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Functioning and

Working of the Hawala


System
and its
impact on
Indian Economy
Prepared By:

Parth Thacker 2015B3A7749G


Kartik Kumar 2015B3A8212G
Lucky Kaul 2015B3A7535G
Charvi Gupta 2015B3A3373G
What is Hawala system?
Hawala is an alternative remittance channel that exists outside of
traditional banking systems.
Hawala is a method of transferring money without any actual
movement. Hawala is "money transfer without money movement."
Transactions between Hawala brokers are done without promissory
notes because the system is heavily based on trust.

Remittance: A remittance is the funds an, individual living in a country other


than his country of citizenship sends to his country of origin, via wire, mail, or
online transfer.

How does Hawala Work?


Basic variant is in which money is transferred via a network of hawala
brokers, or hawaladars.

A Customer, B Recipient, X & M Hawala Brokers.


Now A (in one city) wants to pay P amount of money to B(in another
city).
1. A pays a sum of P money to X(red arrow) along with that specifies a
password(blue arrow) that will allow B to claim money.
2. 2b: Now X calls another broker M in recipient city. Gives the instruction
for deposition and communicates the password.
2a: A calls B and instructs to collect the money from M and also
communicates the password.
3. B approaches M and tells the agreed password and M transfers P-C
amount to B where C is small amount of commission (generally 1-2% of
P depending on broker).
X now basically owes M the money that M had paid out to B; thus M has
to trust X's promise to settle the debt at a later date.
Informal records are produced of individual transactions, and a running
tally of the amount owed by one broker to another is kept. Settlements
of debts between Hawala brokers can take a variety of forms (such as
goods, services, properties, transfers of employees, etc.), and need not
take the form of direct cash transactions.
System does not depend on the legal enforceability of claims, it can
operate even in the absence of a legal and juridical environment. Trust
and extensive use of connections, such as family relations and regional
affiliations, are the components that distinguish it from other remittance
systems.
Sometimes a single firm as an entity deals as a Hawala broker which may
be covered up by a fake business. These firms then have branches in
many prominent cities and thus it helps them to simplify the Hawala
transfer system because there is no other intermediary involved and
hence solves the issue of risk while dealing with other Hawala broker.
The Benefits - Why people still use it
There is no need for formal legal protection and there is a very low
chance of risk with well-known Hawaladars.
Sometimes, the entire transfer of money can occur over a couple of
phone calls, text messages or instant messages.
No official records are kept after the transaction has occurred. All that
exists is a running tally of what is owed which is encrypted or coded.
These transactions can be used to avoid currency controls, official
exchange rates, import and export duties, undesirable tax charges.
No requirement of ID proof or disclosure of source of income.
The commission rates of transferring money through Hawaladars are
low.
It is reliable and efficient.
As there is no physical movement of cash, Hawala operators provide
better exchanged rates as compared to the official exchange rates.
It is simple and hassle free process as compared to the banks money
transferring system.
It is the only way to transfer unaccounted income and helps in money
laundering.
It is the best option for most immigrants and the only option for those
coming from regions devastated by civil conflicts and disasters.

Businesses more likely to be prone to the Hawala


System:

These businesses have higher chances of getting engaged into transactions that
involve payments through the hawala system:

