Underground Banking

FATF report on Digital Hawala and Underground Banking highlights the digital transformation of money laundering. Read here to understand the emerging challenges to India’s financial security.

The Financial Action Task Force (FATF), in its report “Investigating Professional Money Laundering, Underground Banking, and the Use of Hawala and Other Similar Service Providers”, has highlighted the growing professionalisation and technological transformation of underground banking.

Nearly 90% of jurisdictions reported the presence of underground banking and Hawala and Other Similar Service Providers (HOSSPs), while nearly 70% reported growing use of technology to coordinate and settle transactions.

This convergence of traditional hawala networks with fintech, virtual assets and encrypted digital platforms has created a new phenomenon increasingly described as “digital hawala”.

For India, the challenge is particularly significant because of its large remittance flows, expanding digital-payment ecosystem, cryptocurrency exposure and the growing sophistication of organised financial crime.

Underground Banking and Hawala

Underground banking refers to informal arrangements operating outside, alongside or through the regulated financial system to transfer, settle or store value through intermediary networks.

• Such systems are not inherently criminal; however, unlicensed operations can facilitate money laundering and other illicit activities.
• Hawala and Other Similar Service Providers (HOSSPs) constitute a subset of Money or Value Transfer Services (MVTS).
• They generally transfer value through intermediaries and settle balances on a net basis, without physically moving the corresponding money across borders.

The crucial distinction is:

• Licensed HOSSPs are regulated and subject to AML/CFT requirements
• Unlicensed HOSSPs are underground banking and vulnerable to criminal exploitation

What is Digital Hawala?

Digital hawala represents the technological evolution of underground banking. Traditional networks are increasingly supplemented by:

• Encrypted messaging applications
• Virtual assets and stablecoins
• Peer-to-peer crypto networks
• Digital wallets and mule accounts
• Virtual IBANs and prepaid cards
• Fintech and payment gateways
• Automated and AI-enabled transaction structuring

Thus, technology does not necessarily create an entirely new financial crime; rather, it makes traditional informal value-transfer mechanisms faster, more scalable and harder to detect.

Key Findings of the FATF Report

1. Professionalisation of Money Laundering

Money laundering is increasingly becoming a specialised service industry.

Professional money launderers provide illicit financial intermediation to criminal organisations for a fee. Their networks may contain:

• Hierarchical structures
• Specialised intermediaries
• Digitised records
• Cash collectors and settlement agents
• Professional facilitators such as lawyers, accountants, notaries and real-estate agents

This represents a shift from individual financial crimes towards organised financial-service ecosystems.

2. Technology-Enabled “Digital Hawala”

• Around 70% of jurisdictions reported growing technological use in underground banking.
• Criminal networks can combine encrypted communication, virtual assets and digital payment systems to collect funds, layer through multiple accounts/assets, settle offshore, convert to cash, and re-enter the formal economy
• Stablecoins, P2P transactions, and offshore OTC desks can further complicate attribution and tracing.

3. Integration with the Formal Financial System

Underground banking increasingly operates as a “hidden settlement layer” behind apparently legitimate transactions.

Illicit networks may exploit:

• Bank accounts
• Fintech platforms
• Virtual IBANs
• Prepaid cards
• Payment gateways
• Digital wallets

Consequently, financial crime increasingly involves hybrid informal-formal financial networks rather than purely underground transactions.

4. Diversification of Criminal Proceeds

Hawala and underground banking are no longer associated only with drug trafficking and smuggling.

They can facilitate proceeds from:

• Cybercrime and online fraud
• Corruption
• Tax evasion
• Illegal gambling
• Human trafficking
• Smuggling
• Drug trafficking

HOSSPs can also facilitate terrorist financing, particularly in conflict zones and cash-intensive economies.

Challenges for India

India faces a particularly complex risk environment because of its large digital-payment ecosystem, international remittance flows and extensive trade networks.

1. Trade-Based Money Laundering

• Indian authorities have uncovered schemes involving shell companies, forged KYC documents, under-invoicing and circular trade through third countries.
• Such mechanisms can create apparently legitimate justifications for outward remittances while transferring illicit value.

2. Online Gambling-Hawala Nexus

• Illegal gambling networks can exploit UPI/digital wallets, Mule accounts, Cash conversion, hawala transfers abroad, and round-tripping as foreign investment
• This illustrates how India’s sophisticated digital-payment infrastructure can simultaneously become an avenue for financial crime when combined with weak or fraudulent identity structures.

3. Crypto Layering

• The growing use of P2P crypto networks, offshore OTC platforms, decentralised finance and unhosted wallets creates additional difficulties for investigators.
• Although Virtual Digital Asset Service Providers fall under India’s Prevention of Money Laundering Act (PMLA), 2002 framework, criminals continue to exploit regulatory and jurisdictional gaps.

4. Remittance Vulnerability

• India receives substantial remittance inflows, particularly from Gulf and Western countries.
• While remittances are crucial for household welfare and India’s external sector, their scale can potentially provide cover for illicit financial flows, making risk-based detection necessary without disrupting legitimate remittance users.

Why is Hawala Difficult to Curb?

