Islamic finance can support growth

KUALA LUMPUR: Growth prospects of the world economy going forward is expected to remain modest for an extended time, said Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz.

With the global economy on the recovery path now, Islamic finance offered enormous potential in supporting more inclusive and sustainable economic growth, she said. “Developing and emerging economies in particular stand to reap the largest benefits from this potential,” she said at the Islamic Development Bank Prize Lectureheld in Jeddah yesterday.

Zeti said regulatory priorities in strengthening financial stability taking into consideration the specifics of Islamic finance would ensure its continued resilience and its potential to effectively service the functioning of economies and the economic wellbeing of societies.

“Several important lessons have emerged from this recent global financial crisis. The first relates to the exponential expansion of the financial system which did not commensurate with the expansion in economic activities.

“This has resulted in a significant disconnect between the financial sector and its role in serving the economy. A number of factors contributed to the weakening of the link between financial intermediation and productive economic activities,” she said.

In efforts to build stronger defences against a repeat of the events that precipitated the 2008 global financial crisis, Zeti said the global regulatory reform agenda had placed significant focus on addressing elements of the regulatory and supervisory systems that allowed the build-up of excessive leverage.

She said these elements included the unfettered innovation by financial institutions and the prevailing incentive system. “Financial engineering had led bankers and investors to lose focus on their risk exposures when they failed to understand the increasingly complex products that purported to reduce the risks.

“The weak regulatory regime and supervision also failed to rein in such unbridled innovation. Misaligned incentives then fuelled excessive risk-taking both at the institutional and individual levels,” she said.

Zeti said the global reform agenda had made important progress in efforts to reduce the fragility of the financial system and to strengthen its resilience.

She said substantial work had already been advanced and largely completed on the development of global liquidity standards, the adoption of leverage ratios, and the significantly strengthened capital regulations which were important components of the reform effort.

“Greater focus has also been placed on strong supervision, effective resolution regimes and arrangements for the oversight of systemically important financial institutions. While the effective implementation of these reforms is crucial, the world continues to seek more enduring solutions that will place financial institutions firmly back in the service of society,” she said. — Bernama

In some countries, she said, fundamental structural changes were being pursued to reduce the complexity of banking and to protect banking services from such higher risk-taking activities.

“The challenge, however, is how this might be achieved in a sustainable manner without undermining growth and development, and erasing the important efficiencies in financial management,” she added. — Bernama

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