In September 2004, Da Afghanistan Bank, the country’s central bank, introduced legislation to regulate and supervise the activities of money service providers in Afghanistan. This regulation applies to all individuals and legal entities that provide money services in Afghanistan, whether or not the individuals and legal entities are domiciled in Afghanistan. For the purposes of the regulation, money services are defined to include safekeeping, money transmission, check cashing, and currency exchange. A licensed money service provider is entitled to engage in all of the activities of a foreign exchange dealer, but a licensed foreign exchange dealer may not engage in safekeeping, money transmission, or check cashing without upgrading its license to that of a money service provider.1
Da Afghanistan Bank faces significant challenges in its efforts to regulate and supervise the informal financial hawala transactions of the hawaladars of Kabul under the recently introduced Money Exchange Dealers Regulations.2 Reforming the formal financial sector immediately after active conflict is difficult enough; undertaking to regulate the informal sector under such circumstances is doubly daunting.
Further compounding the problem, increasing opium production in Afghanistan and an emerging nexus of drug trafficking with terrorist and militant groups are exerting a very strong effect on the informal financial sector. Much needs to be done to ensure that the successful reforms undertaken to date are not undone.
Implementing the new regulations will be challenging for the central bank because of three specific issues. First, the informal financial system has a long history of independence and self-regulation. Second, incentives for compliance are undermined by the weakness of the legal and judicial framework for the prosecution of financial crimes. Third, investigating money laundering and terrorist financing is complex, given the size of the drug economy and the emerging risk of a nexus of drug trafficking with terrorist or militant groups.
This paper commences with a brief discussion of the rationale for regulating informal financial services then outlines the special challenges the central bank faces in Afghanistan. It concludes with two modest recommendations: the need to continue strengthening the legal and judicial system, and the need to continue working in partnership with the association of hawaladars.
The Rationale for Regulating Informal Financial Services
In a conflict-afflicted country, conventional assumptions about financial risk and abuse do not necessarily apply, at least not everywhere or in every case. In an environment where increasing opium production and occasional terrorist acts have increased the incentives to conceal and obscure the origins and destinations of illicit financial transactions, it will not be possible to accumulate the same breadth and depth of understanding of the informal financial sector that regulators have for formal commercial banks in stable developed economies. That being so, why bother to attempt regulation at all?
The financial sector, and banks in particular, are subject to heavier regulation than virtually any other industry. The reasons for this lie in the combination of several factors. First, banks are vulnerable to failure—and bank failures entail serious negative externalities. Second, there are significant problems of imperfect information between bank owners and depositors. Third, optimal regulation of the market—just enough regulation to minimize failure—is often difficult to achieve, forcing regulators to err on the side of caution with additional regulations. Although none of these factors is unique to banks, their combination is shared by few other industries.
By association, nonbank financial institutions, including informal financial institutions, attract similar regulatory interest and concern. The risk that nonbank financial institutions might create negative externalities for clients by engaging in unsafe and unsound financial practices compels regulators to periodically examine the need for action. Their interest is often spurred by an event such as a bank failure, financial fraud, or, occasionally, a broader economic or political event.
In the specific case of the hawala system, renewed regulatory interest was stimulated by press and law enforcement investigations into the September 11, 2001, terrorist attacks in New York and Washington, D.C. By pointing to a connection between informal remittance systems and terrorist financing, those investigations raised officials’ concerns about informal remittance systems’ susceptibility to abuse. Hitherto, most financial regulators had assumed that the amounts transferred through hawala-type remittance systems were small and did not pose significant systemic risks to the financial system.
On October 10, 2001, the international Financial Action Task Force (FATF) against money laundering responded to those concerns by issuing eight special recommendations aimed at combating terrorist financing. Those recommendations supplemented FATF’s 40 earlier recommendations for fighting money laundering, which quickly became and have remained the world standard for preventing criminal abuse of financial systems.
Arguing that money and value transfer systems had shown themselves vulnerable to misuse for money laundering and terrorist financing, FATF urged in Special Recommendation VI that all jurisdictions contribute to the transparency of payment flows by imposing on all types of money and value transfer systems consistent measures, including either licensing or registration, against money laundering and terrorist financing.
Each country should take measures to ensure that persons or legal entities, including agents, that provide a service for the transmission of money or value, including transmission through an informal money or value transfer system or network, should be licensed or registered and subject to all the FATF Recommendations that apply to banks and nonbank financial institutions. Each country should ensure that persons or legal entities that carry out this service illegally are subject to administrative, civil or criminal sanctions.
