In a dual financial environment, the prudential regulatory design needs to take into account the unique characteristics peculiar to Islamic banking and finance as well as provide a level playing field in relation to conventional banking and finance so as to ensure that Islamic financial institutions and transactions are not at a comparative disadvantage. It also needs to assess and mitigate any potential regulatory arbitrage practices between the conventional and Islamic financial system that could undermine the stability of the overall financial system. While conventional banking is primarily premised on an interest-based debtor-creditor relationship, Islamic banking transactions are relatively more complex arising from the diverse contractual relationships between the Islamic financial institutions and their customers, ranging from the low risk sales and lease-based modes of finance to the higher risk equity-based modes. Each of these modes of finance has a distinct intrinsic characteristic dictated by its underlying Shariah principles and thus, entails different risk profiles. Therefore, the risk management infrastructure in Islamic financial institutions must be in place to identify, unbundle, measure, monitor and manage all the specific risks in Islamic financial transactions and instruments to provide for their effective quantification and management. The establishment of the Islamic Financial Services Board (IFSB) in 2002 marks an important milestone in the development of internationally accepted prudential regulatory standards and best practices for the Islamic financial services industry. Since its establishment, the IFSB has attracted wide participation. To date, there are 13 full members, 4 associate members and 35 observer members in the IFSB.

The second realignment that is taking place is based on the post-crisis realisation that financial stability cannot be secured solely through a combination of macroeconomic policies aimed at price stability and microprudential supervision aimed at the safety and soundness of individual financial institutions. 16. Price stability is not sufficient to achieve financial stability. Sharp increases in asset prices, even in a climate of relatively low consumer price inflation, have typically led to credit booms and risky behaviour that eventually undermined financial stability. Likewise, prudential rules to ensure the safety of individual banks have not been sufficient to keep the banking system as a whole safe. Inter-linkages and common exposures across institutions can multiply aggregate risks and destabilise the system. 2  BIS central bankers’ speeches  17. Hence the resurgence of interest in what is called the macroprudential dimension – policies and tools aimed at containing risks in the financial system as a whole. However, macroprudential policies are still at an experimental stage. Different countries have adopted different measures in the name of sustaining systemic stability, ranging from limits on aggregate credit and caps on debt-to-income ratios to taxes on asset market transactions and controls on capital inflows. 18. Singapore has been experimenting, since 1996, with its own toolkit of macroprudential measures to tame excesses in the housing market. While we do not as yet have a completely coherent policy framework, the main outlines of Singapore’s approach are becoming clearer.