Informal Funds Transfer Systems Building Financial Market Integrity in Afghanistan: Anti-Money Laundering AML Regulation and Compliance Requirements, April 17, 2006 Emiko Todoroki The World Bank

Informal Funds Transfer Systems Informal Value Transfer System (IVTS) Informal Funds Transfer System (IFTS) Alternative Remittance System (ARS)

How the System works It is important to note the difference between informal funds transfer systems (IFTS) and informal value transfer mechanisms (IVTM). While both refer to “mechanisms or networks of people facilitating the transfer of funds or value without leaving a trail of entire transactions or taking place outside the traditionally regulated financial channels”, there is a subtle but important difference. And generally, it is the hybrid Versions of IFTS and IVTM in which individuals, networks and organizations, employ a variety of methods of transferring both money and value informally that causes regulators the most concern. The former, IFTS, refers to transfers of pure monetary value, which have the following features: they constitute traditional ethnic funds transfer operations and businesses; they are generally thought to have originated in the Indian sub-continent and in China, But have spread throughout the globe following waves of immigration and processes of economic globalization; they are currently subject to regulations designed for so-called “money services businesses”; and their clients and services are for the most part well-established, known to their respective local community. Examples of IFTS are hawala, hundi, fei chien, Phoe kuan and other similar services (including couriers). The underlying characteristic is that the transfer is originated, transferred and delivered as a financial asset. The latter, IVTM, refers to the transfer of value in the form of goods, or a combination thereof, for their monetary value. Typically, they involve the use of the formal financial system, but leave no trail for anyone wishing to reconstruct the route of a transaction. They are very often part of legitimate or legitimate-looking trade or financial transactions, which effectively obfuscate substantial value transfers. Primarily, the regulatory concern with transactions involving both IFTS and IVTMs, is that for the most part, there appears to be a direct correlation between the degree of funds and goods co- mingling and the likelihood of a criminal intent to conceal or deceive. These methods show the following characteristics: they do not require the existence of widespread networks of people; most of them can be accomplished by a couple of individuals on an ad hoc or regular basis. Where there is criminal intent to conceal, the transactions are usually combined with other offenses (e.g., tax evasion, subsidy fraud, embargo busting, capital flight, terrorist funding, smuggling, etc.). Source: Maimbo and Niko Passas, “The Regulation And Supervision Of Informal Remittance Systems< December 2003 PS: In other publication it says that IFT is a subset of IVT system. Emiko my idea here in case it is not clear is for you to say that these two systems are nevertheless interrelated. They are problematic because they involve the smuggling of goods to settle differences between Hawaladars, etc. So I think you should talk about this otherwise you are constraint to talk about money only. This is only for your understanding that academically short of speak they are different and if someone asks what is IVTS. Source: Nikos Passas “Informal Value Transfer Systems, Terrorism and Money Laundering”, January 2005

IFTS/ARS around the World Usually names vary based on geographical locations and ethnic group. They also might have small differences from each other: Hawala (it 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 Fei ch'ien (flying money) - Chinese Phoe kuan - Thailand Hui k'uan (to remit sums of money) - Mandarin Chinese Ch'iao hui (overseas remittance) - Mandarin Chinese Nging sing kek (money letter shop) - Tae Chew and Cantonese speaking groups Chop shop - foreigners use this term for one of the Chinese methods Chiti banking – (refers to the "chit" used as receipt or proof of claim in transactions introduced by the British in China;short for "chitty", a word borrowed from the Hindi "chitthi", signifying a mark). Hui or hui kuan (association) - Vietnamese living in Australia Door to door, padala – Philippines Black market currency exchange – South America, Nigeria, Iran Stash house (for casa de cambio) - South American systems Source: Nikos Passas Informal Value Transfer Systems, Terrorism and Money Laundering, January 2005

