R&D is indeed an essential aspect of modern industries and enterprises and is no less the case in the financial world. There are three important pre-requisites in strengthening research and development capabilities, namely, adequate allocation of resources for infrastructure development, forging strategic alliances through smart partnerships and developing the required pool of qualified and skilled talent. Adequate allocation of resources for infrastructure development Islamic financial institutions are continually being confronted with new challenges that need to be addressed. Their institutional capacities and capabilities need to be continuously strengthened. This includes attention to continually review their strategic orientation and key priorities and the necessary adjustments that need to be made to position the institutions to effectively respond to the new developments and challenges that have emerged. In order to meet the increasing demands of a modern and sophisticated market, financial institutions must continually invest in the supporting infrastructure that promotes research and development. This will enhance the capacity for innovation. Attention also needs to be given to the applied approach to Islamic finance and its modern practice. Financial support for advanced research at universities and research institutes will increase research opportunities. Efforts to utilise and install strong technological capabilities will also contribute to enhance research and development. In embracing the new leadingedge technology, the potential for the Islamic financial industry to develop new products and services will also be enhanced. Forging strategic alliances through smart partnerships To further enhance research and development (R&D) activities, the promotion of strategic alliances through smart partnerships can play an important role.

Investors have recently incurred significant losses on complex securities like CDOs and a number are expected to sue for mis-selling. HSH Nordbank is already suing UBS for the mis-selling of CDOs, for example, and Banca Popolare di Intra has a lawsuit against Bank of America for the same reason. Wingecarribee Shire Council is also suing Lehman Brothers for the mis-selling of CDOs. System dynamics and the amplification of shocks 37 The frictions of incomplete information, imperfect incentives and inherent illiquidity of bespoke financial instruments may also be amplified by adverse dynamics within the financial system itself. For example, poorly-designed remuneration structures and short-term performance targets may encourage “herding” behaviour within the financial system that  BIS Review 93/2008  9  raises the costs of taking a contrarian view. And there are also well-documented concerns that regulatory design pays insufficient attention to the risk of procyclicality 6 . 38 It also appears to be the case that many firms failed to take sufficient account of the likely behaviour of other firms, and thus of system properties, when designing stress tests and contingency plans. They were far too confident in their ability to exit or hedge positions in high risk instruments, where trades were highly crowded, and were consequently underprepared for the evaporation of market liquidity.