Special Recommendation VI is considered to be the minimum effective level that a money transfer business should be required to fulfill to comply with international know-your-customer requirements.3 According to the recommendation, it is important to the credibility of the system that businesses reject clients and refuse to conduct business—and under specific circumstances, report the transaction to authorities—if that client fails to produce an acceptable form of identification. In a subsequent interpretive note on Special Recommendation VI, FATF focused on three core points:
Jurisdictions should ensure that money and value transmission services, including informal systems, are subject to all applicable FATF recommendations (in particular, 4–16 and 21–25).4
Jurisdictions should require licensing or registration of persons (natural or legal) who provide money or value transfer services through formal or informal systems.
Jurisdictions should have the power to impose sanctions on money and value transfer services, including informal systems, that fail to obtain a license or register and that fail to comply with relevant FATF recommendations, including that pertaining to record keeping.5
In Afghanistan, the call to regulate informal remittance systems came at a time when development agencies were highly dependent on hawaladars for their financial transactions. No private financial institutions were operating in the country, and the remaining state banks were plagued by significant weaknesses, among them, weak corporate governance and management structures, unskilled human resources, outdated technological capacity and accounting systems, and grave problems of liquidity and solvency.
During the Taliban period, the country’s formal banking system was not operational. The then six licensed state banks did not provide commercial banking services, nor did they have the capacity to offer international or domestic remittance services. Short of physically moving cash around the country, hawala transactions were the only reliable, efficient, and safe means of transferring funds into Afghanistan and within its provinces.
In fact, the hawaladars of Kabul were the only active financial operators. They offered a diverse range of financial and nonfinancial services stratified into local, regional, and international markets. More than 300 registered hawaladars organized themselves into an impressive open market offering foreign-currency exchange, funds transfers, microfinance, trade finance, and deposit-taking activities. Nonfinancial activities included telephone and fax services, regional and international trade, and, more recently, Internet services.
The hawala system was praised by foreign and local aid agencies for its efficiency.6 Transferring funds to Kabul from Peshawar, Dubai, and London took an average of 6 to 12 hours. Most transfers between Kabul and any of the regional centers were completed within 24 hours. Slightly more time was required for payments to more remote regions or villages where the money exchange dealer did not have a local office or representative. The cost of transferring funds into and around Afghanistan was low, averaging 1 to 2 percent. The price depended on the volume of the transaction, the relationship between the client and the hawala dealer, the currency of exchange, the security environment in Kabul and at the destination for the funds, and the negotiating skills of the client. Nearly all nongovernmental organizations, aid donors, and development agencies used the hawala system to deliver humanitarian relief and developmental aid to Afghanistan and to move funds around the country. There was no limit to the volume of funds the hawaladars of Kabul could process, either individually or severally. Single transactions in excess of US$500,000, especially between Peshawar and Kabul, were not uncommon. Smaller organizations regularly remitted US$20,000–30,000 through the system to meet expenses.
The role of hawaladars in facilitating remittances is important. About 15 percent of the rural population receives remittances, which represents about 20 percent of the rural population’s expenditure on average (World Bank, 2004, p. 19). During the past 25 years, more than 30 percent of the Afghan population has been externally or internally displaced (with over 3 million in Pakistan and 2.3 million in Iran). Remittances from Pakistan, Iran, North America, Europe, and parts of Australasia remain a central element of Afghan households (World Bank, 2004, p. 27).
At the same time, the use of the hawala system raised concern, particularly among the international financial institutions. The inaccessibility of the customer records of hawaladars and ambiguities in the settlement process made the system vulnerable to abuse. There were no standard documentary requirements for conducting business in the market. Neither the central bank nor the hawala dealers’ association required dealers to open their books for external inspection, nor did they require periodic financial reports. Standardized documentation and reporting were considered unnecessary because of the high level of trust upon which the informal system is founded. There were no standard requirements for keeping records of completed transactions and no regulatory requirement for customer identification. Consequently, hawala transactions were unlikely to leave audit trails for law enforcement agencies investigating money laundering, tax evasion, corruption, or other related activity.
In early 2002, when Da Afghanistan Bank commenced financial sector reforms, it had four regulatory options regarding the informal sector (Maimbo, 2003): (1) adopt no regulatory or supervisory standard pertaining to the informal money transfer sector; (2) extend formal banking sector regulations to the money-exchange market and establish formal on- and offsite supervisory mechanisms; (3) allow self-regulation and supervision among dealers; or (4) establish special regulatory and supervisory standards for the informal sector.
