240 AN INTRODUCTION TO ISLAMIC FINANCE
it was discovered that some of the agency (mudharabah) fi nancing was done
in the name of fi ctitious parties, while the funds were in fact used for con-
cealing internal fi nancial problems.
Lack of a Risk - management Culture There were serious fl aws in the company’s
risk management framework. Credit was extended to fi nance other busi-
nesses in sibling holding companies and some of the clients became heavily
dependent on Ihlas as a source of funding, thus increasing exposure to credit
risk. The depositors’ funds were used to fi nance several businesses of Ihlas
Holdings which in turn placed the funds in highly illiquid projects such
as construction. Even though these projects were profi table ventures, they
led to increased liquidity risk for Ihlas Finans and were cited as one of the
primary reasons for its failure. It is evident that Ihlas Finans lacked a crisis -
management plan, and decision - making during the crisis was ad hoc and
uncoordinated, internally and externally.
Management Failure It appears that Ihlas Finans did not follow the best practices
in management and did not act in good faith. Its hiring and selection process
was called into question when it was shown to have hired a senior executive
who was the subject of a BRSA investigation of a failed bank — adding further
fuel to customers’ concerns and damaged their confi dence. Furthermore, the
management was slow in responding to the changing legal and regulatory
environment and demonstrated poor judgment by ignoring the severity of the
problem during the early phases of the crisis. For example, while other SFHs
were able to convince depositors to hold off on their withdrawal requests to
avoid a liquidity crunch, Ihlas Finans lost more than US$200 million - worth
of its most liquid assets by paying out on depositors’ demands even before the
liquidity crunch hit. As a result, withdrawal requests increased, which ulti-
mately placed pressure on the BSRA to close down the institution.
The Islamic Bank of South Africa
The Islamic Bank of South Africa (IBSA) failed in November 1997 with
debts of between R50 million and R70 million. The primary depositor base
of the IBSA consisted of small depositors, mostly Muslims, who saw it as
a community bank and deposited their money to make the Hajj pilgrimage
to Mecca. Okeahalam (1998) conducted an analysis of its failure and the
role of the supervisors, and concluded that bad management and improper
accounting and management systems caused the bank to fail. Allegedly, a
large amount of insider unsecured lending took place, which resulted in
a large proportion of non - performing assets in the balance sheet. The study
found that the bank’s management hid behind the self - regulatory position
accorded to true Islamic banks but that IBSA abused this special trust. The
regulators should have been more cautious.^10
Further details of the causes of failure are found in van Greuning (2005),
who makes the following observations: