Sri Lanka's Shadow Banking: How Hawala and Undiyal Built a Parallel Financial World

Sunil is a driver based in Dubai. Every month, when his salary arrives, he carefully sets aside a portion to send back to his mother in Galle. For years, he relied on his bank's official remittance service — until one evening, a friend at the labour camp introduced him to something different.

An Ancient System Thriving in the Modern Age

What Sunil's friend described was not a bank, not a registered financial institution, and not anything that appears on a government ledger. Yet it moves billions of rupees across borders every year with remarkable efficiency. It is the world of Hawala and its local Sri Lankan equivalent, Undiyal — informal value transfer systems that have quietly constructed a parallel banking empire operating in plain sight.

For millions of Sri Lankan migrant workers spread across the Middle East, Southeast Asia, and beyond, these shadow networks are not a last resort. They are often the first choice — faster, cheaper, and more accessible than anything a formal bank can offer.

How the System Works

The mechanics of Hawala are deceptively simple. A sender approaches a local broker, known as a hawaladar, and hands over money along with a small fee. The broker contacts a counterpart in the recipient's country, who then pays out an equivalent sum to the designated person — often within hours. No money physically crosses any border. Settlement between brokers happens later, through a web of trust, reciprocal transactions, and occasionally the exchange of goods.

Undiyal, the Sri Lankan variant of this model, functions along similar lines and has deep roots in the island's trading communities. The word itself carries connotations of trust and informal obligation — the very foundation upon which the entire system rests.

For a migrant worker sending money home, the appeal is immediate: lower fees, faster delivery, and no requirement for a bank account on either end of the transaction.

Why Formal Channels Cannot Compete

Sri Lanka's Central Bank and successive governments have long encouraged migrant workers to use official remittance channels. The reasons are straightforward — formal transfers are recorded, taxed where applicable, and contribute to the country's official foreign exchange reserves. During Sri Lanka's devastating economic crisis of 2022, the shortage of official dollar inflows was a central concern for policymakers.

Yet the informal networks persist and, by many accounts, flourish. The reasons are not difficult to understand:

• Transaction fees through informal brokers are frequently lower than those charged by banks or licensed money transfer operators.
• Settlements are often completed within the same day, compared to multi-day waits through official channels.
• Recipients in rural areas — such as Sunil's mother in Galle — may have limited access to formal banking infrastructure.
• No documentation or formal identification is required in many cases, making the system accessible to undocumented workers abroad.

A Network Built on Trust — and Its Risks

The strength of Hawala and Undiyal lies entirely in the trust between brokers and their clients. Transactions are recorded informally, if at all — sometimes as nothing more than a shared code word passed between sender and recipient. There are no contracts, no receipts that would hold up in a court of law, and no regulatory oversight.

This opacity is precisely what makes these systems attractive to those who wish to move money without scrutiny — and it is what makes them a persistent concern for financial regulators and law enforcement agencies. International bodies including the Financial Action Task Force have long flagged informal value transfer systems as potential conduits for money laundering and the financing of illicit activities.

In Sri Lanka, the use of Undiyal networks has been linked in various investigations to tax evasion, the circumvention of foreign exchange controls, and the movement of funds connected to organised crime.

The Scale of the Shadow Economy

Precisely because these transactions leave no official trail, their true scale is impossible to measure with certainty. Economists and researchers who study remittance flows consistently find that official statistics capture only a portion of the money actually moving between Sri Lankan workers abroad and their families at home.

Some estimates suggest that informal transfers may account for a substantial share — potentially rivalling or even exceeding official remittance figures in certain periods. During times when the official exchange rate diverged sharply from the black market rate, as occurred repeatedly during Sri Lanka's economic turmoil, the incentive to use informal channels became even stronger.

A Dilemma for Policymakers

The challenge facing Sri Lankan authorities is a delicate one. For ordinary families who depend on money sent home by loved ones working overseas, Hawala and Undiyal are not criminal enterprises — they are lifelines. Heavy-handed crackdowns risk cutting off income streams for some of the country's most economically vulnerable households.

At the same time, a financial system operating entirely outside regulatory oversight represents a genuine risk — both to individual users who have no recourse if a broker defaults, and to the broader economy, which loses visibility over significant capital flows.

As Sri Lanka continues its recovery from economic crisis and works to rebuild its foreign exchange reserves, the invisible financial empire built on centuries-old networks of trust remains one of the most complex and consequential puzzles facing the country's economic planners.

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