This is even more relevant in the multi-facet role played by the Islamic financial institutions in dealing with Islamic banking customers as the Islamic financial transaction is not merely based on the lender and borrower relationship as is the case in conventional banking. The move towards the adoption of the supervised market approach requires continuous efforts to enhance product disclosures and to elevate the level of financial literacy of consumers. BIS Review 3/2004  3  To further enhance transparency in the conduct of banking institutions, proper accounting standards need to be in place to reflect the true and fair value of banking operations that would lead to greater accountability and responsibility on the part of the banking institution. Accurate financial reporting requires a body of financial accountants that are well-versed in Shariah principles to ensure that the accounts are not only drawn in accordance with the international accounting standards but are also in line with Islamic principles. This is to enable the investors and supervisors to obtain the true and fair assessment of the Islamic institution’s financial condition and the profitability of the business. Transparency and disclosure is even more crucial in Islamic banking where the concept of mudharabah (profit-sharing) entails an investor-entrepreneur relationship and is a significant element in sourcing of funds. The establishment of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has made a significant contribution in formulating and issuing accounting and auditing standards for Islamic financial institutions.

Islamic banking operations therefore need to be governed by its own standards and best practices in parallel with the international best practice. The establishment of the Islamic Financial Services Board (IFSB) in 2002 as an international prudential standard-setting body to promulgate the international regulatory and supervisory standards for Islamic financial institutions is aimed towards achieving this objective. In this regard, the IFSB has already made progress in developing the prudential standards on the capital adequacy and risk management framework. These standards are expected to be completed in 2005. In addition, the IFSB will commence work on developing standards on corporate governance. At present, some countries have adopted the Basle Accord standards in their regulatory and supervisory framework for their Islamic banking industry. However, these standards do not adequately  2  BIS Review 3/2004  address the requirements of Islamic banking operations and transactions, resulting in gaps in the standards. Therefore, these gaps will be taken into account with respect to the capital treatment and risk associated for the different types of Islamic financial contracts to truly reflect their features and characteristics. While certain products in Islamic finance by their nature may not attract capital, the Islamic financial institutions need to have a more rigorous risk management systems in managing the funds placed under this arrangement. In this regard, the risk management standard needs to specifically address this concern. The Islamic financial institutions can expect to be better regulated and supervised following the adoption of the standards to be issued by the IFSB.