shamshad akhtar : islamic finance – emerging challenges of supervision speech by dr shamshad akhtar, governor of the state bank of pakistan, at the 4th islamic financial services board summit, dubai, 15 may 2007. * i. * * background diversification and structural transformation in financial sector has been accompanied by increasing integration among different segments of the financial sector. the traditional boundaries between banks and non - bank financial institutions are eroding and we are witnessing the growth of universal banking and / or mergers among different segments of sectors. this trend has its benefits but has associated risks as well. supervisors face a dual challenge. on one hand, supervisors are promoting financial diversification and consolidation to achieve market development and innovation. on the other hand, supervisors have to position themselves to recognize the new dimensions and types of risks and encourage appropriate risk mitigation. these considerations have triggered world wide debate on how to effectively supervise different segments of financial sector in conglomerate and universal structure. so far these debates had been concentrated around conventional banking but now it is widely gripping the world of islamic finance ( if ). stronger inter - dependencies among different segments of if are emerging largely because islamic financial institutions ( ifis ), in principle, have features and inherent characteristics and more compulsion, than conventional banking, to conform to universal banking or to evolve inter - linkages among different market segments. ii. factors driving cross - sector linkages and interdependencies first and foremost, ifis ’ depositors / borrowers desire to conduct financial transactions that are shariah compliant. it can be assumed that a person preferring to bank with an islamic bank will also seek to use other faith - based financial services such as takaful and islamic mutual funds. this faithdriven feature in itself forces and incentivizes ifis to offer, along side bank - based services ( i. e. deposit and loans ), a wide range of financial services. as a result, islamic banks end up undertaking non - core banking activities such as fund management, capital market operations, securitization, leasing, and housing finance. this has enhanced the degree of integration between various segments of if. for example : islamic banks are likely to be strongly integrated with the shariah capital markets since on credit portfolio side, islamic banks do not have the same investment avenues as those available to their conventional counterparts. the outcome is that islamic banks either end up taking large exposure in the capital markets directly or acquire subsidiaries which

considerations, including those relating to uncertainty and asymmetric risks, must inform one ’ s judgment on the appropriate stance of policy. as i explained, a variety of analytical tools, including optimal control techniques and simple policy rules, can serve as useful benchmarks. based on such analysis, i consider a highly accommodative policy stance to be appropriate in present circumstances. but considerable uncertainty surrounds the outlook, and i remain prepared to adjust my policy views in response to incoming information. in particular, further easing actions could be warranted if the recovery proceeds at a slower - than - expected pace, while a significant acceleration in the pace of recovery could call for an earlier beginning to the process of policy firming than the fomc currently anticipates. there is also some risk of significantly higher oil prices due to geopolitical events. such a shock would have ambiguous implications for monetary policy because, on the one hand, the contractionary effect of higher oil prices on output and unemployment argues for greater accommodation, while, on the other hand, the upward effect on inflation would argue for less. in my view, as long as inflation expectations remain well anchored, then any higher inflation would be transitory – as proved to be the case last year – and the appropriate balance in fulfilling our dual mandate would likely imply little change in the path of short - term nominal rates, in part because such a policy response would cause real interest rates to be somewhat lower for a time and thereby provide additional policy accommodation. once again, then, the role of inflation expectations remains of central importance to the proper stance of policy. bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches