication and awareness raising issues noted may however be of use forcompetent authorities involved in identifying informal MVT servicesand for sanctioning those who operate illegally.

Areas of Focus

Analysis of the investigations and law-enforcement activities of variousjurisdictions indicates several ways in which informal MVT services have



been abused by terrorists and launderers and suggests areas in which pre-ventive measures should be considered.

(i) Licensing/Registration

A core element of Special Recommendation VI is that jurisdictionsshould require licensing or registration of persons (natural or legal) thatprovide informal MVT services. The FATF defines these terms in its inter-pretative note to Special Recommendation VI. A key element of both regis-tration and licensing is the requirement that the relevant regulatory body isaware of the existence of the business. The key difference between the twois that licensing implies that the regulatory body has inspected and sanc-tioned the particular operator to conduct such a business whereas registra-tion means that the operator has been entered into the regulator’s list ofoperators.

a. Requirement to Register or License• At a minimum, jurisdictions should ensure that MVT services

are required to register with a designated competent authoritysuch as a Financial Intelligence Unit (FIU) or financial sectorregulatory body. Registration of MVT services is likely to be arelatively cost effective approach when compared to the signifi-cant resources required for licensing.

• The obligation of licensing or registration applies to agents. Ata minimum, the principal business must maintain a current listof agents which must be made available to the designated com-petent authority. An agent is any person who provides MVT ser-vice under the direction of or by contract with a legallyregistered or licensed MVT service (for example, licensees, fran-chisees, concessionaires.

b. Applications for Licence • In determining whether an application for licensing can be

accepted by the regulatory authority, it is clear that some form ofscrutiny of the application and the operator needs to be con-ducted. This is in line with FATF Recommendation 233 whichstates that regulators should introduce “the necessary legal or regu-latory measures to prevent criminals or their associates from holding

106 ANNEX 4�

3When this Best Practices Paper was originally issued, these references were to the 1996FATF Forty Recommendations. Subsequent to the publication of the revised FATF FortyRecommendations in June 2003, this text was updated accordingly. All references are now tothe 2003 FATF Forty Recommendations.


or being the beneficial owner of a significant or controlling interest orholding a management function in a financial institution.”

• Authorities should conduct background checks on the opera-tors, owners, directors and shareholders of MVT services. Whenconsidering the suitability of a potential operator, the authori-ties should conduct a criminal record check on the principalpersons having control over the operations of the MVT service,as well as consult appropriate law enforcement databases,including suspicious or unusual reporting filings. Considera-tion should be given to defining the type of criminal recordwhich would make the applicant ineligible to operate a licensedMVT service.

c. Business Address • MVT services should be required to submit details of the

addresses from which they operate and to notify the authoritiesupon any change of address or cessation of business. Wherepossible, this information may be made available to both thepublic, so they may check which MVT service is properlylicensed or registered before using their services, and to inves-tigative/regulatory authorities during the course of their work.This also has value for financial institutions with which theMVT services maintain accounts, as they are able to identifywhich MVT services are licensed/registered and thus are moreable to identify illegal operators and to report to the FIU orappropriate competent authority accordingly.

d. Accounts• In processing cash and in the settlement of transactions, MVT

services use bank accounts. Some operators run a number ofbusinesses, of which MVT service is one, and use businessaccounts to conduct or conceal the remittances of funds onbehalf of their clients thereby masking the true origin of thecommingled funds and accounts.

• MVT services should maintain the name and address of anydepository institution with which the operator maintains atransaction account for the purpose of the MVT service busi-ness. These accounts must be capable of being identified andshould be held in the name of the registered/licensed entity sothat the accounts and the register or list of licensed entities canbe easily cross-referenced.

• Traditional financial institutions should be encouraged todevelop more detailed understanding as to how MVT services



utilise bank accounts to conduct their operations, particularlywhen accounts are used in the settlement process.

