Authors: Hitha Prabhakar
The rise of underground and parallel banking systems and hawalas and the use of large institutional banking systems became a way criminals could stay ahead of banking regulations. They began to be used more frequently, and their schemes came under scrutiny by the authorities.
Inside Job: How a Hawala Is Run
Hawalas (an Islamic term that means “word of mouth”) exist in 50 different countries, primarily in areas where people don’t have access to a large bank. They are found predominantly in Islamic nations but
are cropping up in the Middle East, the Indian subcontinent, Southeast Asia, and Africa.
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The fee to transfer funds varies between 2% and 5% when the money is transferred, but in most cases the fee is much less, if anything. This makes a hawala an appealing way to transfer money for those who don’t have much money to begin with. When someone needs to transfer money, he contacts his local hawaladar, or hawala operator, who then contacts his counterpart hawaladar in the corresponding country. The hawaladar comes from the same family or tribe, creating a net of trust and eliminating the possibility of fraud, misuse of funds, or stealing. If the amount of money is available, a password known only to the two hawaladars is given, and the transfer is carried out. The transaction happens quickly. In most cases, people using a hawala can receive funds just hours after making a few phone calls, as opposed to the 24 to 48 hours it takes for bank or money order wire transfers to go through. The hawaladar delivers the money taken from local funds to the recipient’s business or office.
With a hawala, money never changes hands. No paper trail is left behind, other than scribbled notes on a piece of paper. No electronic ledger tracks funds being transferred. These facts make the auditing and investigating process next to impossible. The U.S. Department of the Treasury estimates that $7 billion in funds circulates between hawalas in Pakistan and a staggering $608 billion in India—an amount roughly the size of Switzerland’s gross domestic product (GDP) and 40% of India’s GDP.
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Despite the vast amount of untraceable funds going between hawalas, they are not illegal and have been used for centuries, according to Ibrahim Warde, a professor of international business at the Fletcher School of Law and Diplomacy at Tufts University. The U.S. requires hawalas to register. However, illegal hawalas are extremely difficult to identify, and the penalties for running one are not severe. Countries such as the United Arab Emirates (UAE) and Afghanistan require hawalas to register with each country’s central
bank. However, the UAE had only 220 registered hawalas in 2007, and Afghanistan had 300. But the World Bank estimates that there are between 500 and 2,000 unregistered hawalas in Kabul and major city hubs in Afghanistan. Loose laws and regulations prevent the UAE from cracking down on unregistered hawalas. Therefore, terrorist organizations have been known to use hawalas to bypass the Bank Secrecy Act (BSA) of 1970 and other instruments established by financial institutions to help combat money laundering.
For example, the 9/11 attacks cost from $300,000 to $500,000 and were financed though wire transfers, travelers checks, and cash. The 9/11 Commission’s
Monograph on Terrorist Financing
acknowledged the use of hawalas to move cash within and outside of the U.S.
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Likewise, 60% of the funds generated from the drug trade in Afghanistan come from hawalas in the Kandahar and Helmand provinces. An estimated $800 million was believed to have been circulated in the Helmand province hawala system, much of which went to fund the Taliban, which in turn used the money to finance kidnappings, the theft of contraband weapons, and the recruitment and training of al Qaeda members. Many of the most recent terrorist attacks in South Asia, especially Pakistan and India in the Kashimir region, were financed entirely through the exchange of cash in these informal banking systems.
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In November 2001, the U.S. government froze the assets of two hawalas: the Al Barakaat (a financial, telecommunications, and construction group headquartered in Dubai that operates largely out of Somalia) and the Al Taqwa. Both were believed to be funneling nearly $10 million a year to al Qaeda by skimming money off transfer fees. The FBI and U.S. Customs agents raided the two networks’ offices in Alexandria and Falls Church, Virginia; Minneapolis, Minnesota; Boston, Massachusetts; Seattle, Washington; and Columbus, Ohio. The founder of Al Barakaat, Shaykh Ahmed Nur Jimale, is believed to be an associate of Osama bin Laden.
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Fighting The Enemy: U.S. Banks Try to Combat Money Laundering and Fail
The Bank Secrecy Act of 1970 was the first law passed that dealt with money laundering concerns and that tried make banking transactions more transparent. However, compliance within U.S. financial institutions remained weak. For example, under the BSA, banks were required to file a currency transaction report (CTR) with the Treasury Department for any currency transactions of more than $10,000. However, as criminals became aware of this new law, they started to think outside the box by moving funds through the purchase of gold, which was often thought of as an international currency. Likewise, terrorist operatives used financial instruments such as unregulated hawalas, profits made from stolen merchandise, and contraband sales of weapons to outfox BSA rules. Operation Polar Cap was an investigation that uncovered the laundering of more than $1.2 million in currency generated by the sale of cocaine in the U.S.
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It was masked by the purchase and sale of gold by way of Switzerland and through the collusion of jewelry and gold dealers in the U.S.
More recently, Farooque Ahmed, a Virginia native who was sentenced to 23 years in prison with an additional 50 years of law enforcement supervision upon being released, pled guilty to providing material support to members of al Qaeda. According to an FBI affidavit, Farooque sent money totaling $10,000 to foreign terrorists in $1,000 increments so as not to raise red flags.
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“Banks knew they were losing leverage, but they didn’t know what or how to combat it,” says a source in JP Morgan Chase’s Global Risk department. “Criminals were getting savvier and coming up with instruments to transfer funds that were ten steps ahead of the banks. Not until 9/11 did banks have a collective ‘wise up’ and implement more stringent regulations along with proper training of their staffs.”