Each approach presented its own administrative and institutional challenges. The fundamental question facing the central bank was whether hawaladars posed systemic risks serious enough to require formal regulatory and supervisory regimes similar to those being developed for the banking sector. Or could the hawaladars be left alone without endangering the long-term stability of the financial sector and monetary policy?
In view of intense international efforts to combat money laundering and terrorist financing, the first option had to be ruled out—it was not feasible to forgo regulatory standards altogether. Therefore, regulators began considering how hawala practices could be brought into closer compliance with international regulatory and supervisory standards.
The following were some of the key questions:
could the registration process in force at the time be strengthened?
could client information collected by hawaladars be standardized?
could hawaladars be induced to report suspicious activity to the central bank?
could hawaladars be made to keep appropriate records?
could an agreement be reached about external oversight and access to those records?
Nearly three years later, the same questions apply. But in the meantime, Afghanistan has made progress in reforming its financial system.7 Compared with conditions in December 2001—an outdated legal framework, no functioning commercial banks, a handful of nongovernmental organizations competing with a vibrant informal financial sector—a basic formal financial system has emerged.
Now the bank relicensing process of the state banks has been completed. Following the enactment of a new commercial banking law in September 2003, the central bank agreed to decide which banks would be allowed to submit applications for relicensing (by March 2004) and which would be relicensed (September 2004). A new central banking law now guarantees the autonomy of Da Afghanistan Bank. After the successful issuance of a new currency, a rudimentary monetary policy regime is emerging. A new banking supervision department has commenced onsite inspections of banks. The central bank’s SWIFT connection is functional, and one-third of central bank branches are now connected electronically for domestic payments. Overall, the central bank’s operational capacity has improved dramatically.
Banking services in Afghanistan, however, remain limited. The passage of the Central Banking Law and the Commercial Banking Laws in September 2003 and the entry of several commercial banks mark significant progress. But there is much to be done before financial services are restored to the level required for meaningful trade and investment activities. State financial institutions are largely nonfunctional. The new private banks have not yet started lending to industry, and it appears that at least some of them will not be inclined to do so in the near future (World Bank, 2004, p. 57).
In light of the experience of other conflict-afflicted countries, Afghanistan’s central bank has fared reasonably well. However, though reforms in the formal financial sector have progressed at an impressive rate, much remains to be done in harnessing the positive aspects of the informal financial system while tempering the risks that it presents.
Special Challenges of Regulating Informal Money Services in Afghanistan
To protect the progress made to date in the formal financial sector, the government must now rise to the challenges of (1) implementing the recently introduced regulations and supervision requirements in a sector of the financial system that has a long history of self-regulation, (2) strengthening the legal and judicial framework for the prosecution of financial crimes, and (3) building its capacity to investigate complex money laundering and terrorist financing transactions. The last is a particularly serious task given the size and rate of growth of the drug economy and the emerging risk of a nexus of drug-trafficking and terrorist-militant groups.
The Hawaladars’ Long History of Self-Regulation
The history of foreign exchange dealers in Kabul dates back to the era when the great overland trade routes between the Mediterranean and the Orient passed through Afghanistan (Nyrop and Seekins, 1986). From the 1930s, when the first banks were established, to present-day Afghanistan, hawaladars have played a central role in financial intermediation, with little or no regulatory oversight.
Before 1930, all foreign exchange transactions were handled by private dealers located primarily in Kabul and Qandahar. Even the Afghan government’s foreign exchange was purchased from these dealers. Through Banki-Melli and later the central bank, the government tried to assert a monopoly of its own over foreign exchange transactions between 1930 and 1960. Despite exchange-surrender regulations and occasional prohibitions of free-market dealings, the bazaars survived so successfully that Bank-i-Melli and the central bank had to keep their own dealers in the money bazaars.
The 1960s were a period of renaissance for the money bazaars, even as the formal banking system stagnated. The volume of business and the number of dealers grew; technological improvements, such as electronic calculators, appeared. Among the money traders, specialization began to emerge.
By the 1970s, dealers normally traded in either rupees or other convertible currencies. The money bazaars maintained close telecommunications links with correspondent banks around the world and handled foreign bank drafts as well as currency. By the 1970s, they could provide nearly all the services of a commercial bank, making trade-finance loans, consumer loans (notably for weddings), working capital loans for farmers and entrepreneurs, housing loans, and loans for long-term industrial undertakings. Because of the bazaars’ high interest rates, businessmen saw them as a last resort for credit. Because bank loans were largely unavailable outside Kabul, the prominence of the rural provincial bazaars continued to grow. Right up until 2002, the authorities continued to follow a policy of noninterference with operations in the money bazaars.
