Liquidity management in the Islamic financial system and the institutional arrangements for resolution are among the other areas that need further development. Of critical importance is for the board and management of Islamic financial institutions to institute higher standard of leadership and a comprehensive governance culture and framework. Mutual recognition in Shariah and human capital challenges On this occasion, I would like to touch on two areas confronting Islamic finance firstly on, the issue of mutual recognition in Shariah and secondly the human capital development in the industry. Malaysia takes cognisance of the diversity of Shariah views within the region and among jurisdictions. Although Islam welcomes diversity of views, there is also a need to promote greater harmonisation among jurisdictions on the specific issues relating to Islamic finance. Such convergence is important for the long-term sustainability of the sector. Malaysia has taken the initiative to organise Regional Shariah Scholars Dialogue in 2006 and 2008 as part of the efforts to foster greater engagement among the Shariah scholars in the region. Indonesia has been active in these dialogues. Moving forward, the newly established International Shariah Research Academy (ISRA) has been entrusted to intensify the regional Shariah Dialogues as well as to enhance further the international engagement among Shariah scholars in our pursuit for Shariah harmonisation. Most encouraging is the greater appreciation and understanding that has been achieved in these deliberations of the Shariah practices that are peculiar to the respective jurisdictions.

The hypothesis that Ed McKelvey and I put forward in 1997 in response to evidence of the so-called “Great Moderation” seems to be well supported by the past two economic downturns and their aftermaths: Put simply, longer stretches of economic growth imply greater leverage and complacency and thus, greater financial problems when recessions do occur. In brief, longer U.S. business cycles logically lead to four linked consequences – more financial leverage, longer bouts of balance sheet repair, more subdued recoveries and longer periods of decline in inflation and interest rates during the early stages of recovery. 2 If the economy is more stable, then market participants will have more appetite for risk. This works fine during the expansion stage, when growth is relatively stable. However, when a recession finally arrives, it is a bigger shock than when recessions were more frequent. This surprise results in a more substantial adjustment in financial conditions. Ironically, the increased stability of the business cycle during the expansion phase appears to increase the volatility and importance of financial conditions when recessions do occur. At this stage, incorporating indicators of financial conditions into forecasting and into evaluating the conduct of monetary policy probably requires relying on constructing a “rough and ready” index. Macroeconomic models – especially dynamic stochastic general equilibrium models – do not incorporate robust financial sectors. Instead, these models have implicitly assumed that the monetary transmission mechanism and the financial intermediation process always works smoothly and predictably.