What is Hawala (حوالہ)?

In Arabic, the term ḥawala or حوالہ refers to “transfer” or “trust”, and it is an informal way of transferring funds where no actual cash is interchanged. The origin of hawala dates back over 1,600 years to the Middle East and South Asia. Merchants developed the hawala system as a secure and efficient way to transfer money across long distances without physically moving cash. In Islamic banking and finance, Hawalah (حِوالة) refers to the transfer of debt liability from one party to another. A Sharia-compliant financial contract allows a debtor to shift their obligation to a third party, who then becomes responsible for paying the creditor.

Instead of utilizing traditional banking methods, it relies on a network of brokers known as hawaladars, and it is particularly predominant in the Islamic socio-economic system because the conventional banking infrastructure is less developed. These brokers operate outside or parallel to formal banking, financial development pathways, and remittance services.

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Hawala: A Bank-Free Alternative for Money Transfers

Hawala is widely used as an alternative method for transferring funds instead of via banks. Hawala brokers maintain an informal ledger to document all credit and debit transactions in their accounts. Debts among hawala brokers can be settled with cash, property, or services. This system is totally based on trust, so a hawaladar who fails to accomplish their part of the agreement within an implied contract of hawala risks being labeled as someone who has lost their honor and may be removed by the network.

Hawalah Contract in Islamic Finance

1. Key Principles of Hawalah in Islamic Finance

a. Debt Transfer Without Physical Money Movement

Unlike the informal hawalah money transfer system, Hawalah in Islamic banking is a legitimate type of Islamic financial instrument/contract used to transfer debts legally.

b. Based on Mutual Consent

All parties (the original debtor, the creditor, and the new debtor) must agree to the transfer.

c. No Extra Charges (Riba-Free)

Since Islam prohibits riba (interest), Hawalah transactions cannot involve any extra financial compensation for transferring the debt.

2. Example of Hawalah in Islamic Finance

  • Ali (Debtor) owes Bilal (Creditor) $10,000.
  • Ali transfers the debt to Zaid (New Debtor), who agrees to pay Bilal instead.
  • Now, Zaid is legally responsible for paying Bilal, and Ali is free from liability.

3. Types of Hawalah in Islamic Finance:

  • Hawalah al-Haq: The transfer of a right (e.g., a claim or contract).
  • Hawalah al-Dayn: The transfer of a debt obligation.

4. Hawalah in Modern Islamic Banking

Many Islamic banks use this contract for trade finance, remittances, and interbank transactions, ensuring Shariah compliance while facilitating financial transactions efficiently.

5. Permissible Conditions of Hawala in Islamic Economics

Hawalah refers to releasing the principal debtor by shifting a debt to another party. The following are the primary conditions that follow in Islamic economics:

  1. A hawalah contract is finalized with the creditor’s approval.
  2. Any debt transfer for whom a guarantee is available is legitimate.
  3. The debtor and his trust, if any, are released from their respective duties due to the transfer. The transferee is the sole person from whom the creditor may collect his debt.
  4. Following payment, the transferee recovers the money from the transferor. Any claim made by the transferee against the transferor will be deducted from the claim.
  5. Until the debt is settled, the transferee has no claim on the debtor.
  6. Under any of the following circumstances, the transferee is freed from his liability:
    • If the creditor agrees, the obligation may be paid in full or transferred to another individual.
    • With the creditor’s consent.
    • If the transfer is accepted by the creditor’s heir after the creditor’s death.

6. Reference of Hawala in Hadith

Hawala is just a transferring of rights and does not indicate a sale contract. The companions of our Prophet Muhammad (PBUH) narrated from him:

“Once, while we were sitting in the company of Prophet, a dead man was brought. The Prophet was requested to lead the funeral prayer for the deceased. He said, “Is he in debt?” The people replied in the negative. He said, “Has he left any wealth?” They said, “No.” So, he led his funeral prayer. Another dead man was brought and the people said, “O Allah’s Apostle! Lead his funeral prayer.” The Prophet said, “Is he in debt?” They said, “Yes.” He said, “Has he left any wealth?” They said, ”Three Dinars.” So, he led the prayer.

