samchain/econo-pairs-v1 huggingface dataset:
Zeti Akhtar Aziz: Islamic finance – constant evolution and emerging opportunities Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Nikkei Islamic Finance Symposium 2008: "Islamic Finance: Constant Evolution and Emerging Opportunities", Tokyo, 23 February 2008. *  *  *  It is my great honour and pleasure to be here in Tokyo to speak at this Islamic Finance Symposium organised by the NIKKEI. This is an important forum that provides the opportunity to foster a greater understanding and appreciation of Islamic finance and its increasing role in the international financial system. We are also very honoured by the presence and participation of Governor Fukui from the Bank of Japan at this Symposium. My remarks today will focus on the evolution and new emerging opportunities in Islamic finance as its growth and development in the global financial system gains further momentum. My presentation will also touch on our experience in the development of an Islamic financial system in Malaysia which operates side by side with the conventional financial system and in which the international dimension has now become increasingly significant. Evolution of Islamic finance Modern Islamic finance was initially developed as an intermediation channel for Muslims to conduct their savings and investment activities in accordance with the Islamic principles. As recent as five years ago, however, Islamic finance has experienced major transformations. Its rapid evolution is particularly evident in five dimensions of its development.

Financial sector repair There is considerable empirical evidence that a strong driver of aggregate productivity growth is “churn” between firms – less productive firms exiting the market and new innovative firms entering, or existing firms reallocating resources to more productive sectors.3 The job of the financial sector is to ensure that credit allocation supports this process. However, what seems to have happened, at least in parts of the euro area, is that banks with weak balance sheets have retarded this process. One recent study found that larger banks have reallocated credit away from riskier firms, preventing new entrants, while smaller banks have engaged in so-called ever-greening of loans, inhibiting firm exits.4 Weak banks also appear to have slowed down sectoral reallocation. To give just one example, despite the recent improvements in cost and price competitiveness in Greece, the sectoral allocation of credits has not substantially shifted towards export-oriented firms.5 This suggests that banks in certain euro area countries are not facilitating sufficiently the shift towards more productive sectors. Financial sector repair therefore has to be at the core of any policy to raise euro area growth potential. And to ensure that lending is directed towards productive activity, in my view there are two policy priorities. The first is to strengthen bank balance sheets – that is, for losses to be properly acknowledged and for adequate recapitalisation to follow.
And, as the banks have grown larger and have increasingly expanded their operations over national boundaries over the last decade, each nation cannot solve such problems alone. The question of how to manage crisis banks is currently the subject of intensive discussion across the world, and new regulations of some form must also arise from this discussion. Today, I plan to address another lesson from the financial crisis, a lesson that has not yet led to any consequences in the form of regulatory changes, but which nevertheless must be dealt with in the long term. It applies to Sweden, but also to many other countries, particularly in Europe. It relates to the banks’ dependence on funding in foreign currencies, primarily US dollars. What kind of risks are the Swedish banks taking when they borrow in dollars – and who bears the cost? As usual, I would like to point out that the thoughts I present are my own and are not necessarily shared by my colleagues on the Riksbank’s Executive Board. The dollar crisis… As we all know, when Lehman Brothers collapsed in September 2008, the immediate effect was a liquidity crisis that affected the entire world to varying degrees. Banks and investment banks that had based their business on being able to rapidly obtain large volumes of shortterm borrowing, for example by issuing securities with short maturities, discovered that investors in these securities suddenly just vanished.

