Being smaller and relatively young, Islamic finance currently offers fewer product choices for consumers and less comprehensive risk management options for institutions. Cross-border investment flows are also constrained by differing interpretations of permissible transactions under  2  BIS central bankers’ speeches  Shariah principles. The isolated pools of Islamic liquidity in each market restrict opportunities for more efficient allocation of capital across consumers, industries, and jurisdictions. Islamic finance must become more integrated with the global financial system. The industry must expand beyond its traditional markets to include a wider range of financial institutions, investors and consumers. This means Islamic finance must strike roots in the key international financial centres of the world. These centres can contribute to Islamic finance in several ways. First, market liquidity. The broad and deep investor pools in international financial centres offer an opportunity to channel non-traditional sources of funds into Islamic finance. In Singapore, for instance, several local and foreign issuers have successfully tapped the capital markets using Islamic instruments. The demand comes from not just Singapore but a diverse group of international investors across Asia and Europe. Many of them are conventional investors, attracted by the credit quality and yields. Second, capabilities in global financial markets. Islamic finance should leverage on the capabilities and strengths offered by conventional financial markets in international centres, to augment the range of Shariah-compliant products. Take for example the market for Real Estate Investment Trusts, or REITs.

Islamic finance in the era of deleveraging The clear and present danger to all financial activity, including Islamic finance, is the risk of contagion from an escalation of the Eurozone crisis. Islamic finance is closely intertwined with underlying economic activity and will be affected by the impact of slower global growth. Contagion from the Eurozone has already curtailed economic growth and capital inflows to many emerging economies where Islamic finance has taken root. Potential spillovers from an escalation of the Eurozone crisis could lower output in the Middle East and North Africa region by about 3¼ percent relative to baseline, the largest spillover effect for any region outside Europe. But Islamic finance has a window of opportunity in the current climate of deleveraging in the global financial system. With its strict prohibition on excessive leverage, Islamic finance has been spared the worst of the financial crisis. Islamic banks are well positioned to reach out to new customers who are in need of financing as many global institutions pull back on their lending due to the need to repair their balance sheets. Islamic finance should diversify into growth areas such as trade and infrastructure financing, where demand is still strong, especially in emerging economies. With a focus on supporting real productive activities, Islamic finance is naturally compatible with trade and infrastructure development. Tapping these sectors also brings about greater diversification benefits, especially for Islamic institutions which have been hurt by their significant lending exposure to the real estate sector.