of the enterprises in generating the expected returns. the absence of an islamic money market infrastructure would also expose the islamic financial system to higher liquidity risks. strategies to strengthen the resilience of islamic financial system as innovation of islamic financial products and services intensifies and as islamic finance becomes more integrated with the international financial system, it becomes imperative that the foundations upon which islamic finance has been built remains intact. this will be the key to sustaining the resilience of the islamic financial system in this more challenging international financial environment. key to this is to embrace shariah - based innovation in the development of islamic financial products. in a highly globalised financial market, innovation has been a key differentiating factor to remain competitive. the current turmoil has however, highlighted that highly complex, unbridled innovation can become highly destabilising resulting in major disruptions in a financial system. it is therefore important for financial innovation to have clear shariah objectives and adhere to the requisite principles of shariah. in this manner, shariahbased innovation would contribute towards islamic financial products that have distinct value propositions with in - built strengths arising from the essential features of shariah. to achieve this objective, it is important to have strong initiatives that promote shariah - based innovation in islamic finance. in malaysia, several steps have been taken. the establishment of the international shariah research academy for islamic finance ( isra ) aims to engage in applied research on dynamic shariah - centric innovation. isra can provide a global platform for greater global engagement and research with the focus on innovation. in addition, the central bank has also embarked on the initiative to develop the shariah parameters to promote more consistent application of islamic financial contracts. this initiative aims to determine the essential features of islamic financial products derived from underlying key shariah contracts. these features will serve as a guide for the application of the shariah contracts for the islamic financial products. the second strategy is to raise the bar in the status of the islamic financial infrastructure that supports the risk management and governance of islamic financial institutions. to ensure sustainability of the resilience of islamic finance, it is important to have the comprehensive enabling infrastructure that allows for the management of the risks that are peculiar to islamic finance. there is a need for islamic financial system to have the capital requirements, effective risk management and strong governance that are fully equipped to manage the risks that are specific to islamic financial transactions. it is also

practices. this resulted in an underestimation of the risks involved and the capital buffers that were necessary. the ensuing turmoil in the financial markets that followed was increasing illiquidity in the financial markets and the subsequent breakdown in the functioning of the markets. as this continued, it has translated into stress and insolvencies in the financial sector. in both crises, this precipitated a sudden pull back in bank lending. the ensuing credit crunch magnified further the damaging impact on the economy. in asia, the economic contraction was severe in the range of minus 7 % to 13 %. in the current financial crisis, however, the spillover impact of the effects on the economy has yet to be fully felt. in the asian financial crisis, it ran its full course with the rapid price adjustments in most asset markets taking place within a period of just over a year. in asia, there was limited potential to reduce interest rates in an environment that was vulnerable to capital outflows. the focus of policy in asia was therefore on the resolution of the banking sector and to restore the functioning of the intermediation process. in most of the crisis affected economies in asia, this strategy produced positive results and growth resumed within twelve to eighteen months. financial crisis and islamic finance in the midst of the unfolding of the global financial crisis, it is useful to review the foundation and structures of the islamic financial system to assess its resilience in withstanding the impact of the current and future crises. in taking into account the dynamics of the crisis and the potential implications for islamic finance, two important dimensions are key in undertaking the assessment. the first key dimension highlights the inherent ability of islamic financial system to deal with the test of such crisis. islamic finance is well - supported by two essential features which serve as pillars to islamic financial transactions. firstly, islamic finance encourages business and trade activities that generate legitimate profits, subject to an explicit requirement of materiality and validity of the transaction. this requirement ensures that the funds are channelled into real financial business activities, reinforcing a close link between financial and productive flows. this reduces the islamic financial system from over exposure to risks associated with excessive leveraging and imprudent risk taking. in islamic financial transactions, money is not a commodity, but a medium of exchange, a store of value and a unit of measurement. money represents purchasing power and cannot be utilised to increase the purchasing power without any productive activity. secondly, islamic finance encourages business transactions