The market has had such a long history of operational and regulatory independence that external oversight is not likely to be welcomed, especially if it is overly burdensome.
A Weak Legal and Regulatory Framework
To its credit, the central bank has not implemented regulations for the informal financial sector in haste. Rather, its new money exchange regulations are the product of months of consultation and discussion. As drafted, they provide detailed eligibility criteria for licensing, minimum prudential requirements, and requirements for compliance with anti–money laundering standards.
Licensing. The proposed regulations specify that licensed hawaladars must maintain, during the entire duration of their operations, the minimum required capital and a standby letter of credit or other guarantee. They must employ at least two fit-and-proper persons to manage the business. If the business is a legal entity, some or all of whose owners possess a qualifying holding, those owners must be fit-and-proper persons or legal entities whose managers are fit-and-proper persons. The business plan of the licensed firm must specify a proper organizational structure with effective internal control mechanisms, an appropriate accounting system for recording transactions, and the financial means to attract and retain qualified staff. The firm must agree to apply the appropriate procedures for the prevention of money laundering and terrorist financing.8 Once a license is granted, the money service business is permitted to engage in any or all of the following activities: money transmission, safekeeping, and check cashing. It is not, however, permitted to accept deposits, make loans, exchange currency, or offer securities services as enumerated in Article 94 of the Banking Law.
Capital. Under the proposed regulations, every money service business is required to meet a graduated minimum capital requirement that is dependent on the volume of money transmitted during the year.9 The lowest requirement is AFN 1 million if the applicant has not previously provided money services in Afghanistan, or if the licensee and its authorized agents had a volume of money transmissions of less than AFN 50 million (or equivalent),10 for the previous 12 months. The highest requirement is AFN 5 million if the licensee and its authorized agents had a volume of money transmissions of AFN 200 million (or equivalent) or more over the previous 12 months.11
Guarantees. Every money service business is required to maintain a standby letter of credit or guarantee for the sum of at least AFN 5 million from a licensed credit institution or other institution specified by the central bank. The security must cover up to five service units or authorized agents. For each additional unit or authorized agent, the business must increase the security by AFN 500,000, up to a maximum of AFN 25 million. The security must be in a form satisfactory to the central bank and issued for the benefit of customers of the licensee. By enabling customers to seek compensation, the regulations intend to secure the good performance of the licensee’s obligations with respect to receipt, handling, transfer, and payment.
Anti–money laundering requirements. In collaboration with the IMF and United Nations Office on Drugs and Crimes (UNODC), Afghanistan’s central bank has been working to improve the country’s anti–money laundering regime.12 The government recently completed the process of legislating against money laundering and terrorist financing activities. The new law meets current international standards. The proposed legislation deals principally with the criminalization of money laundering and terrorist financing, customer due diligence, establishment of a financial intelligence unit (FIU), international cooperation, extradition, confiscation of funds and properties connected to the crimes of money laundering and terrorist financing, and similar provisions.13 When the legislation is adopted, every money service business will be obliged to take measures for the prevention of money laundering.14
To effectively implement the prudential and anti–money laundering standards described above, the central bank will need to further strengthen its legal and judicial framework. Currently, if hawala dealers were to comply with the proposed suspicious activity reporting requirements, it is unlikely that successful prosecutions could be mounted in the Afghan legal system. A hawala dealer would be challenged to find corroborating evidence that one of his clients was financing a terrorist activity or laundering the proceeds of opium. The prosecution would be faced with the task of building its case from anecdotal evidence. Furthermore, to ensure compliance by hawala dealers, the authorities would have to be able to sanction those who did not comply. At present, it is questionable that such sanctions could be enforced.
This problem is not unique to Afghanistan. Even in developed economies, anti–money laundering and counterterrorism programs are hampered by an inability to develop an endgame. Agents of law enforcement agencies in developed economies often gather intelligence with little hope that they will be able to make a criminal case or otherwise disrupt the operation. In Afghanistan, the problems of preparing a firm case are compounded by a very weak judiciary. Years of conflict have resulted in extensive damage to buildings, office records, and essential equipment. Many lawyers and judges have left the country, and the number of law students is low. Many judges lack adequate legal training. Significantly, there is little or no interaction among the judiciary, the police, and prosecutors.
