242 AN INTRODUCTION TO ISLAMIC FINANCE
to some estimates, by 1988 they had managed to attract about half a million
customers and had deposits of between 4.5 and 8 billion Egyptian pounds.
The rate of return offered was so attractive that money fl ew out of the
regular banking sectors, and, in some cases, investors created arbitrage by
borrowing from banks and investing in these companies. However, these
companies were not subject to any regulation and supervision, and their
operations lacked transparency. These investment companies and their activ-
ities were exposed, however, in 1988 when the government decided to regu-
late the sector by requiring full disclosure of their accounts and investment
activities. This regulation triggered the failure of several companies and the
closure of the majority. Below is a summary of the issues pertaining to this
case study.
■ (^) It appears that the investment companies were not following Shari’ah -
approved modes of investment, despite their claims. In some cases,
they were paying high returns by drawing on a continuing high level of
deposits, as opposed to actual profi ts.
■ (^) It was reported that investments of a speculative nature were made in
international currencies and fi nancial markets. When the prices col-
lapsed in international markets in 1987, many investment companies
suffered losses. A major portion of funds were invested in illiquid sec-
tors of construction, tourism, housing, and book publication (mostly
Islamic publications). Several investment companies maintained close
business partnerships with other trading companies and managed a
number of subsidiaries. In short, funds were used to fi nance the busi-
nesses of subsidiaries and partner trading companies.
■ (^) Offi cial audit reports discovered many irregularities and funds unac-
counted for, partly in complex transactions with subsidiaries. Authori-
ties began the investigation of select investment companies for criminal
charges.
Several lessons can be learnt from these three case studies. First, the main
cause of the failure in all three cases was irresponsible management and bad
supervision and governance. Second, there were lapses in both regulation
and supervision. There were improper regulatory frameworks, and in all
cases the regulator failed to anticipate the trouble in time. Third, these fi nan-
cial institutions were clearly engaged in activities that were against the basic
teachings of Islam on contracts, property rights, justice, trust, and honoring
commitments. Fourth, in all cases, none of the Islamic fi nancial instruments
were questioned or gave rise to concern. Finally, in all three cases, signifi cant
reputational risk resulted and the stakeholders’ confi dence was seriously
damaged. The public’s trust was broken, regulators became more suspicious
and cautious, and opponents were provided with fuel to criticize even a legit-
imate effort to establish a fi nancial institution compliant with Shari’ah.
It should be reiterated, though, that these failures arose from a combina-
tion of gross mismanagement, poor governance, negligence, misconduct, and