Informal Funds Transfer Systems Common Characteristics: A traditional system (dates back to 5,000-6,000 BC?) Generally based on trust and strong family ethnic or business relationships Utilized by a variety of individuals, businesses, and even governments to remit funds domestically and abroad Complement weak and/or unstable (formal) banking system and access to finance Efficient, reliable and cheaper than formal financial system Parallel to formal banking system (occasionally interconnection)

Hawala System in Afghanistan US$200 million Cost Reliance Speed Scope Transaction Volume Documentation Fast, reliant and widely used system

Convenient for criminals who like to exploit the system Potential for Abuse Lack of Paper Trail Weak or no consistent record keeping Where Records are maintained they are rarely accessible to third parties Usually, no audit or financial reporting requirements Anonymity of transactions (sender/receiver) Account reconciliation conducted between “providers” to avoid paying taxes Lack of transparency and accountability Absence of regulatory oversight. Parallel to formal banking system (occasionally interconnection) Convenient for criminals who like to exploit the system

Potential for Abuse Source: Samuel Maimbo, “ The Money Exchange Dealers of Kabul”, June 2003 Again some characteristic features of Informal transfer operations, such as their generally inferior customer background checks, customer identification records, transaction records and lack of compliance with laws requiring that suspicious transactions be reported, lure criminal elements to use their services for illegal purposes.

Other Risks of the Non-Regulated Sector In addition, Macroeconomic and Financial risks: Monetary policy Exchange rate policy Fiscal policy

International Standards Financial Action Task Force (FATF) R23 and SR VI: License or Registration EXTENDED AML/CFT requirements to alternative remittance systems (R. 4-11, 13-15, 21-23, and SR VII) Monitoring mechanism Appropriate sanctions

Lessons Learned Need for awareness raising It is also helpful in order to identify providers that have failed to identify themselves Need for flexible, effective, and proportional regulations Two aspects to be effective: Consider skills, capacity, and resources of supervisors Not to impose too much of an administrative and cost burden on remittance provider Regulations will need to be incentive-compatible, and their design will require engagement with the private sector Participation and consensus building with the industry are essential Regulators could seek out informal remittance associations or recognized leadership as potential partners in improving transparency and accountability in the industry

Lessons Learned Requirements Clear and simple requirements, regardless of the type of regime adopted (Registration or Licensing) Application process Annual renew or review Need for background checks Onsite inspections: one way to ensure compliance Government guidelines are very helpful (ML/TF trends and typologies) Regulation is not a panacea. Need to address demand side of the system.

Lessons Learned Appropriate documentation to identify customers must be a strict regulatory requirement Need for flexibility on documents accepted for identification If transaction requested by fax, telephone only after business relationship has been established Full CDD done in a risk sensitive basis Record keeping is essential Some countries have devised simple formats or provided software Providers better able to determine if a transaction is extraordinary or suspicious Sanctions must be enforced

Red Flags Some red flags in ongoing monitoring to detect suspicious transactions: Regular high levels of cash deposits which do not match with client’s profile Cash deposited at banks located at distance from the suspected ARS business premises Regular high-volume international transfers to third party accounts in countries which are not destination countries at the end of known or usual remittance corridors Cash volumes and international remittances in excess of average income of migrant accountholders and/or in excess demand for migrant remittances in the areas Structuring of deposits to avoid reporting thresholds or simply in an attempt not to draw attention Source: Money Laundering & Terrorist Financing Typologies 2004-2005, FATF

Red Flags Some red flags for operators to detect suspicious transactions: Remittance in excess of norm for the customer’s economic background without logical business reasons Escalating levels of remittance for an individual customer above what was to be expected from original KYC assessments Personal remittances sent to destinations that do not have an apparent family or business link Remittances made outside migrant remittance corridors Reluctance of customer to give an explanation for remittance Personal funds sent at a time not associated with salary payments Requests for a large transfer but settling for smaller amount Heavy contamination of bank notes with heroin or cocaine Source: Money Laundering & Terrorist Financing Typologies 2004-2005, FATF

Thank You! Contact: Emiko Todoroki etodoroki@worldbank.org phone: +1-202-458-9466