Underground banking

What underground banking actually is

Underground banking is any system for transferring value from one place to another that operates outside formal banking channels. The person sending money hands it to a local broker; a connected broker somewhere else pays out the equivalent amount to the recipient, often within hours. No money physically crosses the border in between.

Regulators use several near-synonymous terms for this: alternative remittance systems, informal funds transfer systems, informal value transfer systems. Whatever the label, the mechanism is the same: value moves; currency mostly doesn’t.

How a hawala-style transfer actually works

A typical transfer works like this: a customer gives cash to a broker in one country, along with a simple identifying code or password. The broker contacts a counterpart broker in the destination country, who pays the equivalent sum, minus a small fee, to whoever presents that code. No wire transfer happens between the two brokers at the time of the transaction.

The brokers settle their own accounts with each other later, often through trade invoicing, cash shipments, or simply letting balances run in one direction until it’s worth settling, rather than through the formal correspondent banking system most transfers eventually rely on.

The many names for the same idea

The same basic system goes by different names depending on the region. Hawala is the term most associated with South Asia and the Middle East. Hundi is the equivalent term used in Pakistan. Fei ch’ien describes similar networks tied to Chinese communities. FATF’s own typology work groups these together as hawala and other similar service providers, or HOSSPs, precisely because they share the same defining features regardless of what a specific community calls them.

The systems appear across a huge geographic range, from Hong Kong and Paraguay to Canada and Nepal, which is part of why regulators treat them as a single category of risk rather than a narrow, regional concern.

Why it’s older than the formal banking system

Underground banking isn’t a modern workaround invented to dodge banking regulation. Chinese funds transfer networks recognisably similar to modern fei ch’ien systems date back to the Tang Dynasty, between 618 and 907 AD, long before anything resembling a formal international banking system existed. Hawala-style networks across South Asia and the Middle East have similarly deep historical roots, originally built to support trade across regions where formal banking was absent, unreliable, or simply didn’t exist yet.

That history matters for how regulators approach the systems today. This isn’t fringe infrastructure retrofitted for illicit use; it’s older, more established infrastructure that predates the alternative it’s now measured against.

Why it’s legitimate and vulnerable at the same time

For millions of people, underground banking is the only practical way to send or receive money, particularly migrant workers sending remittances home to countries with limited formal banking access, weak infrastructure, or populations that are unbanked for reasons ranging from cost to lack of documentation. The World Bank and IMF have both recognised these systems as a genuine, often essential financial lifeline, not merely a workaround.

The same features that make these systems useful, speed, low cost, minimal documentation, trust-based settlement, are exactly what makes them attractive to criminals moving illicit proceeds. A system built to move money with a password and a phone call, rather than formal identification, is much harder for a regulator or law enforcement agency to trace after the fact.

Where FATF’s standards actually target it

FATF addressed this directly in its 2003 best practices paper on combating the abuse of alternative remittance systems, which grew out of what was then Special Recommendation VI on terrorist financing. The core ask is straightforward: countries should require money or value transfer services, including hawala-style networks, to be licensed or registered, and to comply with the same core AML obligations, customer due diligence, record-keeping, suspicious transaction reporting, as formal financial institutions.

FATF’s later, more detailed 2013 report on hawala and similar service providers pushed further, arguing that outright bans tend to just push the activity further underground rather than eliminating the underlying risk, and that licensing and engagement produce better visibility than prohibition alone.

Red flags that distinguish licit use from laundering

Not every hawala-style transaction is criminal, and firms need to be careful not to treat the underlying mechanism itself as automatically suspicious. What actually distinguishes legitimate remittance activity from underground banking being used to launder proceeds tends to come down to a handful of signals: transaction sizes and patterns inconsistent with an ordinary personal remittance relationship, connections to unlicensed or unregistered money transmitters operating at meaningful scale, and settlement patterns, trade invoices, cash movements, that don’t match any real underlying commercial activity.

None of these signals alone confirm laundering. A genuine migrant worker sending money home through an unlicensed local broker because that’s the only practical option available isn’t automatically a red flag on its own.

What this means for a firm’s own risk assessment

For a firm’s own risk assessment, underground banking exposure usually shows up indirectly, through customers or counterparties operating in or transacting with regions where these systems are the dominant method of moving money, rather than through direct participation in a hawala network itself. Correspondent banking relationships and trade finance are common points where underground banking settlement activity actually surfaces inside the formal financial system.

Firms operating in or with corridors where informal value transfer is common usually need risk indicators calibrated to that reality specifically, rather than applying generic transaction monitoring rules built around formal wire transfer patterns that don’t map cleanly onto how these systems actually settle.

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