(ii) Identification and Awareness Raising

Some informal MVT services are not known to regulatory and enforce-ment agencies, which makes them attractive to the financiers of terrorism.Identification of these MVT services will make it less attractive for criminaland terrorist groups to use them to facilitate and hide the financing of theiractivities.

For the majority of jurisdictions, proactive identification of informalMVT services is an integral element of establishing and maintaining aneffective registration/licensing regime. Once informal MVT services havebeen located, compliance programs can be instituted under which theagents are approached, their details are recorded and they are providedinformation as to their obligations. Once regulatory regimes are in place,ongoing compliance work will include strategies to identify those MVT ser-vices not yet known to regulatory authorities. Jurisdictions may apply arange of strategies to uncover MVT services, using a number of approachesconcurrently. Jurisdictions are encouraged to foster close co-ordinationwithin the relevant authorities for the purposes of developing inter-agencystrategies and using available resources to identify MVT services that maybe operating illegally. Below is a list of suggested best practices for identify-ing MVT services and raising public awareness about their activities. Asbest practices, it is recognized that some of these suggestions may not beappropriate for every jurisdiction and that each jurisdiction must developstrategies best suited to its individual system.

a. Identification Strategies Best practices in the area of identification strategies include:• Examining the full range of media to detect advertising con-

ducted by informal MVT services and informing operators oftheir registration/licensing obligations. This includes national,local and community newspapers, radio and the Internet; givingparticular attention to the printed media in various communi-ties; and monitoring activities in certain neighbourhoods orareas where informal MVT services may be operating.

• During investigations, information about informal MVT ser-vices may be uncovered which should be passed on to the com-petent authorities. Best practices include encouraginginvestigators to pay particular attention to ledgers of businessthat may be associated with informal MVT services; encourag-

108 ANNEX 4�


ing enforcement agencies to look for patterns of activity thatmight indicate involvement of informal MVT services; and,where possible, encouraging enforcement agencies to considerusing undercover techniques or other specific investigative tech-niques to detect MVT services that may be operating illegally.

• Consulting with the operators of registered/licensed MVT ser-vices for potential leads on MVT services that are unregisteredor unlicensed.

• Being aware that informal MVT services are often utilised wherethere is bulk currency moved internationally, particularly whencouriers are involved. Paying particular attention to the originand owners of any such currency. Couriers could provideinsights for the identification and potential prosecution of ille-gal operators with whom the couriers are associated, especiallywhen potential violations by couriers are linked back to thesource of the informal MVT service operation.

• Paying particular attention to domestic suspicious transactionor unusual activity reporting, as well as to domestic and inter-national large value cash reporting, to identify possible links toinformal MVT services.

• Assisting banks and other financial institutions in developingan understanding of what activities/indicators are suggestiveof informal MVT service operations and using this to identifythem. Many informal MVT services maintain bank accountsand conduct transactions in the formal financial sector as partof other business operations. Giving banks the authority tocross-check particular accounts against a register of theseoperators and notify the relevant regulatory authority asappropriate.

• Once informal MVT services are identified, internationalexchange of information and intelligence on these entitiesbetween the relevant bodies. Consideration could be given tosharing domestic registers with international counterparts. Thisstrategy would also assist jurisdictions to identify local opera-tors not previously known.

b. Awareness Raising CampaignsBest practices in the area of awareness raising campaigns include:• Making informal MVT services aware of their obligations to

license or register, as well as any other obligations with whichthey may have to comply. Ensuring that the competent author-ities responsible for overseeing and/or registering or licensing



informal MVT services know how to detect those services thathave not registered or been licensed. Finally, ensuring that lawenforcement is aware of the compliance requirements for MVTservices in addition to the methods by which those services areused for illicit purposes.

• Using education and compliance programs, including visits tobusinesses which may be operating informal MVT services toadvise them of licensing or registration and reporting obliga-tions, as opportunities to seek information about others in theirindustry. Using these outreach efforts by law enforcement andregulatory agencies to enhance their understanding about theoperations, record-keeping functions and customer bases ofinformal MVT services. Extending outreach campaigns to busi-nesses typically servicing informal MVT services (such as ship-ping services, courier services and trading companies). Placingin trade journals, newspapers or other publications of generaldistribution notices of the need for informal MVT services toregister or license and file reports.

