This is derived from the Shariah principles, the key pillar of Islamic finance. The Shariah injunctions require that Islamic financial transactions be accompanied by an underlying productive activity resulting in a close link between financial and productive flows. Under the risk sharing concept, there is an explicit risk sharing by the financier and the customer. In this arrangement, the real activity is expected to generate sufficient wealth to compensate for the risks. Parties to the transactions would thus be insulated from excessive risks exposure given that the Shariah prohibits the excess leverage and involvement in speculative financial activities. The intrinsic principle of profit and risk sharing thus provides an in-built check and balance to the Islamic financial transactions. A combination of these distinct features together with the implementation of prudential risk management standards and practices would contribute to the robustness and resilience of Islamic financial system. Mutual respect on Shariah matters This decade has thus been a phase of innovation in the global Islamic financial system with a number of breakthroughs and major milestones in innovative deals and structures. The advancement of sukuk, Islamic securitization, Islamic private equity, Islamic real estate investment fund and other financial instruments in terms of sophistication and product range has widened the international market reach of Islamic finance, particularly in the cross border transactions. At the same time, this phase is also seeing a number of key issues being raised, particularly in respect of divergence of Shariah views underlying a number of the Islamic financial transactions.

By the time Bank Rate had exerted its full influence on the price level, the effect of the shocks was likely to have already dissipated, if not reversed. Second, Bank Rate would have dampened inflation by adding even more downwards pressure on demand on top of the existing recessionary forces. The consequent fall in output and rise in unemployment would have been greater. These two considerations mean that a monetary policy response would most likely have only injected extra volatility to inflation: by the time the price shocks wore off, we would have been facing a severe undershoot of the inflation target and deflation would have been a distinct possibility. The path of output would have been unnecessarily volatile and the deviation of inflation from target might have been different but no more acceptable. The possibility of such shocks, and indeed the ability to respond as we have done, was foreseen when the inflation target regime was conceived. Indeed our Remit from the Government is clear on the consequences. The Remit says that (with my emphasis): “The framework takes into account that any economy at some point can suffer from external events or temporary difficulties, often beyond its control. The framework is based on the recognition that the actual inflation rate will on occasions depart from its target as a result of shocks and  4  The latter would affect CPI directly though its impact on imported consumer goods and services, and indirectly by affecting the cost of domestic production reliant on imported intermediate inputs.