Evolution and institutional foundation of the hawala financial system

Abstract This article examines the evolution and the institutional foundation of the century-old Islamic hawala financing system. Analysis of the functional principles of this system will show that it is a highly efficient, extremely robust institutional arrangement for overcoming the risks of opportunism among the transaction partners. It is an institution that was developed against the backdrop of a lack of formal legal systems. Thus, hawala can be seen as club-like arrangements, which are able to provide the transaction parties with an institutional framework to assure enforcement of contracts without relying on any national law. Today, therefore, it is able to expand outside and independently of existing laws and regulations. It is able to move large amounts of money without recourse of the formal banking system and even without retaining any bookkeeping notes. Instead, it is based on the trust of the participating parties and its social and religious embeddedness within the Islamic community.

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