• Ensuring that the full range of training, awareness opportuni-ties and other forms of education are provided to investigatorswith information about MVT services, their obligations underthe regulatory regime and ways in which their services can beused by money launderers and terrorist financiers. This infor-mation can be provided through training courses, presentationsat seminars and conferences, articles in policing journals andother publications.

• Issuing various financial sector publications of guidelines toencourage licensing or registration and reporting and also gen-eral material to ensure financial institutions currently subject tosuspicious transaction reporting requirements develop anunderstanding of MVT services. (Also see section on suspicioustransaction reporting below) Informing potential customersabout the risks of utilising illegal MVT services and their role infinancing of terrorism and money laundering.

• Requiring entities to display their registration/license to cus-tomers once they are registered/licensed. Legitimate clients willlikely have a higher degree of confidence in usingregistered/licensed operators and may therefore seek out thoseoperators displaying such documentation.

• Making a list of all licensed or registered persons that provideMVT services publicly available.

110 ANNEX 4�


(iii) Anti–Money Laundering Regulations

The second element of Special Recommendation VI is that jurisdictionsshould ensure MVT services are subject to FATF Recommendations 4–16and 21–25 and also to the Eight Special Recommendations.

There is key information that both regulatory and enforcement bodiesneed access to if they are to conduct effective investigations of money laun-dering and terrorist financing involving MVT services. Essentially, agenciesneed the information about the customers, the transactions themselves, anysuspicious transactions, the MVT service’s location and the accounts used.The MVT service must also have further records on hand available to regu-latory and enforcement bodies as needed.

It is considered that to be effective in addressing the problem of MVTservices, regulations should not be overly restrictive. Regulation must allowfor those who abuse these systems to be found and stopped, but it shouldnot be so burdensome that it in effect causes the systems to go “under-ground,” making it even harder to uncover money laundering and terroristfinancing through alternative remittance.

a. Customer IdentificationThe principle of Know Your Customer (‘KYC’) has been the back-

bone of anti–money laundering and counter-terrorist financing mea-sures which have been introduced to financial service providers inrecent years, and this should also be the case for the MVT service sec-tor. Customer identification requirements in the formal financial sec-tor have had a deterrent effect, causing a shift in money launderingactivities to other sectors. FATF Recommendations 4–10 and 12 con-cern customer identification and record keeping.

• FATF’s Recommendation 5 is considered to be the minimumeffective level which MVT services should be required to fulfil.The current recommendation sets out that for persons, theinstitution should be “identifying the customer and verifying thatcustomer’s identity using reliable, independent source documents,data or information.” The documents commonly acknowledgedand accepted for identification purposes are identity card, pass-port, drivers’ license or social security card. It is important forthe credibility of the system that failure to produce an accept-able form of identification will mean that a client will berejected, the transaction will not be conducted and, under spe-cific circumstances a suspicious transaction report will be made.

• Proof of identity should be required when establishing a businessrelationship with the MVT service, whether the relationship is a



short term, i.e., a single transaction, or a long term one. Transac-tions via phone, fax or Internet should only be conducted aftercustomer identification complying with FATF Recommendation5 has occurred (i.e., a business relationship has already beenestablished). If the client’s identification has not been previouslyestablished, then the transaction should not be processed.4

b. Record Keeping RequirementInvestigative agencies need to be able to retrace transactions and

identify persons effecting the transactions (i.e., the audit trail) if theyare to successfully investigate money laundering and terrorist financ-ing. The requirement for MVT services to maintain records is essen-tial for effective regulation of the field, but it is this area in which thebalance between the regulator’s needs and the burden on the operatormost clearly needs to be struck.

