The figure shows how Hawala works: A customer “A” approaches a broker “X” in one city and gives a sum of money (1 red) that is to be transferred to a recipient “B” in another, usually foreign, city. Along with the money, he usually specifies something like a password that will lead to the money being paid out (1 blue). The broker “X” calls another broker “M” in the recipient’s city, and informs “M” about the agreed password, or gives other disposition instructions of the funds (2b). Then, the intended recipient “B”, who also has been informed by “A” about the password (2a), now approaches “M” and tells him the agreed password (3a). If the password is correct, then “M” releases the transferred sum to “B” (3b), usually minus a small commission. “X” now basically owes “M” the money that “M” had paid out to “B”; thus “M” has to trust the promise of “X” to settle the debt at a later date.
Hawala is an informal value transfer system based on the performance and honor of a huge network of money brokers, which are primarily located in the Middle East, North Africa, the Horn of Africa, and South Asia. It has its origins in classical Islamic law and is basically a parallel or alternative remittance system that exists or operates outside of, or parallel to traditional banking or financial channels.
In the most basic variant of the hawala system, money is transferred via a network of hawala brokers, or hawaladars. It is the transfer of money without actually moving it. In fact, a successful definition of the hawala system that is used is “money transfer without money movement”.
The unique feature of the system is that no promissory instruments are exchanged between the hawala brokers; the transaction takes place entirely on the honor system. As the 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.
Hawala banks are operated by hawala brokers, usually small Muslim shopkeepers such as butchers and grocers. They also act as savings banks. The hawala brokers charge a commission which is lower than the charge for similar services by official banks. Hawala banks also operate according to Sharia principles, e.g.,refusing to invest in pornography, pork, etc.