Zeti Akhtar Aziz: The future prospects of the Islamic financial services industry Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the IFSB interactive session, Bali, 31 March 2004. *  *  *  Our endeavour is to develop an Islamic financial system as an intermediation process that will contribute to overall wealth creation, growth and development and a greater shared prosperity. As the pace of globalization and liberalization accelerates, securing financial stability and confidence have increased demands for more robust and resilient financial systems. The challenge is therefore to evolve strategies that will promote a competitive, dynamic and sustainable Islamic financial services industry. Central to this common vision, to create a comprehensive Islamic financial system that will be able to respond to meet the requirements of the domestic economies and also to become an integral component of the international financial system. Distinguished guests, Assalamu’alaikum Warahmatullahi Wabarakatuh, It is my pleasure to be here today at this conference organised by the Islamic Financial Services Board to discuss the future prospects of the Islamic financial services industry. Malaysia’s experience in the development of our financial system is outlined in our ten year Financial Sector Masterplan. The Masterplan represents the blueprint that provides the strategic direction for the development of the sector that looks beyond the near term and takes a long-term perspective into the needs of the future.

Regulatory emphasis has shifted towards a more risk sensitive regulatory capital framework and the assessment of risk management systems and processes in financial institutions. Extensive investment has been made by the industry to adopt a comprehensive and robust internal risk management infrastructure. In Islamic banking, the requirement to manage risks becomes more important due to the special nature of the financial intermediation process that is guided by the Shariah. Islamic financial institutions have a multi-facet role. On the asset side, Islamic financial institutions enter into diverse modes of Islamic financial contracts, each with its own peculiar risk characteristics. Basel II, has to a certain extent, incorporated the identification of credit, market and operational risks that can be assimilated by Islamic financial institutions. However, Islamic financial institutions need to be ahead in exploring other dimensions of risks in these Islamic financial contracts. The risk management infrastructure in Islamic financial institutions must therefore be in place to identify, unbundle, measure, monitor and control all the specific risks in Islamic financial transactions and instruments to provide for their effective quantification and management. Strong risk management capabilities become more pertinent in view of the different contractual arrangements entered into by the Islamic financial institutions with the different classes of depositors. Demand deposits, under the guaranteed custody contract and investment deposits, under the Mudharabah contract, each has its own unique risk and return attributes. Islamic financial institutions must ensure that demand depositors are protected from the risks of Islamic banking business.