The level of mistrust among US investors towards new instruments with collateral in property in small, distant countries should not be underestimated. BIS central bankers’ speeches  7  So, in terms of risks for an acute liquidity crisis, it is important how the banks borrow, in particular which proportion of the borrowing is short-term. And this brings the problem back to just how to get hold of dollars. However, the problem is also related to that of how the borrowed dollars are used. In principle, there are three options. One way is to purchase US government bonds to use as a liquidity reserve. Borrowing for this purpose (and this has been significant for a couple of banks, at least) does not form a problem. Government bonds can always be sold on the market when the loans fall due, as they are highly liquid and remained so throughout the entire crisis. Another way of using the borrowed money is to exchange it immediately into Swedish kronor, but at the same time to enter into a forward contract where these kronor are exchanged back to dollars on the same date as the loan falls due. This entire process – borrowing in dollars, the immediate exchange into kronor and the exchange of these back again into dollars when the transaction falls due – is generally combined into a single transaction known as a currency swap.
Collective bargaining arrangements should be made more flexible to provide a framework in which, establishing  8  BIS Review 60/2006  the necessary guarantees for workers, wage and working conditions are adapted more readily to the needs of an efficient and competitive functioning of firms and industries. It is also crucial to promote permanent hiring, to correct the duality persisting in the labour market, since the ratio of temporary to total employees has continued to increase in 2005 and in 2006 to date. The agreement on labour market reform recently signed by the social agents and the government is a very timid step in this direction; although it seeks to discourage temporary hiring (with results that are difficult to assess in advance), it leaves some of the core problems underlying the restrictive use of permanent hiring largely unchanged. In particular, although a more transparent system of rebates has been introduced for this type of hiring, the dismissal costs linked thereto have not been changed. In this connection, mention may be made of the extension to 2007 of the period in which employers can convert temporary contracts into permanent ones, availing themselves of the employment-promoting contract, which envisages a smaller redundancy payment. The issues pending in the field of labour reform are very important, since this is a very significant area for the effectiveness of the numerous liberalisation measures implemented first, under the Plan de Dinamización (plan to bring about a more dynamic economy), and further under the National Reforms Programme.

In the face of these risks, and with monetary policies in the main areas closer to a neutral stance (which also entails greater uncertainty about their future course), central banks must persevere with those decisions that bolster the credibility of these policies, since price stability is the best contribution we can make to economic growth. A second main factor of risk is that continuing world growth might be jeopardised by the presence of growing global imbalances. These could trigger or amplify significant adjustments on international financial markets, such as sharp increases in interest rates and in risk premia. Correcting the imbalances requires the adoption of appropriate economic policies in each of the main economic zones, policies which will, fortunately, also shore up the foundations for growth in each of these areas in the long run. A clear instance of this complementarity can be found in US fiscal policy, whose moderation would contribute to reducing its external imbalance and would improve its mediumterm growth prospects. As to the emerging Asian economies, further steps towards making their  2  BIS Review 60/2006  exchange-rate regimes more flexible will be needed, especially in China. This will not only contribute to more harmonious and sustainable world growth, but will be an essential ingredient for entrenching progress in China towards higher levels of well-being.
So it is worth taking the time to ensure that the new security features, which are complex, technologically innovative and have never before been applied to banknote design, can also stand up to the rigours of industrial production processes. A number of tests are currently being carried out. The first denomination in the new series – the 50-franc note – will not be issued until 2015 at the earliest. We will announce the exact issue date as soon as production of the first banknote denomination has been completed. BIS central bankers’ speeches  3

The increasing interest in the region is also motivated by the need at many pension funds and sovereign funds to achieve more diversified investment portfolios. •  These funds are increasingly diversifying their portfolio allocations across geographies and reducing the home bias towards investment in domestic markets. •  They are also diversifying across assets to include more non-traditional assets such as real estate, private equity and infrastructure, which promise sustained and attractive risk-adjusted returns. Emerging Asia offers both asset and geographical diversification. •  Emerging Asia will remain one of the fastest growing regions in the world offering prospects of higher long-term returns, while the depth and liquidity of its asset markets should continue to improve. •  The growth dynamics of Emerging Asian economies is not only different from that of developed Europe and America but also differentiated from one another. •  Emerging Asia offers great potential for the development of alternative investment assets such as infrastructure, for which the region has enormous need. I congratulate NPS on the opening of its Singapore office and wish you continued success in your regional strategy. BIS central bankers’ speeches  3
Chart 1 Outstanding Notional Amounts of Derivatives $ 700  Interest rate contracts Foreign exchange contracts Credit default swaps  600  Equity-linked contracts  500  Commodity contracts Unallocated  400 300 200 100 0  98  99  00  01  02  03  04  05  06  07  Source: BIS. •  The credit default swap (CDS) component has experienced explosive growth. The outstanding value of CDS contracts has surged to more than five times the outstanding principal of global corporate bonds by the end of 2007. Yet only three years’ ago, at end-2004, the CDS market was only some 85% of the size of the corporate bond market. The CDS market is now by far the more liquid market for trading credit risk. •  The outstanding value of commodity derivatives outstanding has risen from around $ billion in 1998 to $ trillion at the end of 2007. •  Options markets have also grown very strongly. For example, the outstanding principal of interest rate options has increased from $ trillion to $ trillion in the past decade. •  Innovation and the removal of barriers to cross-border activity has spurred global capital market integration. For example, turnover in foreign exchange markets has tripled since the BIS survey in 2001. And cross-border asset holdings have outpaced the strong growth in the global stock of financial assets. •  Markets offering investors ready-made portfolios rose very rapidly in advance of the credit crisis.

