inherent in the islamic financial transactions. the risk management infrastructure in islamic financial institutions needs to identify, unbundle, measure, control and monitor all the specific risks in the islamic financial transactions and instruments. this is to ensure that the systems and controls will be effective in the quantification and management of the risks arising from the operations. new innovations in technology would be particularly important to enhance the potential to manage risks. in addition, as the returns in islamic banking are uncertain and can only be ascertained on an ex - post basis, well - developed it systems would be necessary to enable islamic banking institutions to make projections on future returns so as to reduce the degree of uncertainty in the returns to be paid to the depositors. this would also strengthen the potential competitiveness of the islamic financial services industry. another facet to risk management is the need for the islamic banking industry to develop a derivatives market. in the current increasingly uncertain global financial environment, investors need to be in a position to mitigate and manage these emerging new risks. islamic banking institutions, in particular, have to a large extent long - term assets which include long - term islamic housing mortgages and islamic financial instruments, that are funded by short - term deposits, thus giving rise to a maturity mismatch between the assets and liabilities. there is therefore a need for the development of a broader range of islamic financial market instruments to provide the industry with effective risk mitigating instruments. in addition to the derivatives market, the islamic financial system also needs deeper and more efficient money and capital markets to facilitate sound asset and liability, and liquidity management by islamic financial institutions. in this regard, bank negara malaysia will issue sukuk al - ijarah, to meet the requirements of participants in the islamic money market. at the core of a strong islamic financial system in any jurisdiction, there needs to be a strong regulatory framework which enforces the standards for capital adequacy, ensures effective risk management practices, financial disclosure and governance, reinforced by a strong shariah and legal framework. shariah principles serve as a self - regulating mechanism that protects islamic financial institutions from unproductive, speculative and unethical activities, given the prohibition of interest or usury in banking business, and the requirement that all financial transactions are to be accompanied by genuine trade and business - related transactions and the prohibition from the involvement in illegal and unethical activities. the regulatory framework in which islamic banking operates is thus able to draw

evolved the islamic financial system to increasingly become an integral component of the international financial system. the malaysian experience has been to evolve a comprehensive domestic islamic financial system that is diversified in terms of its institutions, markets and players. the strategy has been to institute the entire financial system chain to ensure the efficient functioning of the system. the initiatives include establishing the required financial institutions including, the islamic banking institutions, takaful companies, the non - banking institutions and developing the islamic money and capital markets. these respective components have recently been progressively liberalized in terms of allowing for the entry of new foreign players and in terms of increasing the potential for foreign participation in the domestic financial markets. in addition, both these domestic and foreign operations have been encouraged to tap on regional and international business opportunities. as a result, this has strengthened the crossborder financial inter - linkages, prompting greater international integration. to ensure the robust functioning of the system, these developments are supported by a strong regulatory and supervisory framework reinforced by the legal and shariah framework and the payment and settlement systems. while the positive growth and developments in the islamic financial system have brought about expanded opportunities, the financial liberalization and technological advancement have brought about increased competition and greater innovation in the development of products and services, operational processes and delivery channels. these developments have contributed to increasing the risk profile of the institutions. these new risks are generally more complex and have more profound systemic implications to the financial system. this has increased the need for strengthened risk management capabilities by the industry and for greater attention to this aspect by regulators and supervisors in promoting the stability and integrity of the financial system. of importance is to ensure an understanding and awareness of the risks inherent in islamic banking activities. the challenge is to ensure that each component that supports the risk mitigation requirements, comprising the framework and institutional infrastructures, legal, regulatory, supervisory as well as the shariah infrastructures are in place. my remarks this morning will focus on the challenges of risk management in islamic financial institutions, and the roles of effective regulation and supervision in this context as part of the efforts to promote the development of a robust and sound islamic financial system. in islamic banking, the management of risks becomes more challenging due to its peculiar risk characteristics and the requirement for compliance to shariah principles. while the basel ii initiatives on the identification of credit, market and operational risks can be assimilated into islamic banking, the initiatives have to be complemented with consideration of the other dimensions of risks that are