Import/Export Businesses- To evade the customs duty, businesses might


resort to the hawala kind of transactions. This saves them money but
leads to the loss of national welfare.
Jewelry (Gold/Precious Stones) - Importing gold to India involves local
gold sales tax on top of the import duty as well. So importers can use
hawala system for payments.
Rugs/Carpets and Other Imported Items- These items also face heavy
taxes when imported, and are prone to be affected by the hawala system.
Impact on Indian Economy
Hawala transactions have a number of effects on the functioning of the
Indian economy, which include
Negative Fiscal Impact: Since Hawala is a word-of-mouth transaction,
where a simple transfer of money is done through middlemen, there are
no legal taxes or duties paid on the money transferred or earned, just
the commissions to the Hawaldars are. This causes a major loss in the
national revenue which could have otherwise been used to achieve
economic growth and development.
Financial Leakages: Hawala transactions can be used to cause outflow of
illicit funds outside the Indian economy. Normally, Government imposes
what are called exchange controls, which are restrictions on the flow of
currency between countries. So people attempting to transfer money
with the motive of capital flight use Hawala since they can transfer large
amounts of foreign currency across places, thereby causing drain in
financial resources.
Challenges the effectiveness of policy implementation: Since Hawala
transactions cause illegal flows of money, thus the proper data regarding
inflows and outflows is not available to Government and it ends up not
recording these transactions. This further makes it challenging for the
Government to monitor money supply and hence interest rates and
prices. Hawala transactions can also cause economic distortion.
Social Impact: Hawala transactions are used very frequently by terrorist
organizations for their funding and can in turn cause impact on the
public if theyre harmed, hence causing loss of social welfare.
Some Cases of Hawala Scams
1. 2000 Crore Hawala Scam in Mumbai. August 29, 2016
The Directorate of Revenue Intelligence (DRI) officials said the
scam, worth more than Rs2,000 crore, involves four nationalised
banks and one private bank, and the fraud was carried out
between October last year and March 2016 from the banks' south
Mumbai branches.
Like most such scams, the people whose identities were stolen in
this case too have no idea about the fraud. For instance, an
account was opened in the name of an Ulhasnagar cinema hall
worker, and Rs 400 crore were transferred from this account to a
company based out of India, the DRI officials said.
Similarly, accounts were opened in the names of a ticket-checker,
a sweeper working at Govandi Railway Station, and a roadside
bhelpuri vendor in Ghatkopar among others, and each account
was used to transfer between Rs 400 crore and Rs 600 crore out
of India, the DRI sources said.
It was found to be a clear cut case of black money being
transferred to safe havens. A bogus company was set up from an
office at Masjid Bunder. The office was vacated once the
transactions were carried out.While officials denied disclosing the
names of the banks, they said that "A single company is involved
in the fraud. Its address was shown at Masjid Bunder, and the
accused used 12 import-export codes to claim that money was
used to import goods from several South-East Asian countries,".
Interestingly, the people in whose name the accounts were made
in the first place did not earn even Rs. 10,000 a month!

(Source: http://timesofindia.indiatimes.com/city/mumbai/Rs-
2000-crore-hawala-scam-unearthed-in-
Mumbai/articleshow/53904414.cms . Dated August 29,2016).
2. Gujarat Hawala Scam worth INR 5395 Crore (Economic Times July 19,
2014)
Hawala transactions worth Rs 5395 crore in Gujarat and has filed
charge-sheets against 79 accused. The illegal route was being used
for gold payments and property transactions, investigators said. The
entire transaction took place from ICICI BankBSE 0.08 %'s two
branches in Surat, as per the officials, between December-January-
February making officials term it as Indias largest Hawala Scam
Hasan Fata, Bilal Haroon Gilani and Madan Jain were the main
accused. The modus operandi was to transfer the money send by
traders and business houses to overseas via submission of forge
documents of diamond imports using the banking channels.
Madan Jain opened as many as nine bogus companies and
appointed paid directors to these companies. These bogus
companies were used for sending money in overseas companies
based in Hong Kong and Dubai. Enforcement Directorate(ED)
officials have traced down 17 such foreign companies.
Afrosh Fata used to get 0.1% commission on each transaction that
he would execute. ED officials have attached Rs 9 crore worth of
assets and bank belonging to Afrosh and his close relatives. ED has
slammed section 3 & 4 of Money Laundering Act against the 79
accused. Role of ICICI Bank was also under the scanner since such
huge amounts could not have probably be transferred without bank
insiders.

(Source: http://economictimes.indiatimes.com/news/politics-and-
nation/largest-hawala-scam-worth-rs-5395-crore-unearthed-in-
gujarat/articleshow/38686639.cms )

