As Joseph Stiglitz put it, “Whenever there are “externalities”– where the actions of an individual have impacts on others for which they do not pay or for which they are not compensated – markets will not work well.” 8 In the real world of banking, potential market failures are particularly relevant. An important market failure stems from the fact that banks enjoy the benefits of a safety net. Many countries have explicit deposit insurance schemes, which limit depositors’ losses. Moreover, in almost every country there is some degree of implicit government protection for large banks. In the current crisis, government protection has become manifest and explicit in the form of the recent G7 and G20 communiqués. Most notably, in October the G7 finance ministers and central bank governors declared unambiguously that they “agree to take decisive action and use all available tools to support systemically important financial institutions and prevent their failure.” 9 In other words, governments imply that large banks are simply “too big to fail”. Clearly, there are benefits to banks having safety nets. But there are also serious costs. It is a fact that the presence of insurance leads to less careful behaviour, otherwise known as moral hazard. If you rent a fully insured car, you will likely exercise less care driving it. 4  See the October 2008 issue of the IMF‘s Global Financial Stability Report, entitled ”Financial Stress and Deleveraging“. 5  Declaration of the Summit on Financial Markets and the World Economy, G20, 15 November 2008.

The regulatory framework governing market practices by the Islamic financial institutions can also be strengthened further to ensure its continued soundness. This will involve the implementation of the prudential standards that have been issued by the Islamic Financial Services Board, the IFSB. Greater transparency through the observance of minimum disclosure requirements needs to be adopted by the industry. Good business practices need to be embedded in all aspects of Islamic financial operations, not only as part of good governance and corporate social responsibility, but also as part of brand building. Market efficiency in conducting Islamic business activities can also be enhanced further to ensure its sustained competitiveness as an intermediation process. As we are advancing into the third phase of the Financial Sector Master Plan, where the environment will become increasingly more liberalised and dynamic, we now have to look beyond the 2010 strategies. A key feature of the new environment is increased competition. The benefit of this trend will be to the consumers and businesses in terms of better prices, better range of products and services that are of a higher quality. This in turn would contribute to the overall performance of the economy. To be at the leading edge of competition, continuous efforts have to be intensified to enhance business efficiency and innovation. In this regard, the Islamic subsidiaries, with their increased autonomy in business operations, would be better positioned to determine their own business strategies and to realise the vast growth potential in the Islamic financial industry.