A good number of readers who contacted me tried to put the blame on the financiers. Their arguments were financiers want submission of good financial plans to suit their standards which force seekers of financing to present information that is not real. My answer to these arguments are all included in this article. Every one of us should be honest, ethical and responsible instead of blaming others.
In this article I will share various instances from my career where witnessed and learnt from others who achieved success by using funds advanced by financiers while abiding to agreed-upon terms.
In contrast, those who misused finances provided in a way that deviated from the original agreement, which is referred to as “diversion of funds” often faced detrimental outcomes. In this article I will also highlight the significance of Islamic financing in preventing the diversion of funds.
Why is funds diversion inappropriate, and why does it often have negative effects on the recipients being individuals, sole proprietorships, companies and government?
Three important principles are violated when funds are diverted:
First, it breaches integrity or the principle of being honest. It is a well-known fact supported by literature that dishonesty invariably leads to failure, which goes hand in hand with lack of trust. Henceforth, I will use the terms “honesty” and “integrity” interchangeably.
Second, financiers provide resources after thorough analysis of the plans and the recipient’s experience in utilizing the funds. Diverting funds to activities outside of the agreed-upon plans or the recipient’s domain of experience and expertise often results in poor outcomes.
Third, mainstream financial literature and practical experience clearly demonstrate that diversion of funds is unhealthy and can lead to disastrous consequences. These disasters are even more harmful when diversion of funds is done by public institutions as they affect the whole society.
In Islamic finance transactions, cash is not directly provided to customers. Instead, customers are supplied with goods or services and the funds from financiers are paid directly to suppliers of goods or services.
Although this approach aims to prevent the misuse of funds, it does not entirely eliminate the possibility of funds diversion. There are instances where unethical behavior occurs, with customers and suppliers colluding to circumvent the intended use of the funds. Instead of delivering goods or services, suppliers may transfer the cash received from financiers to customers under certain agreements, often involving bribery.
In contrast, diversion of funds faces fewer obstacles in conventional loans, where cash is typically deposited directly into the customers’ accounts, making it easier for them to use the funds for purposes other than those originally intended.
Experience from Uganda, on the importance of utilizing funds for their intended purposes, is worth sharing. During my tenure as Managing Director of Amana Bank Tanzania Limited, the Ugandan government secured funding from the Organization of Islamic Conference on condition that the facilities be provided to micro-entrepreneurs in a Sharia-compliant manner (Islamic finance) to reduce poverty.
As the Managing Director of a fully-fledged Islamic bank, I had the opportunity to host guests from Uganda who visited twice for practical training in Islamic banking. During a dinner arranged by the bank, our guests explained how Islamic finance plays a crucial role in preventing the diversion of funds.
Our guests informed us that these programs were initially conducted using conventional credit arrangements, with funds provided in cash. The entrepreneurs involved were primarily women. After receiving the cash, some of the women’s husbands demanded the money and spent it on unrelated matters, rather than using it for the intended business purposes.
As a result, the businesses failed, and poverty was not reduced as expected. When they shifted to Islamic finance, instead of providing cash, they supplied commodities for sale.
The outcomes were significantly better, businesses flourished, and poverty was reduced. The initial lack of trust and misuse of funds contributed the negative effects, but the adoption of Sharia-compliant principles prevented misuse of the facilities leading to success stories.
I also encountered similar situations at a University setting, where some students were given cash by their parents or guardians to pay tuition fees and other educational expenses. However, instead of using the funds as originally intended, some students chose to invest in businesses, which eventually failed, while others spent the money on personal expenses.
I recall a parent coming to my office one day, asking, “Why is my child not allowed to sit for exams despite having paid tuition fees?” It turned out the student had lied to his parent. When the parent discovered that his son squandered the funds, he was devastated and ended up in tears.
This diversion of funds not only led to a major conflict between the parent and his son, but also resulted in the student’s inability to continue with his studies. Unfortunately, there were several such cases at the university, where dishonesty and lack of proper planning had detrimental consequences.
I have met several business-people who have been successful in repaying the facilities provided to them by banks on time. Their primary principle was to ensure that these facilities were used according to the agreed terms.
One customer, who has grown his business into one of the largest ventures in the country, emphasized the importance of using the funds as stipulated. He managed to expand his operations from only one outlet to several outlets all over the country.
While other factors may have contributed to his success, his honesty and adherence to his concrete plans stand out. When someone demonstrates integrity in one aspect of their business, it is reasonable to expect that similar principles will apply in other areas.
Good conduct is often reflected across all spheres.
In contrast to the previous example, another businessman in a similar industry, who initially had good orders, often diverted funds to other purposes. Within a span of less than five years, the results were catastrophic. Almost all his businesses failed and he accumulated significant debt, ultimately becoming bankrupt.
He had gone off on a tangent, engaging in any business opportunity that came his way. He had no plans, struggled to repay his facilities, and frequently failed to fulfill his promises, often resorting to dishonesty. He ended up using the funds provided by financiers on personal expenditures such as travel and sponsoring various events that had no connection whatsoever with the improvement of his businesses.
In extended family setups, which are typical in African culture, there is a tendency for members to help one another, including the provision of funds for personal use or business undertakings. Research findings in developing countries support this notion, indicating that major sources of financing often come from friends and family.
However, when it comes to business financing, diversion of funds can contribute to both business failure and strained relations.
A certain person was once approached by the mother of a distant relative for help with her son. He agreed to assist on the condition that the funds would be provided as a loan and he would recover only the principal amount. This is known as in “Qardh Hassan” in Islamic finance.
He met the young man for a lengthy discussion, during which the latter provided him the business data and his intentions to open a genge – a small shop selling cooking essentials. The young man had identified a location, and the rental charges were known.
