Zeti Akhtar Aziz: Globalisation of Islamic finance services – opportunities and challenges Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Fifth IFSB Summit: Session 1: Globalisation of Islamic Finance Services – Opportunities and Challenges, Amman, Jordan, 13 May 2008. *  *  *  This decade has seen the financial globalisation of Islamic finance gain significant momentum. While the early development of Islamic finance was domestic centric, its internationalisation is now manifested by increased cross border flows, greater participation in international Islamic financial markets, the increased presence of Islamic financial institutions in new jurisdictions and more recently, the increased number of Islamic financial institutions which have shareholders from multiple jurisdictions. This trend has strengthened the international economic and financial interlinkages between nations bringing with it mutually reinforcing gains. Financial globalisation has essentially been facilitated by the more rapid pace of liberalisation, the advancement in the information and communications technology, and the significant progress achieved in the development of the international financial infrastructure. This trend has also been reinforced by the search for higher returns and the need to diversify risks. In the current international financial environment of increased uncertainties, this trend has become even more pronounced prompting investors to venture into new asset classes and markets that provide stability. The globalisation of Islamic financial services With the increased significance of the international dimension of Islamic finance, the financial landscape has been dramatically transformed with more diverse players and a more competitive environment.

The symptoms of this are apparent in the high risk premia across a range of assets, as well as in the dramatic contraction in the volume of transactions for certain assets and the securities that reference those assets. Elevated term premia in the interbank market has the effect of tightening overall financial conditions, offsetting some of the impact of reductions in the target federal funds rate. The danger this poses is the risk of an adverse, self-reinforcing dynamic in which concerns about overall liquidity magnify concerns about credit problems. As financial institutions prepare for a more challenging funding environment, in part by conserving capital, and as they anticipate the higher potential losses that would normally accompany an economic slowdown, their response, in aggregate, makes markets and the economy potentially more vulnerable to that adverse outcome. The risk is a greater contraction in the availability of credit beyond what might have otherwise occurred, with attendant risks to growth. BIS Review 149/2007  1  Monetary policy has an important role to play in addressing these dynamics in markets. By adjusting policy proactively as the risk to the outlook changes, central banks can help reduce the probability of the extreme adverse outcome. And this can positively affect the incentives that might otherwise lead market participants to protect themselves against the extreme outcome. Central banks have been employing a range of different tools to help reduce the incentive for an excessive level of liquidity hoarding by banks that might impede an efficient flow of liquidity among banks.