Then a third dead man was brought and the people said (to the Prophet ), Please lead his funeral prayer.” He said, “Has he left any wealth?” They said, “No.” He asked, “Is he in debt?” They said, (“Yes! He has to pay) three Diners.’ He (refused to pray and) said, “Then pray for your (dead) companion.” Abu Qatada said, “O Allah’s Apostle! Lead his funeral prayer, and I will pay his debt.” So, he led the prayer”.

Hadith

“Procrastination (delay) in paying debts by a wealthy man is injustice. So, if your debt is transferred from your debtor to a rich debtor, you should agree”.

Hadith

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Features, Benefits, Mechanism & Applications of Hawalah

1. Key Features of Hawala

Hawala, often called underground banking, transfers funds without the physical movement of currency. Here are some key features of hawala discussed below:

  1. Hawala systems are currently prevalent among refugees from developing nations for sending money back to their homes.
  2. Transactions conducted through hawala offer ambiguity, as no official records are maintained and the origin of the funds remains untraceable.
  3. It is increasingly gaining traction in the financial technology sector, providing money transfer options for unbanked and underbanked communities around the globe.
  4. It has an unregulated and informal nature.

2. Benefits of Hawala

As hawala is used informally, it facilitates:

  1. Money transfers for individuals who lack formal banking relationships or access to established financial systems.
  2. For Individuals without government-issued ID or a bank account, hawala networks can be the sole means of sending remittances, especially when the receiving party is in another country.
  3. More affordable or quicker than navigating the bureaucracy of official financial channels.
  4. Nations with restrictions on monetary flows.
  5. Business people and refugees from authorized nations rely on hawala networks to execute payments to their partners in neighboring countries.
hawalah in Islamic finance

3. Mechanisms of Hawala Money Transferring

As discussed above, the hawala system is a network of agents known as hawaladars. Therefore, various hawaladar operators have networks of mediators in different cities worldwide. Generally, the process functions as follows:

Step 1: Transferring Funds

The Sender hands over money to a sending hawala agent (Agent S) with the recipient’s name and location in another city or country.

Step 2: Submitting Instructions

The Sender gives Agent S a code or password (Token). This Token acts as a key for the Recipient to collect the funds.

Step 3: Communicating the Token

The Sender gives the recipient information about the Token, either directly or via another method, such as a phone call or electronic messaging.

Step 4: Starting the Transfer

Agent S communicates with another receiving Hawala agent (Agent R) located in the Recipient’s locality. They notify Agent R about the funds being transferred and share the Token needed for the Recipient to access the money.

Step 5: Collecting Funds

The Recipient approaches Agent R, who provides the transferred amount, taking a small commission.

Step 6: Trust Mechanism

Hawala system is built on a system of trust among agents (e.g., Agent S and Agent R). Agent S owes Agent R the total amount given to the Recipient.

Step 7: Maintaining Integrity

It ensures integrity and trust by rigorously scrutinizing new agents and sticking to established protocols and codes of conduct. Reputation within the network is crucial, and any violation of trust can lead to severe implications.

4. Applications of Hawala in the Modern Epoch

There are various modern applications of ḥawalah:

  1. Bills of exchange and issuance of cheques.
  2. Remittance, where migrant workers remit money to their family or relatives in their home country.
  3. The efficiency and ambiguity provided by ḥawalah also make it a system that could be used for money laundering and crime financing.
  4. Transfer money between less developed nations.
  5. Where conventional banking systems are costly or difficult for those from lower socioeconomic backgrounds.
  6. Recommended because of its speed and convenience in terms of payment transfer.
  7. Comparatively lower commission rates than those charged by banks in traditional banking systems.

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