The Complexity of Investigating Financial Crimes
Documenting the degree to which hawala is used to launder money in Afghanistan remains a difficult task. It is equally difficult to trace illegal money flows, to separate legal flows from illicit flows, and to establish the financial links to criminal activities. Law enforcement agencies are often unable to penetrate informal financial systems because of the close business or kinship ties of the participants. Additional constraints in Afghanistan include poor monitoring of cross-border currency movements, no reporting requirements for large cash transactions, lack of uniform guidelines for identifying suspicious transactions, large parallel black-market economies, and ineffective information procedures and systems for sharing information with foreign law enforcement authorities.
In addition to the legal constraints, law enforcement agencies face the considerable challenge of investigating financial crimes committed in a less than transparent sector. The legal and regulatory framework, particularly the reporting requirements, merely provides techniques for improving the basis of knowledge. Reports may not have evidentiary value and can be disappointingly weak if their limitations are not recognized.
Financial reporting requirements are generally designed to help transform the raw material provided by financial institutions so that regulators and law enforcement officers can assimilate it as they do the other information they receive. To be effective, the recently established financial intelligence unit in Da Afghanistan Bank and law enforcement authorities must be able to identify and define data that will be useful for investigative purposes; they also must be able to demonstrate to the sector how these data will in fact be used. Law enforcement and the financial sector need to have and understand typologies they can use in flagging data to be reported.
The data also need to be validated to remove information that is unreliable (including reporting that has been deliberately inserted to mislead officials). Detailed analysis should assemble fragmentary intelligence into coherent, meaningful accounts. Assessment should then put intelligence into a sensible real-world context and identify how it can affect specific investigations and relate to regulatory and law enforcement policy. But there are limitations, some inherent and some practical, on the scope of information reported by hawaladars—indeed, as with information reported by any financial institution. Those limitations must be recognized by the authorities responsible for receiving and using reported data.
The most important limitation on financial intelligence is its incompleteness. Much ingenuity and effort is expended by money launderers and terrorist financiers on making secret information difficult to acquire and hard to analyze. Although the financial intelligence process may overcome such barriers, it seldom yields the full story. In fact, when first acquired, the intelligence is often sporadic and patchy; even after analysis, substantial inferences often must be made and then proved.
The way that financial intelligence is presented can contribute to misperceptions. The security procedures with which financial intelligence is necessarily handled can reinforce a mystique of omniscience and omnipotence that can discourage compliance. In fact, financial intelligence is not only obviously incomplete; it also can be incomplete in undetectable ways. There is always pressure, at the assessment stage if not before, to create an internally consistent and intellectually satisfying picture. When financial intelligence becomes the dominant, or even the only, source of law enforcement information, it can become difficult for those responsible for the assessment process to establish a context and recognize that there may be gaps in that picture. Furthermore, to ensure full cooperation and compliance from the sector, law enforcement needs to be able to show that financial intelligence is in fact used in legitimate and valuable investigations. Without that verification, the credibility of reporting requirements can easily be lost.
These limitations are best offset by ensuring that the ultimate users of financial intelligence, decision makers at all levels, properly understand its strengths and limitations and have the opportunity to acquire experience in handling it. It is not easy to do this while preserving the security of sensitive sources and methods. But unless financial intelligence is properly handled, the effort made to gather it is wasted.
Unfortunately, in Afghanistan, two specific factors further threaten the legal process for investigating and prosecuting financial crimes: the size of the drug economy and the emerging risk of a nexus of drug trafficking with terrorist and militant groups.
Size of the drug industry. In 2003 the total area under opium poppy cultivation in Afghanistan increased by 8 percent—from 74,000 hectares in 2002 to 80,000 hectares in 2003 (UN Office of Drugs and Crime, 2004, p. 7). There has been a clear and accelerating extension of opium cultivation to previously unaffected and marginally affected areas. The number of provinces where opium poppy cultivation is reported has steadily increased from 18 of 32 provinces in 1999, to 23 in 2000, 24 in 2002, and a staggering 28 provinces in 2003. Potential opium production amounted to 3,600 tons in 2003, an increase of 6 percent compared with 3,400 tons the year before. The area under cultivation in 2003 ranks third in the country’s recent history, and the harvest is the second highest recorded so far in Afghanistan. Even though the 2003 opium price of US$283 per kilogram represents a 19 percent decrease from last year’s price of US$350, the resulting revenue flows15 from this level of opium output remain high, with significant implications for the financial sector, particularly the hawaladars. The pressure to launder funds is high—and will remain so for a significant while.
