Alan L Tyree

Informal funds transfer systems

Alan L Tyree¹

1 Introduction

Informal funds transfer systems (IFTs) are funds transfer systems that operate outside the “normal” banking and financial system. The terminology is far from standard. The Financial Action Task Force (FATF) refers to them as “alternative funds transfer systems” and notes that they are also referred to by regional names such as “hawala”, “hundi” and “padala”.

IFTs are used by migrant workers to remit funds to family in their home countries by small businesses who need to transmit funds.

Since IFTs are, by definition, outside the usual banking channels, it is difficult to get an accurate reading of their size and reach. The APEC study [2] states that worker remittances account for the majority of money flows. Orozco [5] estimates that the worldwide flow of worker remittances is in excess of US$80 bn per year. Some 16 countries receive about 75% of the total flow.

2 How IFTs work

IFTs are often treated in the press as something mysterious. a 2001 article in the New York Times [1] refers to “Ancient secret systems” which transfer funds but in which “no cash moves across a border”. Even official publications seem to assume that there is something unusual in the way that IFTs operate. The Interpol web site contains an article [3] “The hawala alternative remittance system and its role in money laundering” which describes in detail methods used to transfer funds but which does not observe that the methods are precisely those used in the ordinary financial system.

As in an ordinary funds transfer, the process becomes transparent once it is realised that no “funds” are transferred. Liabilities are undertaken by a series of agreements which ensures that payment to the ultimate recipient is effected.

In a typical transaction, a person T wishes to transfer funds to a recipient R in another country. T arranges with a “hawaladar” TA to make the transfer. T will usually give TA cash, but in some cases T might pay by a credit or debit card. TA will also assign a secret password to the transaction which he will give to T.

TA has a correspondent relationship with RA who is in the same location as R. TA notifies RA of the funds transfer, instructing RA to pay R who will provide the password for the transaction. TA may notify RA by fax, telephone or, more commonly these days, by electronic mail or SMS message. Similarly, T will notify R of the password. R then collects the remittance from RA.

This leaves a debt owed by TA to RA. The debts will be netted (if there are any remittances in the other direction) and settled by agreed means. Settlement will often be by a funds transfer initiated by TA through normal banking channels.

It is often said that hawala banking operates through trust and that there are no formal contracts. This may be, but in the unlikely event that a hawala funds transfer came to court it is almost certain that the court would find implied contracts similar to ordinary banking arrangements. According to Royal Products Ltd v Midland Bank Ltd [1981] 2 Lloyd's Rep 194, the legal relationships are:

TA acts as A's agent for the purpose of making the transfer
RA acts as R's agent for the purpose of receiving the payment (in the form of a debt owed to RA by TA)
RA is not an agent of T, but is an agent of TA for the purposes of completing the remittance.

There are, of course, certain aspects of the hawala transaction which are different from the operation of a banking transfer. T will seldom have an account with TA but will instead pay for each transfer with cash or other agreed means. Another important difference is that traditionally records of the transaction were destroyed upon completion.

3 Why IFTs are used

The incentives for using IFTs are usually analyzed in terms of the “first mile” and the “last mile”. In more common language, the analysis looks at reasons why the sender, the “first mile” might use IFTs instead of the regular banking system. The “last mile” considerations are the circumstances of the recipient of the funds.

In the absence of hard research, analysing the senders reasons for choosing an IFT involves a certain amount of guesswork. The APEC study suggests that there are three categories of incentives:

personal
customer service and
economic.

There are several powerful personal reasons for choosing IFTs. In the context of migrant workers, the anonymity and secrecy of IFTs is an important factor. If the worker is an illegal immigrant, he or she probably cannot risk contact with the formal funds transfer system. Many immigrants may be intimidated by the bureaucracy of the formal banking system. In many cases, the remitters will be men who are sending funds to wives or family in countries where it is not the social norm for women to go into public alone or to interact with formal institutions such as banks.

From the standpoint of the sender, an IFT may offer substantially better customer service than the established banks. Language difficulties and lower social status may lead to perceived or actual discrimination by established financial institutions.

Finally, the sender will probably find that an IFT offers a cheaper and quicker service than the established banks. According to the APEC study, an IFT between major international countries may take as little as six hours. Even when the destination is remote and undeveloped the transfer will usually be completed in 24 hours. The cost of an IFT transaction will usually be between 2 and 5 percent of the amount transferred, a rate that is generally considerably lower than the cost of a comparable transfer through the formal funds transfer systems.