The good Samaritan prepared a spreadsheet that included forecast expenditures and revenues based on the young man’s explanations and the results looked promising.
With a solid plan in place, the good Samaritan advanced the funds and even gifted the recipient a mobile phone, believing it would help him boost his business by facilitating customer orders. He did not impose stringent conditions and repayment was to start when the business had grown, most likely after six months.
However, when he finally began receiving repayments, they were made irregularly and instead of being advanced by the person he had loaned money, the funds came from his sister. Initially, the good Samaritan was informed that the genge business had not succeeded, and the owner had begun sending items for sale.
This response was most likely devised in case the good Samaritan decided to visit the genge, a fact he learnt about much later. As the Eid festive season approached, the good Samaritan stumbled upon the truth – the funds he had provided had been misused, and there was no business to speak of.
One evening, on a whim, he decided to reach out to the young man. He told him that he had decided to write off the loan entirely. The young man was surprised and asked why. The good Samaritan replied that he was in the spirit of giving and the young man could consider it a fresh start to grow his business.
On Eid day, the good Samaritan received an angry call from the young man elder sister. “What have you done to my younger brother?” she demanded. Confused, the good Samaritan asked her why she was so upset.
She explained, “He’s been pestering us to return the funds because you supposedly want your money back immediately.” The good Samaritan clarified that he had informed the young man that he had cancelled the entire debt.
To his surprise, it became clear that somehow, the funds had ended up with the young man’s sister, and most likely his mother too, instead of being used for the intended business purpose. The entire family had deceived the good Samaritan and the dishonesty was evident. The young man had not achieved anything on his own.
This situation reminds me of a conversation I had with a group of successful businessmen while we were driving together. As we passed a man in a modest car, one of them remarked, “We have stopped doing business with that guy.” Curious, I asked why.
“He does not repay his loans,” one of them explained. “He often diverts the funds for purposes other than what was agreed upon. He is neither honest nor trustworthy.” For these businessmen, honesty and trust are essential qualities for building and sustaining successful relationships in business.
I know two brothers who began by setting up a small shop in the late 1990s. Today, as I write this article, their business has grown remarkably, surpassing their competitors in Kenya. They have become East Africa’s largest suppliers of the products they deal in, a testament to their dedication and smart business practices.
How did they manage? The answer lies in strictly avoiding the diversion of funds and maintaining a high level of integrity in handling the loans advanced to them. From the start, they focused expanding their business through credit facilities granted by suppliers.
Initially, these facilities came from suppliers in Tanzania and then extended to suppliers from Kenya and later on they expanded to sourcing from India. The key to their success was straightforward – never divert funds from their intended purpose and always pay creditors on time.
This disciplined approach allowed them to grow steadily. As their business expanded, they were able to secure supplies from a wider range of sources because they had the funds to pay upfront. Now they can pay cash to suppliers who do not offer credit facilities, giving them an even stronger competitive advantage in the market.
One of the two brothers shared a different side of their success story, highlighting the challenges some of their customers faced. In efforts to expand their businesses, they began to issue credit facilities to their customers.
Those who honored agreements and paid back saw success, but those who failed to keep their commitments ended up struggling.
He provided an example a customer in Mtwara, a region in southern of Tanzania, who bought items on credit and sold them at a good profit.
However, instead of using the funds to repay the loan, the customer decided to buy onions and sell them in Dar es Salaam. He had no experience in the onion business, which was not part of their original agreement. Unfortunately, heavy rains ruined the onions, causing a loss leaving him unable to repay the funds. This not only damaged his business but also ruined the relationship due to dishonesty and poor planning.
Expanding on the success stories of individuals who have thrived by not diverting funds can shed more light on this important principle. After retiring from the Peoples’ Bank of Zanzibar, I was approached by an individual seeking advise on how to run his business.
He mentioned that his company had taken a facility from a bank and was continuing to repay well.
I advised him to never divert funds provided by financiers, emphasizing its significance. He responded that the same advice had been given to him by his bank’s Managing Director.
I reiterated that adhering to this principle is crucial for success and he confirmed that they had strictly followed this guideline since their first facility from the bank, always ensuring timely repayments. Thanks to their commitment to integrity, they were able to secure additional financing and expand their business.
It is crucial not to divert funds as this can lead to significant problems for the recipient when they face repayment challenges. In such situations, recipients may feel compelled to be less honest with their financier for fear of repercussion of admitting that they have misused the funds.
This dishonesty can severely damage relationships with financiers and ultimately result in business failures. Steve Chandler in his book 100 ways to Motivate Yourself, connects truth to beauty. He quotes Nathaniel Branden who states, “One of the greatest self-deceptions is to tell oneself, only I will know that I am a liar: only I will know that I deal unethically with people who trust me; only I will know that I have no intention of honoring my promise. The implication is that my judgement is unimportant and that only the judgement of others counts.”
In writing this article, I have chosen to use various examples to highlight the detrimental effects of diverting funds provided by financiers for other purposes. The key issues associated with this behavior are dishonesty and a lack of proper planning.
When it comes to government evidence can be clearly seen on the level of development in the country in terms of infrastructure and social services. When we see good improvements in the development of roads, schools, hospitals, water facilities and other kinds of social services that is the manifestation that the funds are appropriately utilized.
Value for money audits are essential in the public sector to ensure that all funds received are utilized in the manner that is agreed by financiers. The good thing is that most of these financiers are vigilant and they keep on watching. After all, when funds are well utilized in the improvement of the society, then there will be better future cash flow to the government coffers for the purpose of repaying these loans in the future.
To mitigate this risk, it is essential to engage in discussions with the providers of funds before any diversion occurs. Ensure that you pay back your initial facility and present any new proposal. If the new terms are agreed, then you can proceed. If not, explore alternative options.
