In the area of Islamic banking, the requirement to manage the risks becomes more important because of the unique peculiarities in the contracts. Basel II has, to a certain extent, incorporated some aspects in the identification of risks, in particular the credit, market and operational risks that can be assimilated by the Islamic banks in terms of its product offering. However, further refinement will have to be done by the Islamic financial specialists to assess the appropriateness of the capital definition in particular as outlined by the Basel committee. One of the considerations that need to be addressed in assessing the risks associated with the Islamic bank is with regard to the capital charge on its investment accounts. Basel II does not address this unique feature in its framework. Assets that are funded by monies in the investment account may not require the capital charge for the purpose of capital adequacy measurement except in the case of misconduct and negligence. Similarly, if the Islamic banking institutions were to be more engaged in the profit-sharing arrangement in its balance-sheets, it will require the Islamic bank to have a more rigorous risk management assessment and monitoring mechanism. This is an area that is being addressed by the Islamic Financial Services Board in the drafting of the standard on the overall risk management framework for the Islamic financial community that takes into account this unique requirement of Islamic banking. While risk mitigation is desirable in Islamic finance, further improvements need to be made to the existing risk management framework.

Monetary policy operations were made more market based and active, especially after the introduction of the independent float of the exchange rate in 2001. Monetary policy has concentrated on stability, while promoting economic growth. However, monetary expansion was somewhat above the expected path in 2004. The relatively higher monetary expansion during 2004 was mainly driven by the higher expansion in credit to the private sector as well as to the public sector. Responding to these developments, the Central Bank tightened its monetary policy by raising policy rates in the fourth quarter of 2004. The policy focus was on market stability in the immediate aftermath of the tsunami. Subsequently, after ensuring market stability, the Central Bank has conducted open market operations aggressively to mop up excess liquidity. The Central Bank will continue to mop up liquidity in the coming months. Monetary growth is expected to be contained to 15 per cent in 2005. Monetary policy will focus on restraining inflationary pressure. An area that has experienced rapid growth since liberalisation is the financial sector. This has not only contributed to economic growth in its own right, but has also facilitated growth in other sectors. The Central Bank has actively promoted financial sector stability and development by assisting in the deepening of markets, creation of new instruments and strengthening of the regulatory framework. Prospects and challenges The foregoing forms the background for the economic policies of the government. I would now like to highlight several challenges that have to be faced.