The emerging risk of a nexus of drug trafficking with terrorist/militant groups. The greatest threat to Afghanistan’s economic development is the growing risk of a nexus of drug trafficking and terrorist/militant groups—often referred to as narcoterrorism.16 The presence of opium and terrorism in Afghanistan poses significant risks of abuse of the financial system—formal and informal—regardless of the legislation or regulations enacted. Historically, terrorists have played a significant role in sustained conflicts in numerous countries—among them Bolivia, Colombia, and Peru (coca), Kosovo (primarily opium), Lebanon (opium), and Myanmar (opium) (Winer and Roule, 2003, p. 19). The simultaneous presence of opium and terrorism imposes significant financial and ideological pressure on financial intermediaries to side with money launderers and terrorist financiers, extending the criminalization of the economy. While drugs pose the highest risk to Afghanistan, given the level of opium produced, we cannot ignore the risks (often related to the opium trade) of arms trafficking, smuggling of humans and goods, or other serious crime.
Afghanistan’s Council of Ulemas has stated that cultivation, processing, trafficking, and consumption of drugs must be prevented. “Even if it is not consumed by Muslims or if it is done out of poverty, [narcotics-related activity] is illegal,” stresses the statement, which was endorsed by the UN Office on Drugs and Crime. Despite the statement, however, the trade continues to grow, and more remains to be done.
Conclusion and Recommendations
Many of the regulatory and supervisory challenges of the hawala system in Afghanistan are unique. In assessing the success of the country’s central bank in regulating the hawaladars, analysts, the press, and the public must avoid the risk of “mirror imaging”—believing that experience with informal financial systems gained elsewhere is universal. Increases in opium production and terrorism have compounded the incentives for concealing illicit financial transactions; thus, it is not possible to accumulate the same level of knowledge about the informal financial sector that we have about formal systems (commercial banks) in developed economies.
In a conflict-afflicted country, it is critical that observers and regulators alike appreciate that the conventional assumptions about financial risk and abuse may not necessarily apply. The striking feature of Afghanistan’s economic structure is the dominance of the informal sector—not only in agriculture and in the drug economy, but also in other sectors of the economy. It is inherently difficult to estimate the size of the informal economy, except in sectors where it is dominant, such as agriculture and drugs. The World Bank estimates that as much as 80 percent to 90 percent of the economic activity in Afghanistan occurs in the informal sector (World Bank, 2004, p. 5). The size of the informal economy represents a self-reinforcing equilibrium inherited from the past, involving failed governments, competing power bases, insecurity, a lack of rule of law, and a very poor investment climate for formal activities. For this reason more than any other, it is essential that the central bank sustain its pragmatic consultative approach to regulation.
In the long term, an effective strategy for isolating illicit funds being transferred through the hawala system is to encourage legal transfers to migrate to conventional financial instruments. The effectiveness of this strategy depends on the ability of formal financial instruments to compete with the hawala dealers with respect to exchange rates, speedy service, and coverage of areas that now lack banking services. The entry of new banks in Afghanistan is a first step toward such a transition. The rate at which banks open regional and provincial branches, offer services at attractive rates, and reach out to local customers will determine the long-term success of that first step.
Although the informal sector is dynamic, a recent World Bank study concluded that the sector cannot be the “engine” for sustained long-term growth. The study rightly observed that international experience suggests that development beyond a certain point is accompanied by a decrease in the share of the informal sector. Informality does not protect property rights and reduces the possibility of formalizing and enforcing contracts, weakens incentives to invest, and diminishes opportunities for division of labor and trade (World Bank, 2004, p. 8).
Despite improvements in policies and in conventional financial institutions, hawaladars will continue to represent an important and often necessary element of Afghanistan’s financial architecture. The market’s simplicity, cost-effectiveness, and convenience will ensure its survival for many years to come. It is therefore advisable that oversight policies focus primarily on regulation rather than on eradication. Cost-effectiveness and speediness are virtues that cannot be regulated away. Only competitive market forces can replace the hawaladars.
Meanwhile, Afghanistan’s central bank should, as it has already, continue working with the hawaladars of Kabul. Their association has an executive committee responsible for enforcing the tacit rules and business conduct of the market. Under the committee’s leadership, code violations bring serious consequences.17 The shaming and stigmatizing associated with committee condemnation often curtail dealers’ critical ability to collaborate with other dealers to facilitate large transactions. Being limited to one’s own funds in this business may force one out of the market. The committee is also responsible for the amicable settlement of disputes. It charges no fees for its services, and its appointed members are not salaried or otherwise compensated.
Forming partnerships with the hawaladars is in line with the World Bank’s recommendation that the government generate economic growth by harnessing the dynamism of the informal sector. Strategies for doing so include facilitating further growth of the informal sector, to the extent that it is legitimate—for example, by using microcredit and by gradually shifting informal activities to the formal sector (World Bank, 2004, p. xiii).