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Following the Money Trail: The U.S. Department of the Treasury
Regulating hawalas has been a thorn in the side of the U.S. Treasury. Security issues that arise because of money laundering through hawalas pose a potential threat to the U.S. On the other hand, heavily regulating hawalas cuts off a large amount of money that is circulated in the financial system by low-wage workers and that makes up a large percentage of the GDP in other countries. In 1994, Congress passed a law to regulate informal financial enterprises such as hawalas and check-cashing businesses by requiring them to register with the government and report transactions greater than $3,000. Yet regulations for the statute were never published, outlining what legal ramifications businesses would encounter, so many informal banking institutions continue to operate unregulated. A few years later, the United Nations adopted the International Convention on the Suppression of the Financing of Terrorism. Article 2(1) of the convention reads as follows:
Any person commits an offence within the meaning of this Convention if that person by any means, directly or indirectly, unlawfully and willfully, provides or collects funds with the intention that they should be used or in the knowledge that they are to be used in full or in part, in order to carry out:
(a) An act which constitutes an offence within the scope of and as defined in one of the treaties listed in the annex...
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The issue is that the U.S. and other countries have been grappling with the definition of “terrorism.” Because no universal definition of terrorism and terrorist act exists, regulations have yet to be set.
The Financial Action Task Force (FATF) is an intergovernmental body whose purpose is to develop and promote national and international policies to combat money laundering and terrorist financing. In 2003 the FATF established a list of “best practices” for countries that defined the term “money or value transfer service” and anti-money-laundering regulations. These involve customer identification, record-keeping requirements, suspicious transaction reporting,
compliance monitoring, and, most importantly, sanctions if informal financial institutions violate these clauses.
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Regulations may be in place in countries such as Germany, Iran, Iraq, Afghanistan, Thailand, UAE, UK, Qatar, Saudi Arabia, Singapore, and Syria that are not being enforced and thus allow terrorist funding to occur. India became the 34th country to join the FATF by requiring national banks to create suspicious activity reports (SARs) to generate evidence that shady activity was going on within their banking system. According to my source who has consulted for India’s top state-owned banks, the government called top bank executives at the Canara Bank, one of the oldest banks in India, with close to $50 billion in assets. The executives were asked to submit false SARs to indicate potential terrorist transactions and accounts that had ties in India as well as overseas.
“While it’s a good thing India wanted to be a part of the FATF, the flip side is that they had to have banks like Canara create a false paper trail, because a legitimate one didn’t exist,” says my source. “If one of the biggest banks in India had to falsify transactions happening in their bank, could you imagine what the nationalized and cooperative banks are doing?”
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Banking Regulations: Still Behind the Eight Ball
Immediately after 9/11, the world and the U.S. devised an entirely new strategy when it came to banking systems. In an effort to halt terrorists in their tracks and go for the proverbial jugular of these terrorist organizations, the Bush Administration in conjunction with the U.S. Department of the Treasury decided to aim U.S. policy at “starving the terrorists of funding and shutting down the institutions that support or facilitate terrorism.”
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Months after the attacks, the Treasury Department was on a mission to freeze all terrorist assets within banks.
To crack down further on terrorist financing, the U.S. Department of State implemented an anti-money-laundering counter-narcotics/
counterterrorist financing strategy.
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It sought to disrupt terrorist financiers through “investigations, diplomatic relations, and criminal prosecutions.” The State Department decided to build programs to improve domestic financial, legal, and regulatory institutions of U.S. allies outside domestic borders. It also would implement a global effort including intelligence gathering, financial regulation, and law enforcement. By doing so, the State Department would create a foolproof web of checks and balances that would make money laundering difficult. As well-orchestrated as these efforts were, organized and technologically savvy terrorist organizations continue to slip through the cracks. The most pertinent law implemented, when it comes to terrorist financing, is Title III of the Patriot Act, which was passed shortly after 9/11. The premise of this revamped law was to establish that laundering “dirty money” through shell stores; selling stolen products on auction web sites; or funneling money to organizations through illegal means such as drug sales, theft, or kidnapping is considered an offense for money laundering prosecution under Section 1956, Title 18, of the U.S. Code [38]. Such a person also could be charged with providing terrorist organizations with material support. Specifically, this law compels financial institutions to take extra steps past the BSA and the Currency and Foreign Transaction Reporting Act (CFTRA), established in 1970 under the Anti-Money Laundering Act. In addition to requiring banks to file a CTR and SAR for transactions of more than $5,000, banks can obtain information through correspondent accounts. Under the Patriot Act, financial institutions are prohibited from establishing other corresponding accounts in “shell” banks overseas—meaning banks that do not have a physical presence in the corresponding country. Banks are subject to a $1 million fine if they do establish such accounts.
Even though banks have established and taken extra measures to ensure that laundered funds can’t move through the system, the process is not automated. It relies on bank and fund managers as well as executive regulators to communicate if they see suspicious
activity. The “If you see something, say something” mantra indoctrinated into the American public after 9/11 still has not resonated with bank managers, despite their extensive training on how to identify and flag a suspicious account. Section 312 of the Patriot Act outlines how banks should do special “due diligence” when they encounter suspicious accounts. This includes procedures to identify bank owners and account security and enhanced “scrutiny” of senior political figures’ accounts.
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However, banks never implemented set standards for global regulation; individual banks must come up with their own arbitrary, individual procedures. The result is that human error allows suspicious and potentially dangerous accounts to slip through.
“I cannot tell you how much training we’ve had, and there are still problems [such as] false positives or accounts that go undetected,” says a source in global risk management at JP Morgan Chase. “While the Patriot Act and all the regulations that came with it have definitely helped, it’s an imperfect system, and the only way it will ever be regulated is if communication within the banks, both domestically and internationally, are working in tandem—and that won’t happen.”