We are now almost a year into a credit crisis centred around a sudden evaporation of market liquidity for many structured credit products that rapidly spilled over into wholesale bank funding markets and beyond, given a complex web of interconnections. 2 So it is an opportune moment to review whether the financial innovation of recent years that created such structured products has indeed been a positive force, as argued by Alan Greenspan 3 , for example, or whether financial innovation has been a malign development, producing “financial weapons of mass destruction” in the words of Warren Buffett 4 ? 3 There is clearly some force in both arguments. On balance, we continue to see considerable benefits to households and corporates from the broadening of choice in financial products and from improvements in the completeness of financial markets. But equally, the severe pressures and strains of the past year have highlighted the pervasiveness of some market frictions that have a major bearing on system-wide behaviour and dynamics, amplifying and transmitting shocks. Action to lower these frictions is consequently important to capture the full benefits of innovation and to ensure that these are durable. 4 This paper explores these issues further. Section 2 provides a short reminder of the staggering extent of financial innovation in recent decades. Section 3 sets out the theoretical vision of how financial innovation offers the potential for substantial improvements in the capability of corporates and households to manage financial risks.
To do this properly, we will have to work with international supervisors, regulators, and governments to achieve global solutions. On this score, lots of progress has been made in the credit default swap space – with several new CCPs likely to be up and running in months, if not weeks. But we can do much more in this area. •  We need an accounting and disclosure regime that allows investors to meaningfully ascertain the risks they are taking. For example, the same assets are often carried on different bank books at different prices. If you can’t trust the valuation marks on the assets, how robust can confidence be in the ability of the financial system to withstand stormy weather? •  We need a resolution mechanism for bank holding companies and non-bank financial institutions – legislation is needed here. Judging from the actions of the past year, there are indeed institutions that are “too big to fail”, at least in certain circumstances. Let’s set up a resolution framework that is robust and transparent so everyone understands the rules of the road and likely outcomes beforehand. An ad hoc approach increases uncertainty and reduces policymaker credibility. •  If large systemically important institutions are indeed too big to fail, then there needs to be an explicit quid pro quo for this. Otherwise, this implicit support will create moral hazard and discriminate against smaller institutions.

Commercial paper rates in the market were high and the issuers wanted to extend the maturity of their obligations. But since that time, purchases have slowed sharply. Following the introduction of the CPFF, commercial paper rates in the marketplace dropped below the rates charged by the CPFF. As a result, issuance into the program has collapsed because many issuers can now raise funds more cheaply in the private market. About half of the maturing paper in the CPFF has not been rolled over. As a result, the amount of CPFF holdings, which peaked at around $ billion in mid-January, has fallen by over $ billion, to below $ billion. To date at least, the CPFF has worked as planned and has been very successful in rehabilitating the commercial paper market. Second, the Term Asset-Backed Security Loan Facility or TALF will provide balance sheet capacity directly to investors beyond the banking and dealer community. This program is designed to restart the securitization markets. The TALF is being rolled out in two stages. In the first stage, which I’ll call TALF Version 1.0, the Federal Reserve will provide non-recourse loans to investors against AAA-rated consumer asset-backed securities collateral. Primary dealers will serve as the contact point with these investors to make it easier for the Fed to interface with potentially hundreds of investors. The AAA-rated securities eligible as collateral for this non-recourse lending program are used to fund a wide variety of consumer and business loans, including student , credit card, auto and small business administration loans.
The policy debate for the time being remains - as I’ve said before - a comparatively narrow one about just how strong the growth, how high the level of employment and how low the rate of inflation. In terms of the economy as a whole, I’m tempted to rest my case. Our problem - and it is a real problem, as we have recognised for some time - is the imbalance, within the overall economy, between the domestically-oriented businesses and sectors, and those that are most internationally exposed. In part that imbalance is a hangover from the earlier global slowdown - though the welcome recovery in global demand means that this influence is now diminishing. The more important factor now is the persistent weakness of the euro - not exclusively against sterling but equally against the dollar and the yen. The impact is particularly severe on the UK because of the closer ties between our economy and that of the euro zone. I’ve not heard a wholly convincing explanation for the euro’s persistent weakness. Many analysts relate it to market concerns about structural rigidities in some parts of the euro zone, which are encouraging direct capital outflows attracted elsewhere by higher prospective earnings growth. Whatever the cause, few of those I talk to expect it to persist. But in the meantime, given that the problem is a general weakness of the euro rather than any particular strength of sterling, it is very difficult to see what we can do directly to resolve it.