Coordinated efforts to strengthen legal and regulatory frameworks must also include engagement of the sector itself. This will help regulators understand and implement measures that address vulnerabilities without inadvertently affecting dealers who work outside criminal circles. Outreach also will help to separate at least some legitimate dealers from those working in illicit finance. Any external oversight of the market will require the active collaboration of the hawaladars’ association. Indeed, subcontracting some basic supervisory measures to the association in the interim may serve the central bank’s objective of opening up the market to greater transparency.
Bibliography
El Qorchi, Mohammed, Samuel Munzele Maimbo, John Wilson, 2003, Informal Funds Transfer Systems: An Analysis of the Informal Hawala System, IMF Occasional Paper 222 (Washington: International Monetary Fund).
Maimbo, Samuel Munzele, 2003, The Hawaladars of Kabul, World Bank Working Paper No. 13 (Washington: World Bank).
Maimbo, Samuel Munzele, and Nikos Passas, 2004, “The Regulation and Supervision of Informal Remittance Systems,” Small Enterprise Development, Vol. 15, No. 1, pp. 53–62.
Nyrop, Richard F., Donald M. Seekins, 1986, Afghanistan Country Study, Foreign Area Studies (Washington: American University). Available via the Internet: http://www.gl.iit.edu/govdoc/afghanistan.
Passas, Nikos, 1999, “Globalization, Criminogenic Asymmetries, and Economic Crimes,” European Journal of Law Reform, Vol. 1, No. 4, pp. 399–423.
Rondinelli, Dennis A., 2004, “International Goals and Strategies for Afghanistan’s Development” in Beyond Reconstruction in Afghanistan: Lessons from Development Experience, ed. by John D. Montgomery and Dennis A. Rondinelli, (New York: Pal-grave Macmillan), pp. 11–15.
UN Office of Drugs and Crime, 2004, Afghanistan Opium Survey 2004, p. 7. Available via the Internet: www.unodc.org/unodc/en/crop_monitoring.html.
Winer, Jonathan M., Trifin J. Roule, 2003, “Follow the Money: The Finance of Illicit Resource Extraction,” in Natural Resources and Violent Conflicts: Actions and Options, ed. by Ian Bannon and Paul Collier (Washington: World Bank), pp. 170–71.
World Bank, 2004, The Financial Sector in Afghanistan (Washington: World Bank, South Asia Finance and Private Sector Unit).
Samuel Munzele Maimbo is a financial sector specialist in the South Asia Region of the World Bank. Since March 2002, he has led the Bank’s work on informal remittance systems. The author wishes to acknowledge the research assistance provided by Katrina Karaan in preparing this paper.
This regulation shall not apply to commercial banks licensed by Da Afghanistan Bank, their branches, and foreign bank branches permitted by the bank. Money services provided by these banking organizations are regulated and supervised as part of their overall operations, under the regulations issued pursuant to the Law of Banking in Afghanistan.
In Arabic, hawala simply means “transfer.” For analytical purposes, the term is used to refer broadly to money transfer mechanisms that exist in the absence of, or in parallel to, formal banking channels. In some countries, commercial banks use the term hawala to refer to formal-sector money transfers. That definition is not used here. A hawala transaction, as defined here, encompasses financial transfers made by principals or by customers located in countries A and B (Customers CA and CB in examples below), through hawala service providers in their respective countries. Those providers (designated hawaladars HA and HB) operate outside the formal financial sector, regardless of the use or purpose of the transaction and the country of remittance or destination. Typically, HA receives funds from CA and asks HB to advance the amount to CB in the local-currency equivalent. In a prototype hawala transaction, an expatriate worker (CA) uses a hawaladar (HA) to arrange a remittance to his home country. CA makes payment in dollars or another convertible currency to HA, who contacts a hawaladar counterpart (HB) in the receiving country to arrange payment in local currency to the remitter’s family or other beneficiary (CB) (El Qorchi, Maimbo, and Wilson, 2003).
The recommendation states that the institution should be “identifying the customer and verifying that customer’s identity using reliable, independent source documents, data or information.” The documents commonly acknowledged and accepted for identification purposes are identity card, passport, driver’s license, and social security card.
FATF recommends that jurisdictions should introduce transaction reporting in line with their current reporting requirements for financial institutions. Thus, jurisdictions may consider issuing to the money-transfer sector specific guidance as to what may constitute a suspicious transaction. Some currently used indicators of suspicious financial activity, such as those found in the FATF’s “Guidance for Financial Institutions in Detecting Terrorist Financing,” are likely to be relevant for money and value transfer activities. However, particular activities and indicators unique to this sector should be developed further.
