Zeti Akhtar Aziz: Current issues and developments in Islamic banking and finance Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the ASLI’s Conference on Developing Islamic Banking and Capital Market: “New Opportunities, New Market and New Frontier in Islamic Banking and Finance”, Kuala Lumpur, 25 August 2004. *  *  *  Islamic banking and finance has emerged as a financial intermediation process that is competitive and resilient and that contributes to the overall wealth creation, growth and development of our nation. Amidst an increasingly challenging and competitive financial environment, the evolution of a comprehensive Islamic financial system seeks to meet the range of requirements of a rapidly changing economic environment, with its soundness and stability secured through the robustness of its regulatory framework supported by the strength of its financial infrastructure and the sophistication of its products and services. Indeed, the strength of the respective components of the system and the interconnections of its markets will open new frontiers in Islamic banking and finance and will maximize the potential and opportunities that it accords. Distinguished guests, It is my pleasure to be here today at this conference organised by ASLI to speak on the current issues and developments in Islamic banking and finance. The Islamic financial system in Malaysia has evolved as a viable and competitive component of the overall financial system, complementing the conventional financial system as a driver of economic growth and development.

In a dual financial environment, the prudential regulatory design needs to take into account the unique characteristics peculiar to Islamic banking and finance as well as provide a level playing field in relation to conventional banking and finance so as to ensure that Islamic financial institutions and transactions are not at a comparative disadvantage. It also needs to assess and mitigate any potential regulatory arbitrage practices between the conventional and Islamic financial system that could undermine the stability of the overall financial system. While conventional banking is primarily premised on an interest-based debtor-creditor relationship, Islamic banking transactions are relatively more complex arising from the diverse contractual relationships between the Islamic financial institutions and their customers, ranging from the low risk sales and lease-based modes of finance to the higher risk equity-based modes. Each of these modes of finance has a distinct intrinsic characteristic dictated by its underlying Shariah principles and thus, entails different risk profiles. Therefore, the risk management infrastructure in Islamic financial institutions must be in place to identify, unbundle, measure, monitor and manage all the specific risks in Islamic financial transactions and instruments to provide for their effective quantification and management. The establishment of the Islamic Financial Services Board (IFSB) in 2002 marks an important milestone in the development of internationally accepted prudential regulatory standards and best practices for the Islamic financial services industry. Since its establishment, the IFSB has attracted wide participation. To date, there are 13 full members, 4 associate members and 35 observer members in the IFSB.