The “last mile” considerations will also have an effect on the sender's choice of system. In many parts of the world, the “unbanked” vastly outnumber the “banked”. Social considerations already mentioned may also influence the sender in the choice of funds transfer system.

4 The dark side

The dark side of IFTs is the same as the dark side of ordinary banking: IFTs may be used in money laundering operations and to finance terrorism and other crimes. The lack of record keeping mentioned above facilitates the use of IFTs for nefarious purposes.

The Report of the 9/11 Commission [4] claims that al Qaeda uses established hawala networks to move money. However, the attack on September 11, 2001 was financed through the ordinary banking system. The Commission Report notes (at p 237) that the “ hijackers made extensive use of banks in the United States, choosing both branches of major international banks and smaller regional banks.” The hijackers opened accounts in their own names using identification documents that appeared valid. They made deposits using travellers' cheques and cash obtained from ATMs debited to accounts with foreign banks.

Hard evidence is obviously difficult to obtain. However, the potential for abuse is such that the Financial Action Task Force (FATF) has advised greater government supervision of IFTs.

5 FATF recommendations

The International Financial Action Task Force on Money Laundering (FATF) was founded in 1989. Its stated purpose is the development and promotion of national and international policies to combat money laundering and terrorist financing. To this end, it works to encourage legislative and regulatory reforms so that money laundering and terrorist financing may be prevented and, where it does occur, detected.

The first set of “Forty Recommendations” was published in 1990. These were revised in 1996 and again in 2003. The Forty Recommendations establish principles which should be followed in drafting legislation and establishing regulatory structures. Although not binding in a treaty sense, they have been widely accepted and many countries, including Australia, have committed to their implementation.

In October 2001, the FATF released Recommendations on Terrorist Financing. Originally eight, the ninth was added in October 2004 and are now known as the “Nine Recommendations”.

Recommendations VI and VII of the Nine recommendations refer explicitly to measures to be taken in respect of funds transfer systems. Recommendation VI calls for licencing or registration of all funds transfer systems and the agents of such systems. It also recommends that they be subject to all the FATF Recommendations that apply to banks and other financial institutions.

Recommendation VII requires funds transfer messages to contain accurate and meaningful information about the originator of the transfer instruction. The information is to be a part of the funds transfer instruction and is to remain a part of it throughout the entire life of the message.

These Recommendations have been implemented as part of the Anti-Terrorism Act (No 2) 2005. Schedule 9 amends the Financial Transaction Reports Act 1988.

The definition of “cash dealer” in the FTRA already includes IFTs either under part (k)(ib) or (l). The new amendments call for the Director to establish a register of these two types of cash dealers.

The amendments come into operation on proclamation or, if there is no such proclamation, on 15 December 2006. It is possible that the amendments will never come into effect since the Government has expressed its intention to implement a comprehensive Anti-money laundering/counter terrorist financing regime in mid-year.

6 Alternatives

IFTs are facing increasing competition from new funds transfer systems. At least one organisation offers an arrangement whereby credit cards may be used as payment by the originator. The recipient is then sent an ATM card which may be used immediately to withdraw funds.

Other schemes involve providing instructions via the Internet or by email. One well-known service will deliver payments to anyone with an email address.

All of these services may be expected to target some of the same customers who would otherwise use IFTs. However, the factors identified above should ensure that ethnic IFTs continue to serve a legitimate purpose. The new regulatory scheme should help to ensure that they do serve illegitimate purposes.

References

[1]: Douglas Frantz. Ancient secret system moves money globally. http://www.nytimes.com/2001/10/03/international/03LAUN.html?ex=1138078800&en=18e65cc67b0460ad&ei=5070, Oct 2001.
[2]: APEC ARS Working Group. Informal funds transfer systems in the apec region. Technical report, APEC, 2003.
[3]: Patrick M Jost and Harjit Singh Sandhu. The hawala alternative remittance system and its role in money laundering. http://www.interpol.int/Public/FinancialCrime/MoneyLaundering/hawala/default.asp, Jan 2000. Sighted 23 Jan 2006.
[4]: National Commission on Terrorist Attacks Upon the United States. The 9/11 commission report. Technical report, US Government, 2004.
[5]: Manuel Orozco. Worker remittances in an international scope. Technical report, Inter-Americal Development Bank, 2003.

1: Consultant; formerly Landerer Professor of Information Technology and Law, University of Sydney. The views expressed are my own and do not necessarily reflect the views of any other person or organisation.

This document was translated from L^AT_EX by H^EV^EA.

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Last modified: Sat Jul 15 09:49:49 EST 2006