What Is Underground Banking
The vast majority of our financial transactions are facilitated by regulated financial institutions (banks, credit card companies, etc.). Each transaction is documented, taxes are collected according to national and local tax laws, ownership of the funds is handed off and documented, and disputes are resolved through legal processes. Underground banking bypasses these formalities. While it is impossible to calculate it is estimated that tens of billions of dollars are transferred to and from every continent each year through underground banking systems.
When financial transactions go underground, documentation often is either nonexistent or cryptically noted by the individuals involved in the transaction. Hawala, an underground banking system used for 90% of transactions in Afghanistan for both illegal and legitimate transactions, provides a good example of how underground banking works.
Let’s say, Farid, living in Kabul, wishes to pay Safia (living in Kandahar) 4500 AFN (about 100 USD). Farid contacts a hawala dealer, Broker A (a hawalandar), hands him 4500 AFN in currency and gives him a password, Safia’s name, and Safia’s contact information. Farid then contacts Safia, tells her a hawalandar will contact her to give her 4500 AFN and tells her the password. A contacts another hawalandar, B, in Kandahar to provide Safia’s contact information and the details of the transaction including the password. B meets Sofia in Kandahar and, if the password is correct, hands her 4500 AFN (perhaps minus a small commission). The entire transaction may take only a few hours. In practice, several trusted hawalandars may be involved in a single transaction.
Now A owes B 4500 AFN. A and B will settle the debt in some agreed-upon manner, often when they next meet in person. The debt is recorded by both A and B. Had Safia been in London rather than Kandahar, Farid would have given hawalandar A AFN and Safia would have received British pounds from hawalandar B converted at official exchange rates.
There are no promissory notes or other legally enforceable documents. The hawala system is based on honor and the benefits of maintaining access to the system. Therefore many hawala networks are made up of extended family members, close-knit religious groups, or close friends. Cultural bonds also help keep the systems reliable. There are, of course, exceptions: recently two men in South Africa suspected of being affiliated with a hawala network were shot (one was killed) possibly over a failure to settle debts.
There are no promissory notes or other legally enforceable documents. The hawala system is based on honor and the benefits of maintaining access to the system. Therefore many hawala networks are made up of extended family members, close-knit religious groups, or close friends. Cultural bonds also help keep the systems reliable. There are, of course, exceptions: recently two men in South Africa suspected of being affiliated with a hawala network were shot (one was killed) possibly over a failure to settle debts.
Because hawala transactions, and similar "Informal Value Transfer System" (IVTS) transfers are not traceable, the system is favored for illegal transactions. As I explain in the next section, things get a bit more complicated when transactions are illicit.
The Dark Side Of Hawala Networks
Illicit transactions demand greater secrecy and obfuscation. In the example above, Farid would use untraceable communications such as an encrypted phone (e.g., Blackphone), encrypted text messages (e.g., Vuvuzela), or an anonymity network (e.g., Tor) to communicate with Sofia.
Certainly the terrorist activities in Syria, Yemen, Iran, Afghanistan
and other areas of conflict could not function without hawalandars or their counterparts; the hawala networks are nearly immune to any attempts to disrupt the flow of illicit funds since they rely on extensive tribal and regional bonds and personal connections, leaving no bread crumbs for authorities to follow.
In the case of Farid and Sofia, the money Sofia received never left Kabul, and the lingering debt may very well have been settled by trading favors, or perhaps offset by other transactions between A and B at another time and place, or by over-invoicing or under-invoicing one another for unrelated business. Legal banks must move currency (or formal claims on currency) from country to country navigating heavily regulated bureaucracies. An inter-country transfer can take many days and cost far more than an IVTS which does not require any actual movement of currency and can be completed in hours. Other than old fashioned barter, IVTS transactions occur as deep underground as banking can get.
Flying Money
A system similar to hawala originated in China During the Tang Dynasty around 1500 years ago. Fei-chien (alternatively, fei qian), aka “flying money”, began as a legitimate means of facilitating trade and paying taxes to the Chinese government.
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| Kai Yuan Tong Bao |
The certificates were not legal tender but because the government freely redeemed them for a small fee, merchants began to trade them among themselves rather than take the more cumbersome step of acquiring coins. Thus, the Chinese had invented the equivalent of paper money (which, of course, unlike coins could blow away in the wind --hence the term "flying money").
Benefits accrued to the government as well. To pay taxes merchants would hand over the cash from their business activities to provincial memorial courts. The merchant would then receive certificates for the after-tax portion of the revenue. At home, the merchants could exchange the certificates for cash at any of 40 government offices throughout the country.
Over time Chinese workers migrated to other countries where jobs were more plentiful. Many workers abroad would send money to China to help support families at home. Chinese merchants abroad set up side businesses to execute IVTS transfers. Today such businesses still flourish in Chinese shops and throughout the world's "China towns." The system works much the same way as the hawala system and relies on the close family and cultural bonds of trust.
Cryptocurrencies and Money Laundering
I didn’t include Bitcoins, Ripple, Tron (and more than 1500 competing cryptos in this blog post for two reasons: 1) many cryptocurrencies have become so popular they have been declared “financial instruments” (legally enforceable monetary contracts) in advanced countries and therefore are not part of what I included in my definition of underground banking; and 2) the subject is complicated and would take this blog post down too many unrelated rabbit holes. For the same reasons I didn't include a discussion of the many ingenious ways, money is illegally laundered. Perhaps someday I will be inspired to write about these intriguing topics.
Personal Note: My blog topics are truly unpredictable random musings that have captured my interest for no particular reason other than my ignorance demands an occasional feeding. For example, my wife, Helen, triggered the research for this post by sending me a link to an article about hawala, a word I hadn't previously encountered.