zeti akhtar aziz : strengthening linkages in the islamic financial markets speech by dr zeti akhtar aziz, governor of the central bank of malaysia, at the seminar on derivatives in islamic finance, “ strengthening linkages in the islamic financial markets ”, kuala lumpur, 24 june 2005. * * * distinguished guests, ladies and gentlemen, " islamic finance in malaysia today has become increasingly more entrenched and integrated both on the domestic and international fronts. the successful integration has contributed to its rapid growth in assets and created a more robust and resilient islamic financial system. the challenge now is to further strengthen the linkages in the respective components of the islamic financial system, in particular, the islamic financial markets. " it is my pleasure to welcome you to this seminar on derivatives in islamic finance jointly organised by bank negara malaysia and the financial market association of malaysia. during this recent two days, we have organized the investors conference, the seminar on the 10 - year masterplan on islamic finance and the dialogue among shariah scholars which have gathered an extensive participation, from policy makers, investors, industry players and shariah scholars. today's event is another important initiative which brings together financial experts to deliberate on a vital aspect in the development of islamic finance. ladies and gentlemen, the successful development of a robust and resilient islamic financial system depends on the ability to integrate the various components of the islamic financial system that includes the islamic banking industry, takaful and the money and capital markets. of equal importance is also to integrate the domestic islamic financial system with the international financial system. for more than two decades, we have witnessed the success of the development of each of these respective components that has contributed to the rapid expansion in malaysia's islamic financial services industry. indeed, we have seen the development of a comprehensive islamic financial system. this has placed the malaysian islamic financial system at the forefront of the global islamic financial system. notwithstanding this, there have been imbalances in the pace of the growth of the components of the financial system. while islamic banking, being the core component, has recorded significant progress, more efforts need to be directed to promote the growth of takaful and the financial markets. my remarks today will focus on measures to accelerate the growth of the islamic financial markets by strengthening its required linkages. of most importance is the development of a wider range of islamic financial instruments, developing the relevant indicators to support benchmarking and an efficient pricing mechanism as

hoped that this seminar will be able to generate new ideas that can be implemented to support the requirements of the islamic financial services industry players. ladies and gentlemen, as the islamic finance is undergoing transformation, the financial infrastructure and product development must be complemented by the ability to manage risks by market participants. this becomes particularly important as the growing and changing needs and expectations of consumers occurs as a result of increased education levels and growing wealth. corporate customers have become more performance - oriented and are demanding both competitively financial products and world - class financial advisory services. consumers too are becoming increasingly discerning and have become more involved in their financial decisions, demanding a broader range of products and services at more competitive prices through more efficient and convenient channels. in this environment, product innovation needs to be escalated accordingly in particular, to respond to the growing need for managing risks to realign the risk - return profile of assets and liabilities for financial institutions and investors in reaction to fast changing economic variables. this is made more pronounced by the fact that increasingly, with the unprecedented economic integration, financial markets across the globe are not immune to financial volatilities. therefore, it is crucial that market participants have the necessary tools to manage financial risks prudently and this is where derivatives can be applied. application of derivatives will yield benefits to the general public as spread of risk among economic agents will mitigate risk of financial shocks to the financial markets at the macro level and individual institutions at the micro level. as a result, the financial system becomes more robust, stable and resilient to extreme volatilities in the financial markets. the introduction of derivatives in the islamic finance with adequate legal, regulatory and corporate governance framework will enhance the development of the functioning of the islamic financial system. developing the relevant indicators the pricing mechanism for the islamic financial instruments has so far been based on the prevailing interest rate framework. there appears to be no real difference in both the conventional and islamic instrument. in order for the islamic financial instrument to be efficiently priced, it needs to have its own indicator. as an example, for an instrument issued based on ijarah principle using the property as its underlying asset, the actual rate of rental can be used to determine the rate of return on this instrument. the indicator of the rate of rental will fluctuate based on the demand and supply of the said property. by having its own indicator, it will give a true reflection of the price of the underlying property asset as opposed to being linked to the