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Informal Value Transfer Systems (IVTS)

by R Suresha

email: r.suresha@oracle.com 19th Sep 2011

Agenda

© 2011 Oracle Corporation – Proprietary and Confidential 3

• Overview of Informal Value Transfer

Systems

• Informal Value Transfer Systems and

AML/CFT regulations

• Depth of this problem

• Regulatory framework to address the

Informal Value Transfer System

• Measures to deal with Informal Value

Transfer Systems

© 2011 Oracle Corporation – Proprietary and Confidential 4

Overview of Informal Value Transfer Systems

Informal Value Transfer Systems (IVTS)

• IVTS was coined to de-mystify and

describe more accurately what used to be

called “underground banking” or

“alternative remittance systems”.

• “Any system or network of people

facilitating, on a full-time or part-time basis,

the transfer of value domestically or

internationally outside the conventional,

regulated financial institutional systems”

(Passas, 1999)

Types of IVTS…

• Hawala (means “transfer" in Arabic and “reference” in Hindu) – India,

United Arab Emirates (UAE), and the Middle East

• Hundi (akin to a bill of exchange or promissory note; it comes from a

Sanskrit root meaning "to collect") - Pakistan, Bangladesh

• Invoice manipulation schemes

• Trade diversion schemes

• In-kind fund transfers (India and elsewhere)

• Courier services and physical transfer methods

• Stash house (for casa de cambio) - South American systems

• Chop shop - foreigners use this term for one of the Chinese methods

• Door to door, padala – Philippines

…Types of IVTS

• Stash house (for casa de cambio) - South American systems

• Black market peso exchange networks

• Fei ch'ien (flying money) – Chinese

• Phoe kuan – Thailand

• Black market peso exchange networks

• Ch'iao hui (overseas remittance) - Mandarin Chinese

• Chiti banking – (refers to the "chit" used as receipt or proof of claim in

transactions introduced by the British in China)

• Black market currency exchange – South America, Nigeria, Iran

IVTS Mechanisms

Hawala Network

• Originated in South Asia

• Born before the spread of Western banking in

the 19th and 20th centuries

• Hawala networks have emerged as a cheap

and convenient means for migrant workers to

remit their savings to their kinsfolk back home

– Small amount remits are prohibitively expensive

in formal banking system

• Over time, IVTS have become steadily more

sophisticated, aided by advancements in

communication technology, allowing for larger-

scale value transfers with speed, accuracy,

and with high levels of reliability

• Estimated value of hawala transactions in

India range between USD 15 billion to USD 20

billion

Hawala – Operational Details

IVTS Cash Pools

Reasons for Existence…

• High costs of banking or official channels

• Repatriation of immigrant income

• Lack of access to formal banking system (high costs, lack

of experience with institutions outside cultural traditions)

• Lack of confidence in the conventional banks

• Delays, in official sector, due to holidays

• Lack of efficient banking infrastructure

• Rigid/strict foreign exchange regulations

• Circumvent restrictive exchange controls and regulations

• To avoid currency reporting controls

• Quick service & lower fees

• Wide divergence between official and black market

exchange rates (i.e. Favorable exchange rate)

…Reasons for Existence

• Cultural, political, social reasons

• Criminal purposes such as money laundering, terrorism financing,

tax evasion, accepted by Hawala networks

• Avoid taxes

• High degree of anonymity

• Leaves no paper trail which impedes law enforcement investigations

• Is not subject to external auditing, control, or supervision by

regulatory authorities

Abuse of IVTS

Destabilization of Financial Markets

• Illegal funds are an unstable deposit base

Undermining legitimate private sector

• Local businesses cannot compete with companies that offer services below market rates because their primary income comes from money laundering

Economic Distortion

• Money Laundering occurs predominantly in construction/real estate. Decision to move out, can cause the sectors to collapse

Loss of Revenue

• Money launderers decrease government tax revenues

Loss of Control of Economic Policy

• Money laundering can distort currency and interest rates

© 2011 Oracle Corporation – Proprietary and Confidential 15

• Informal Value Transfer Systems and AML/CFT

regulations

Net Result of Global Regulations…

• In principle, the new regulations have not banned Hawala networks

• Demand conformity to AML/CFT, KYC and other financial services

industry regulations

• Initially, initiatives appeared to have desired effect

– Migrants switched to more expensive services of formally constituted banks

to send money home

– During 2001 to 2004, remittances through formal channels increased at the

expense of informal channels

• Post 2004, globally formal channel inflow slackened and no evidence

suggests the end of informal networks

• World Bank estimates suggest, the annual global flow of migrant

remittances through formal channels in 2005 exceeded $233 billion

worldwide, of which developing countries received $167 billion

… Net Result of Global Regulations

• Unrecorded flows moving through informal

channels push the total far higher (conservatively

estimated to amount to at least 50% percent of

recorded flows)

• Wherever possible Hawala dealers have adjusted

their practices to comply with AML/CFT regulations

– In doing so IVTS operators have taken every

advantage of local variations in interpretation of AML

requirements

• IVTS is still thriving across the globe

Non-Compliance of IVTS

Record Keeping

• Customer records are maintained by individual operators

in the IVTS network. Hence, the system is unaware of the

origin and destination of the funds

• Records are destroyed on completion of the transaction

• Missing Audit Trail

• No check with published lists of criminals and terrorists (

OFAC List etc.,)

Absence of KYC norms

• Customers identity is never established nor verified

• Makes it easy to launder money while staying anonymous

Few country specific cases - Regulations in

IndiaIndian Law

• In India, under the Foreign Contributions Regulation Act, 1976, Hawala operators

were not required to be registered, and thus weren‟t regulated

• In 2003, India enacted the Prevention of Money Laundering Act (PMLA), which

requires Hawala brokers to maintain detailed records about their transactions

• Due to lax enforcement, Hawala network remains unregulated and continues to

operate as before

Madhu Koda Case

• Mr. Madhu Koda laundered money through Hawala channels. Income Tax

Department uncovered illegal transactions worth USD 500 million

• Banks involved never raised a red flag when money to the tune of USD 160 million

was transferred to foreign accounts

• Provisions in Indian law require keeping records of the transactions and identify the

senders/recipients & registration of Hawala operators.