The FATF’s Recommendation 10 called for financial institutions to maintain records for at least five years. The FATF recommends that jurisdictions consider setting some minimum requirements for the form in which those records should be kept.
From 1980 to 1986 official development assistance to Afghanistan never exceeded US$20 million a year. Between 1988 and 1998, official development assistance averaged a little more than US$200 million a year, and during the years of the Taliban rule, external aid fell to a little more than US$130 million a year. From 1992 to 2001, the United Nations provided a total of US$160 million in aid. At the 2002 International Conference on Reconstruction Assistance for Afghanistan in Tokyo, the international community pledged more than US$4.5 billion toward the US$15 billion that international organizations estimated it would cost to develop the economy (Rondinelli, 2004, pp. 11–15).
When reforming their financial sectors, conflict-afflicted countries face many challenges, among them damaged physical infrastructures, staff with outdated skills, and absent or outdated technology. Because properly functioning financial systems enhance economic development, reduce transaction costs in the economy, promote the efficient use of financial resources, and improve financial market liquidity, it is vital that those conditions be read-dressed. Experience from Bosnia-Herzegovina, the Democratic Republic of Congo, and East Timor shows that the challenges are not insurmountable. Buildings can be rebuilt, staff retrained, and technology upgraded. Comprehensive, well-sequenced, and well-coordinated financial sector reforms can restore basic services in the short term, and the financial sector can return to long-term growth and vitality.
The proposed prudential regulatory process is consistent with standard bank licensing procedures, which commence with the screening of license applicants to exclude those with inappropriate professional qualifications, banking experience, financial capacity, and ethical backgrounds. At a minimum, regulators generally assess three issues: the sufficiency of a bank’s initial capital, the suitability of major shareholders and management, and the transparency of its corporate and organizational structure. In the case of foreign banks, the bank receives adequate supervision in its home country, and the home-country regulator approves the establishment of the branch.
The rationale for a minimum capital requirement for hawaladars may be questionable, given that that equity might not be the most important concern for regulators of money-transfer operations. Instead, a minimum liquidity ratio might be a more prudent measure of financial soundness.
Average rate in 2004: US$1=AFN 50.
In choosing to define a minimum capital standard for money-service providers, regulators in Afghanistan have opened themselves up to the same issues that the banking sector has been contending with for years. How should capital be defined? What level of capital is adequate for money service businesses to remain safe and sound? What criteria should be used to assess the adequacy of capital?
For the purpose of compliance with UN Security Council Resolution 1373, the government has become a party to all relevant UN conventions and protocols relating to terrorist financing and laundering of funds and properties.
Provisions from the following legislation were also used as the basis for Afghanistan’s draft legislation: UNDCP Model Legislation on Laundering, Confiscation and International Cooperation in Relation to Proceeds of Crime; the IMF Draft Model Financial Transactions Reporting Act; EU Directives 2001/97/EC of the European Parliament and the European Council dated December 4, 2001; the Law on Prevention of Money Laundering of Slovenia; and the Belgian Royal Decree of June 11, 1993, on the composition, organization, operation, and independence of Belgium’s FIU.
Some of those measures are an appropriate customer-acceptance policy that identifies circumstances under which customers will be rejected; an appropriate customer-identification policy that includes identification of the beneficial owner of the transmitted funds when such owner may differ from the customer; continuous training of staff so that they are able to recognize transactions that might be related to money laundering; instructions as to what action the staff should take in such circumstances; effective internal control and communication procedures; submission of reports to the FIU or another authority as required by the laws of Afghanistan; and retention of records on transactions.
The aggregate value of the Afghan opium harvest (at farm-gate prices) declined to US$1.02 billion in 2003 from US$1.2 billion in 2002 (−15 percent). The 2003 harvest represents, on average, a potential income of about US$3,900 per opium-growing family. The potential opium income per capita for 1.7 million growers averaged US$594. In comparison, on the basis of a population estimated at 24 million and a GDP estimated at US$4.4 billion, Afghanistan had a GDP per capita of about US$184 in 2002.
A subset of terrorism in which terrorist groups, or individuals, participate directly or indirectly in the cultivation, manufacture, transportation, and distribution of controlled substances and the monies derived from those activities. Narcoterrorism may be characterized by the participation of groups or associated individuals taxing, providing security for, or otherwise aiding or abetting drug trafficking efforts to further or fund terrorist activities.
At periodic meetings the money exchangers select 10 individuals to serve as members of the executive committee.