level of financial literacy among the consumers and businesses. towards achieving this objective, consumer education programs have been conducted, providing information among others, on the unique characteristics of islamic banking and finance, islamic financial products and services and the underlying shariah principles and concepts. enhanced consumer awareness is expected to strengthen the role of market discipline in driving the islamic financial institutions towards strict shariah compliance, enhanced operational efficiency, and strengthened risk management infrastructures and practices. in malaysia, islamic banks and conventional banks with islamic banking windows observe similar prudential standards as imposed on conventional banks such as the minimum risk weighted capital ratio ( rwcr ), standards for corporate governance and risk management, financial disclosures and know your customer policy. the principles of prudent management and enhanced operational efficiency are inculcated through the minimum risk weighted capital adequacy requirement. corporate governance standards have been enforced through specific guidelines on the code of conduct for directors, officers and employees of the banking institutions and guidelines on the directorship and prohibition of loans to directors, staff and their selected corporations. in addition, strict compliance with the tenets of shariah would also ensure that the islamic financial institutions are managed on the basis of a high degree of prudence, ethics and integrity. the basel committee on banking supervision has enhanced its capital regulation to include operational risk in the computation of capital adequacy, in addition to credit and market risks. the task of formulating a framework that addresses the peculiar risks associated with islamic banking is being undertaken by the islamic financial services board ( ifsb ), which serves as an international standardsetting body for regulatory and supervisory agencies. its mandate is to develop prudential, regulatory and disclosure standards for islamic finance, and promote uniformity in the best practices on the governance of islamic financial institutions worldwide. in this respect, the ifsb has recently issued two prudential standards on risk management and capital adequacy for institutions offering islamic financial services, which are recommended for implementation in 2007. the ifsb has also made progress in developing three other standards on corporate governance, transparency and market discipline, and the supervisory review process to be released in due course. a key challenge in managing operational risk in islamic banking is ensuring shariah compliance. bank supervisors in their assessment would need to give due attention to the adequacy of the financial institutions'board and management oversight, policies, procedures and limits, risk measurement, monitoring and management information systems, and internal controls. the

the increased capital inflows following the capital account liberalization represents another source of financing that would contribute towards increased investment and growth. it will allow jurisdictions with surplus funds to be channelled to those regions with productive investment opportunities and thus contribute towards a more efficient allocation of funds across international borders. the stronger cross border financial linkages has the potential to enhance international trade and investment opportunities. it allows countries to leverage on the respective comparative advantage and complementarities to reinforce mutual growth. this would be important in the current environment to facilitate cross border economic activity. the liberalisation of the capital account in the form of removing restrictions to foreign exchange transactions would also increase the flexibility of managing such foreign exchange transactions. this would increase the potential to better manage its associated risks, while bis central bankers ’ speeches the increased efficiency gains would also reduce the cost of doing business. finally, it is also argued that in a more liberalised environment, there would be greater market discipline which would in turn promote financial stability in the domestic financial system. this however, relies on a sufficient level of disclosure and transparency to allow the efficient functioning of the markets. the internationalization of financial systems is however, not without risks and challenges. the risk of contagion following from the increased connectivity increases significantly, in terms of the extent and speed. the contagion can result from external events and developments that can range from failure of large and important international financial institution to the eruption of wars or political incidents that have regional or global repercussions. meanwhile, global developments including from global policy spillovers have also resulted in more volatile capital flows. the increased openness of the financial system also increases the vulnerability to economic cycles in other parts of the world. the increased interdependence of financial systems and economies and the contagion effects can be expected to be among the significant outcomes of financial internationalization. financial liberalization could for example amplify further the implications of financial stress from other parts of the world on the domestic financial system. it could also accentuate and amplify asset bubbles and boom bust cycles. other implications are that it could contribute to the widening of income disparities and also to the marginalization of domestic financial institutions if they are not able to perform in a more competitive environment. finally, volatile capital flows may not only affect the efficient functioning of the financial markets but could result in misaligned exchange rates that do not reflect underlying fundamentals. these potential risks and vulnerabilities continue to be