• Due to the nature of Hawala transactions, it is near impossible to keep proper

records or identify senders/recipients of such transactions.

• The case has laid bare the ineffectiveness of current AML regulations

Case of India …………………….contd

‘Hawala King’ Naresh Jain Case

– Alleged head of Global Hawala racket of over Rs 5,000 crore (Approx USD 1 Bil.)

– Described by Directorate officials as „the world‟s undisputed Hawala king‟

– Been on the watchlist of security agencies in the United States and the United

Kingdom for his alleged links with the underworld and the Al Qaeda

– Wanted in Italy for running a drug racket

– Allegedly ran his hawala network from Dubai for 20 years

– Investments in Real Estate

• Invested around Rs 100 crore ( approx USD 20 mil) in properties around Delhi

– Arrested in Dec 2009

Trade Invoicing

– Exporters under invoice goods, and receive the remaining balance through Hawala

– Beneficial for exporters since, money received through Hawala remains non-taxed

– Government loses out on tax revenue

– Similarly over invoicing by importers, allows them to bring in black money stashed

abroad

© 2011 Oracle Corporation – Proprietary and Confidential 21

Depth of this problem

Estimated Private Remittances(1981-2000)

Source: IMF, International Financial Statistics and Balance of Payments Statistics Yearbook.

© 2011 Oracle Corporation – Proprietary and Confidential 23

Regulatory framework for the Informal fund

transfer system

Overview of Present AML Regulations

• Provide more comprehensive details regarding customer due diligence

• Require firms to vary customer due diligence and monitoring according

to the risk of money laundering or terrorist financing

• Require firms to take enhanced customer due diligence measures in

higher risk situations, while allowing firms to take reduced identification

measures for specific situations with a lower risk of money laundering

• Allow firms to rely on certain other firms for undertaking customer

identification

Some Unorthodox Approaches…

South Africa

• Provides an example of how a country‟s AML/CFT regulations can be

modified to attend to the needs of low-income clients.

• Authorities have adopted a flexible approach to client identification and

verification

• Introduced a compliance exemption that relaxes requirements for a

category of clients known as mass banking clients (small balances and

small size transactions)

• Exemption applies to accounts that have maximum balance at any time of

around US$4,000, that limits the size of deposits or withdrawals.

• International fund transfers aren‟t allowed

Uganda, Tanzania, and Kenya

• Accept letters from the local authority in rural villages as identification for

their clients who do not have an official identity card

…Some Unorthodox Approaches

Microfinance

• Microfinance institutions should not compromise their core objective

of providing financial services to a broad range of poor people as a

result of compliance with AML-CFT regulations

• Use of credit can be monitored through the group lending system

whereby clients disclose the use of their loans to other group

members

• Part of the loan methodology could be weekly visits to clients by loan

officers, who already knew their clients well (as done in Mexico)

Implications

• Anti money laundering strategies targeting the Hawala system are

based upon suspicious transaction reporting and record keeping

for Hawala transactions

– Simplest strategy is to help the developing countries to expand their

banking networks and build up a trustworthy relationship with people

• AML/CFT regulations can have serious implications for financial

institutions that serve low-income clients

– Additional costs of compliance and tighter restrictions may have the

unintended consequence of driving low-income clients from the formal

financial sector

– Costs associated with regulations tend to be greater in countries

where there is generally a culture of poor compliance

© 2011 Oracle Corporation – Proprietary and Confidential 28

Measures to deal with the Informal

fund transfer systems

Measures…

Allow Hawala Networks to operate over ground, albeit they comply with

• AML Regulations

• KYC Norms

• Maintain Audit Trail

• Maintain records for a specified period

In countries where IVTS exist

• Hawala dealers should be registered

• Dealers should maintain adequate records in line with FATF recommendations

• Efforts should be made to improve the level of transparency in these systems

Measures…

Regulatory response should address weaknesses in the formal sector

• Formal and informal financial systems tend to benefit from each other‟s deficiencies

Regulations alone will not ensure compliance

• Regulators need to posses appropriate supervisory capacity to enforce regulationson IVTS.

• Compliance will be weak when major restrictions exist on transactions through theformal financial system

International standards should not be applied blindly

• Pay due regards to specific domestic circumstances and legal systems

…Measures

Policy makers should acknowledge the practical reasons behind the existence of IVTS

• As long monetary incentives exist, IVTS will remain in operation

• Addressing informal systems requires well-conceived economic policies and financial reforms, effective regulatory and supervisory framework

Leverage technology

• Informal movement of funds can be tracked along the transit routes – like airports, Railway and Bus routes and rigorous check on road travel.

• Central banks can closely monitor cash flow in various cities and regions to look at clues on increased flow of funds.

• De regulate the economy – a classic example that happened in India was freeing of the markets and associated exchange controls.

• Evolve cheaper and efficient funds transfer mechanism which would automatically discourage Informal fund transfer.

Suresha Iyer CAMSDirector, Oracle Financial Services Crime and Compliance Management - Professional Servicesr.suresha@oracle.com

Thank you