Fundamental to this is the development of the institutions, the markets, the range of financial products and services and having in place the accounting, legal, regulatory, supervisory and shariah frameworks, as well as, for the monetary authority to have the capacity to manage its financial policies within this context. With the development of these respective components having made significant progress, we are now seeing the Islamic financial services industry enter a new phase of development. Following increased liberalisation, the progress in the development of the international financial architecture for Islamic finance and the increased innovation resulting in the development of new products and services, the international dimension of Islamic finance is becoming increasingly more significant. Islamic financial institutions are now also venturing their operations beyond their domestic borders. Islamic-based papers are also being issued in international financial markets, generating significant interest from global investors. The international financial architecture for the development of Islamic finance has also been strengthened with the establishment of the international boards to set the accounting and prudential standards. These developments have cumulatively evolved the Islamic financial system to increasingly become an integral component of the international financial system. The Malaysian experience has been to evolve a comprehensive domestic Islamic financial system that is diversified in terms of its institutions, markets and players. The strategy has been to institute the entire financial system chain to ensure the efficient functioning of the system.

The initiatives include establishing the required financial institutions including, the Islamic banking institutions, takaful companies, the non-banking institutions and developing the Islamic money and capital markets. These respective components have recently been progressively liberalized in terms of allowing for the entry of new foreign players and in terms of increasing the potential for foreign participation in the domestic financial markets. In addition, both these domestic and foreign operations have been encouraged to tap on regional and international business opportunities. As a result, this has strengthened the crossborder financial inter-linkages, prompting greater international integration. To ensure the robust functioning of the system, these developments are supported by a strong regulatory and supervisory framework reinforced by the legal and Shariah framework and the payment and settlement systems. While the positive growth and developments in the Islamic financial system have brought about expanded opportunities, the financial liberalization and technological advancement have brought about increased competition and greater innovation in the development of products and services, operational processes and delivery channels. These developments have contributed to increasing the risk profile of the institutions. These new risks are generally more complex and have more profound systemic implications to the financial system. This has increased the need for strengthened risk  BIS Review 8/2006  1  management capabilities by the industry and for greater attention to this aspect by regulators and supervisors in promoting the stability and integrity of the financial system. Of importance is to ensure an understanding and awareness of the risks inherent in Islamic banking activities.