• Jurisdictions should consider FATF’s Special RecommendationVII on Wire Transfers5 when developing guidance in this area.This recommendation specifically deals with funds transfers,including those made through MVT services. It should be notedthat Special Recommendation VI covers the transmission of“value” as well as money.

• MVT services should comply with FATF Recommendation 10to maintain, for at least five years, all necessary records on trans-actions both domestic and international. Jurisdictions shouldconsider setting some minimum requirements for the form inwhich the records should be kept. Because records associatedwith MVT transfer services may often be coded and/or difficultto access, jurisdictions should also establish minimum stan-dards for ensuring that they are intelligible and retrievable.

c. Suspicious Transaction ReportingTo maintain consistency with the obligations imposed on other

financial institutions, jurisdictions should introduce transactionreporting in line with their current reporting requirements for finan-cial institutions.

112 ANNEX 4�

4See footnote 3.5Text of SR VII: Countries should take measures to require financial institutions, including

money remitters, to include accurate and meaningful originator information (name, addressand account number) on funds transfers and related messages that are sent, and the infor-mation should remain with the transfer or related message through the payment chain.Countries should take measures to ensure that financial institutions, including money remit-ters, conduct enhanced scrutiny of and monitor for suspicious activity funds transfers whichdo not contain complete originator information (name, address and account number).


• Jurisdictions may consider issuing specific guidance as to whatmay constitute a suspicious transaction to the MVT serviceindustry. Some currently used indicators of suspicious financialactivity, such as those found in the FATF’s Guidance for Finan-cial Institutions in Detecting Terrorist Financing, are likely to berelevant for money/value transfer service activity. However, par-ticular activities and indicators that are unique to this sectorshould be further developed.

• The second half of FATF’s Special Recommendation VII onWire Transfers should also be taken into account when devel-oping guidance in this area. For example, operators that receivefunds/value should ensure that the necessary originator infor-mation is included. The lack of complete originator informa-tion may be considered as a factor in assessing whether atransaction is suspicious and, as appropriate, whether it is thusrequired to be reported to the Financial Intelligence Unit orother competent authorities. If this information is not included,the operator should report suspicious activity to the local FIUor other competent authority if appropriate.

(iv) Compliance Monitoring

Regulatory authorities need to monitor the sector with a view to identi-fying illegal operators and use of these facilities by criminal and terroristgroups. Jurisdictions are encouraged to consider the following options:

• Competent authorities should also be entitled to check onunregistered entities that are suspected to be involved in MVTservices. There should be an effective process for using thisauthority.

• Granting regulatory agencies or supervisory authorities theauthority to check the operations of a MVT service and makeunexpected visits to operators to allow for the checking of theregister’s details and the inspection of records. Record keepingpractices should be given particular attention.

• Establishing a process of identifying and classifying operatorswhich are considered to be of high risk. In this context, “highrisk” means those operators which are considered to be ofhigh risk of being used to carry out money laundering or ter-rorist financing activities. Jurisdictions are encouraged to givesuch high risk entities extra attention from supervisingauthorities.



(v) Sanctions

In designing legislation to address this problem, one of the aspects to beconsidered concerns the sanctions which are available to redress non-com-pliance. If a MVT service operator is found to be non-compliant with therelevant requirements of the legislation the competent authorities would beexpected to sanction the operator. Ideally, jurisdictions should set up a sys-tem to employ civil, criminal or administrative sanctions depending on theseverity of the offence. For instance, in some cases a warning may initiallysuffice. However, if a MVT service continues to be in non-compliance, itshould receive stronger measures. There should be particularly strongpenalties for MVT services and their operators that knowingly act againstthe law, for example by not registering.

To monitor the continued suitability of an individual to conduct a MVTservice, jurisdictions are encouraged to put systems into place which wouldbring any conviction of an operator, shareholder or director followinglicensing or registration, to the attention of the appropriate authorities.Consideration should be given to defining the type of criminal recordwhich would make the applicant ineligible to be a MVT service provider.

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