Challenge	Implication
Anonymity and trust networks	Transactions can occur without conventional banking trails
Digital transformation	Encrypted platforms and crypto increase speed and concealment
Cross-border jurisdiction	Evidence and suspects may be spread across multiple countries
Formal-informal integration	Illicit funds can enter legitimate financial channels
Trade-based laundering	Manipulated invoices can disguise value transfers
Mule accounts	Innocent or recruited account holders complicate investigations
High remittance flows	Distinguishing legitimate from illicit transfers is difficult
Regulatory fragmentation	Different jurisdictions follow different AML/CFT standards
Technology asymmetry	Criminal networks can adopt new technologies faster than enforcement agencies

A further concern is over-compliance. Indiscriminate account freezing or financial de-risking may affect innocent citizens and legitimate businesses, potentially pushing genuine users towards informal channels.

India’s Existing Institutional Framework

India has developed a broad framework to combat illicit financial flows, including:

• Prevention of Money Laundering Act, 2002 (PMLA)
• Foreign Exchange Management Act, 1999 (FEMA)
• Financial Intelligence Unit-India (FIU-IND)
• Enforcement Directorate (ED)
• Central Bureau of Investigation (CBI)
• Income Tax Department
• Customs authorities
• RBI-regulated financial institutions
• AML/CFT obligations for relevant Virtual Digital Asset Service Providers

The challenge is therefore not merely the absence of laws, but effective coordination, technological capability, enforcement capacity and cross-border cooperation.

Global Best Practices

Country	Best Practice	Relevance for India
Sweden	Licensing and registration of money-transfer operators	Bring informal operators within regulatory visibility
Belgium	Barrier Model targeting the entire laundering chain	Disrupt recruitment, collection, settlement and cash-out
Netherlands	Dedicated Taskforce Underground Banking	Strengthen multi-agency coordination
Indonesia	Blockchain analytics through PPATK	Improve crypto-tracing capabilities

These examples indicate that successful enforcement requires a system-wide approach, rather than targeting only individual transactions.

Way Forward for India

1. Adopt a Whole-of-Government Approach

• A specialised multi-agency underground-banking task force can integrate intelligence from FIU-IND, ED, RBI, Police, Customs, Income Tax, GST authorities, and Cyber agencies
• Financial, GST, customs and tax datasets should be systematically cross-matched to identify suspicious financial and trade patterns.

2. Build Technology-Driven Financial Intelligence

India should expand the use of:

• Blockchain analytics
• AI/ML-based anomaly detection
• Network analysis of mule accounts
• Automated beneficial-ownership identification
• Crypto-wallet clustering
• Transaction graph analysis

The objective should shift from identifying individual suspicious transactions to detecting financial networks and behavioural patterns.

3. Target the Entire Money-Laundering Chain

• Enforcement should focus on the complete ecosystem: recruitment, Cash collection, Layering, Settlement, Conversion, Integration, Asset acquisition
• Early account freezing, rapid intelligence sharing and timely asset recovery can prevent dissipation of illicit proceeds.

4. Strengthen Regulation of Vulnerable Sectors

AML/CFT supervision should receive greater attention in sectors frequently used for value concealment, including:

• Real estate
• Precious metals
• Casinos/gambling
• High-value goods
• Money-transfer businesses
• Digital-asset intermediaries

Beneficial ownership transparency should also be strengthened.

5. Deepen International Cooperation

Digital hawala is inherently transnational. India should strengthen:

• FIU-to-FIU cooperation
• Egmont Group information sharing
• INTERPOL cooperation
• Mutual Legal Assistance Treaties
• Joint investigations
• Real-time intelligence exchange

Greater harmonisation of legal definitions and evidentiary standards can accelerate cross-border investigations.

6. Preserve Financial Inclusion

AML enforcement must not become synonymous with indiscriminate financial exclusion.

India should:

• Expand low-cost formal remittance channels
• Maintain proportionate KYC for low-value transactions
• Improve grievance redressal for wrongly frozen accounts
• Strengthen customer due diligence without creating excessive compliance burdens

Formalisation should be made more attractive than hawala, rather than relying solely on punitive enforcement.

The Security Dimension

The problem extends beyond financial crime.

• Underground banking can potentially create linkages between Cybercrime, Organised crime, Drug trafficking, Terror financing, and cross-border networks
• Thus, disrupting illicit financial flows is an important component of national security and counter-terrorism strategy.
• The digitalisation of hawala also demonstrates a broader transformation in internal security: financial crime is increasingly data-driven, borderless and technology-enabled.

Conclusion

The FATF findings demonstrate that underground banking is not disappearing in the digital age; it is adapting to it.

Traditional trust-based hawala networks are increasingly being combined with cryptocurrencies, fintech platforms, encrypted communication and digital payment systems, producing more sophisticated forms of illicit finance.

For India, the objective should not merely be to “ban hawala”, but to make illicit financial networks visible, disrupt their entire ecosystem and simultaneously strengthen legitimate financial inclusion.

A combination of AI-enabled financial intelligence, inter-agency coordination, crypto-tracing, stronger beneficial-ownership frameworks, international cooperation and accessible formal remittance channels can help India address the emerging challenge of digital hawala while protecting the integrity of its rapidly expanding digital economy.

Financial security in the digital age requires not only tracking money, but understanding the networks through which value moves.