4  See Kenneth Rogoff, Aasim M. Husain, Ashoka Mody, Robin Brooks and Nienke Oomes (2003): “Evolution and Performance of Exchange Rate Regimes”, IMF Working Paper 03/243; Eduardo Levy-Yeyati and Frederico Sturzenegger (2003): “To Float or to Fix: Evidence of the Impact of Exchange Rate Regimes on Growth”, American Economic Review, September 2003, pp. 1173-1193; Jeannine Bailliu, Robert Lafrance and Jean-Francois Perrault (2003): “Does Exchange Rate Policy Matter for Growth?”, International Finance 6:3, 2003, pp. 381-414. BIS Review 25/2004  5  In 2003, wage growth was considerably lower than in the previous five years. This provided a sounder basis for substantial reductions in Norwegian interest rates, resulting in a narrowing of the interest rate differential between Norway and other countries. The reduction has contributed to a weakening of the krone since December 2002. Thus, the real exchange rate has also weakened and business sector competitiveness has improved. However, the business sector is still feeling the effects of the loss in competitiveness that resulted from high wage increases. The internationally exposed sector has been scaled back. Those companies that are still operating may be in a better position to bear the high wage level. Nevertheless, costs may hamper activity and employment growth. For a long time, a stable exchange rate and the level of cost inflation among our trading partners provided an anchor for wage determination in Norway.
Twenty-five years from now, I am confident that one of my successors will be able to look back and explain in his or her Mais Lecture the great improvements that took place between 2005 and 2030. But I like to think that the inflation target framework has the ability to serve us well over that period. Thirty years ago the theory of monetary policy was ahead of its practice, at least in the United Kingdom. Now I hope that the practice has given the theorists something to think about. Table 1: Inflation targeting countries Country New Zealand Chile Canada Israel U.K. Sweden Finland Australia Spain Czech Republic Korea Poland Mexico Brazil Colombia South Africa Thailand Iceland Norway Hungary Peru Philippines  Adoption of Inflation Targeting Dec. 1989 Jan. 1991 Feb. 1991 Jan. 1992 Oct. 1992 Jan. 1993 Feb. 1993 Mar. 1993 Jan. 1995 Apr. 1998 Apr. 1998 Oct. 1998 Jan. 1999 Jun. 1999 Sep. 1999 Feb. 2000 May 2000 Mar. 2001 Mar. 2001 July 2001 Jan. 2002 Jan. 2002  Source: Truman, Edwin (2003), Inflation Targeting in the World Economy, Institute for International Economics, Washington DC. The table not only includes current inflation targeting countries, but also Spain and Finland, which have since joined EMU.

But it went on, “…there are serious possibilities of conflict between them.”4 Second, the rate of inflation in the long run is determined by monetary policy, not by microeconomic factors. Again, that is now taken for granted, but much effort was devoted to the imposition of detailed direct wage and price controls in the 1960s and 1970s. Nicholas Kaldor, adviser to Harold Wilson, wrote in 1971 that “It is also far more generally acknowledged – even by Conservative Prime Ministers – that the process of inflation is 'cost-induced' and not demand-induced', with the evident implication that it can be tackled only by an incomes policy'”. Not many Whitehall advisers would give that answer today. Third, in the short run monetary policy does affect output and employment and so has the potential to be an effective stabilisation tool. Reflecting a post-war consensus that monetary policy was rather ineffective, however, the Radcliffe Report concluded that “…. there can be no reliance on this weapon [interest rate policy] as a major short-term stabiliser of demand”5 It is now accepted that monetary policy lies at the heart of any attempt to stabilise the economy. The source of monetary policy’s influence over output and employment lies in frictions, which mean that prices and wages do not adjust instantaneously to clear markets whenever demand and supply are out of balance. Firms change prices only irregularly in response to changes in demand; wages adjust only slowly as labour market conditions alter; and expectations are updated only slowly as new information is received.