3. Jain Brothers Hawala Scam (1991)


This was an Indian political scandal that took place between
February 1988 to April 1991, involving some of Indias leading
politicians. The scam was orchestrated by four Hawala brokers,
namely, the Jain brothers, the main person involved being a
Surindra Kumar Jain. The magnitude of the scam was to the tune of
$18 million (INR 650 million)
The scandal said without proof that the said funds were being
directed towards Hizbul Mujahideen to carry out terrorist activities
in Kashmir. Major politicians accused included LK Advani, VC Shukla,
Sharad Yadav and Madan Lal Khurana. A Public Interest
Litigation(PIL) was filed in 1997 by Vineet Narain, a journalist, yet
the accused were not punished and the scandal deflated without
any verdicts.
Sadly, even after this major scam, no Government has really looked
into probing it, and post 1991 saw three general elections in four
years with Three Prime Ministers taking oath. The accused still run
free.
The perils of Hawala system:
Since Hawala transactions neither require documentations nor there are official
records for them, they are extensively used by Terrorists, Smugglers, Naxals
and other Anti-Social activities for funding.
Indian authorities have found Kashmiri militants making extensive use of the
Hawala system. However, the bigger chunk of money comes from defrauding
trade regulations: An importer arranges with a supplier to charge a fraction of
his real prices on an invoice, and pays the difference via Hawala. It is estimated
that 90-95% of their funding comes through this channel only. For example, a
series of bomb blasts in a major Indian city in 1993 was financed through
Hawala, with the subsequent investigation revealing that the funds supporting
these bombings (specifically funds used to buy explosives and to pay the
bombers) were handled by Hawala operators in the United Kingdom, Dubai and
India. The US Treasury Department report states that India, Pakistan and
Persian Gulf form the Hawala triangle. Some cases are:

On August 18, 2011, Mohammad Younis pled guilty in Manhattan


federal court to operating an unlicensed money transfer business
between the United States and Pakistan. One of the money transfers
was used to fund the May 1, 2010, attempted car bombing in New York
Citys Times Square by Faisal Shahzad who is serving a life sentence in
federal prison
In April 2008, Money remitter sentenced to over 9 years for money
laundering conspiracy and concealing terrorist financing Saifullah Anjum
Ranjha, a Pakistani national residing in Washington, D.C. and Maryland,
was sentenced to 110 months in prison for conspiring to launder money
and for concealing terrorist financing in addition to being ordered to
forfeit USD 2 208 000 worth of assets

It is also used to send the profits of drug trafficking to arms dealers abroad in
the US.

Money transferred around the world needs to be kept track off, and
accounted in such a volatile global situation. This parallel system
disturbs the existing banking and foreign exchange system.
Existing Legal and Regulatory Framework in
India against the Hawala System:
FEMA- Under both FERA (Foreign Exchange Regulations Act 1973 )
and its successor FEMA (Foreign Exchange Management Act 2000) the
Hawala type transactions have been explicitly prohibited.

FEMA states that except with the permission of the Reserve Bank of India
(RBI), no person shall
Deal in, or transfer any foreign exchange or foreign security to any
person not being an authorized dealer.
Make any payment to, or for the credit of, any person resident
outside India.
Receive (except through an authorized dealer) any payment by
order, or on behalf of, any person resident outside India in any
manner.
Financial penalties of up to 3 times the sum involved or 2,00,000
Rupees
FERA regulated foreign contributions to political parties, charitable trusts, quasi
or non-governmental organizations and monitored the use of such contributions
for Hawala or for money laundering.

The Enforcement Directorate- It is responsible for the enforcement of


the (FEMA) and certain provisions under the Prevention of Money
Laundering Act. It acts as the watchdog to prevent remittances of Indians
abroad otherwise through normal banking channels.
Suggested Measures:
1. Taxation:
Through mutual cooperation, countries can enforce taxation of
hawaladars. Hawaladars often transfer funds or their equivalent in value
across borders and an evidential or intelligence picture cannot be
obtained by one countrys authorities without the open exchange of
information between all the other countries in which the hawala system
has a presence. Unfortunately, few examples of international
cooperation are there likely due to lack of training and expertise of law
enforcement or other competent authorities. This would help provide
some regulation to the process and bring revenue to nations, especially
poor ones.

2. Registering and Licensing with the government:


Under a registration regime, the service provider has to identify its
business to the authorities and provide certain information (as may be
requested by the authorities). Authorities usually attach few or no
conditions to the ability of the service provider to provide its services
under the registration regime, making the market entry easier. Although
there are varying practices of registration requirements, registration
regime tend not to require compliance systems prior to registration
unlike licensing system, and the initial application fee for registration is
also lower than that for obtaining a license. A licensing regime provides
more front-end screening by authorities and requirements to meet
certain criteria. Regulatory authority grants the licensee the permission
to engage in certain activities subject to specified terms and conditions.
Such terms and conditions may define purpose, time-period, territory,
compliance requirements, and operational instructions among others.
Hefty fines and penalties can be imposed on those who fail to do so.