With its growing international dimension, Islamic finance has assumed an increasingly important role in facilitating regional and international trade and investment flows thereby intermediating significant cross border financial flows. More recently, international financial centres such as London and Hong Kong have been increasing their connectivity with the Middle East and Asian regions, two important growth centres in the global economy. The increased international dimension of the sukuk market, in particular has facilitated the movement of funds across borders from jurisdictions with surplus funds to regions with investment opportunities thereby enhancing its potential as a vehicle to foster greater trade flows and investment and thus facilitating growth and development. The development of Islamic finance and its risk-sharing and equity financing aspects could be significantly rewarding for countries that venture into this alternative form of financial intermediation. However, to fully realise its potential, different elements of the financial system must evolve in tandem to provide the enabling conditions for this to occur. In such a system, it is essential for both investors and entrepreneurs to embrace different approaches in managing risk and return relationships that are embedded in the many variations of Shariah contracts. It is important that these relationships are well understood by the parties involved, and aligned with the clear contractual and operational requirements. 4  BIS central bankers’ speeches  Islamic finance: financial stability issues and challenges It is imperative that the lessons of the global financial crisis are not lost as the growth of Islamic finance gains further traction.

Some observers have voiced concerns that the APP could in fact negatively affect bank lending by squeezing margins and hence banks’ profitability. I do not share this view. ECB staff estimates of the impact of the APP show the overall effect on bank capital to be positive. Capital gains on securities held, lower funding costs, improved credit quality and higher intermediation volumes outweigh the negative impact of the flattening of the term structure on net interest income. Though structural problems certainly remain in the euro area banking sector, banks’ weak profitability is to a large extent linked to the macroeconomic environment – something that the successful implementation of our programme will help address. In sum, the expanded APP, combined with our other credit easing measures, is largely producing its desired effects. We judge that the recent volatility in financial markets has not materially affected this picture, although close monitoring and continuous assessment are warranted from a monetary policy perspective. It is nonetheless clear that the effectiveness of the APP would be enhanced by complementary measures from other policymakers. In particular, the improving economic and financial environment provides the ideal conditions for governments to press ahead with structural reforms, which are in turn necessary to make  BIS central bankers’ speeches  1  the recovery lasting. Raising expectations of future growth is vital to lift animal spirits and encourage a stronger rebound in investment, which is the cornerstone of a self-sustaining economic recovery. 2  BIS central bankers’ speeches