BIS Review 43/2003  1  The key constituents within the Islamic financial system, which includes the Islamic financial institutions as well as the capital and money markets need to be firmly reinforced by the legal and regulatory framework that adequately address the unique characteristics of the industry. These intradependent key components ultimately form the enabling environment for the Islamic financial services industry to effectively play its role as an efficient conduit for mobilising resources and channelling them to productive purposes. The absence of any one of the components could reduce the effectiveness and efficiency and could affect the viability and sustainability of the system. While the Islamic banking system plays an important role in mobilizing deposits and providing financing, the development of the capital market allows the corporate sector to source their long-term financing needs based on Islamic principles. In addition, it would increase the range of Islamic financial instruments available to meet the demand of the Islamic investors. In the absence of a comprehensive Islamic financial system with financial services based on Shariah principles, the development of Islamic banking and finance would be hindered. The government would need to assume an important role in the development of the Islamic financial system. The role of the government is, amongst others to provide the enabling environment and put in place from the outset, the necessary infrastructure through the formulation of a comprehensive set of legal and regulatory framework for Islamic banking and finance.
For the same reason, this phenomenon can act to mask or offset the effects of high levels of present and expected future government borrowing on interest rates, perhaps contributing to a false sense of reassurance that we can continue to run large structural deficits without risk of crowding out private investment and damaging future growth. BIS Review 18/2006  3  What might this mean for the conduct of monetary policy? To the extent that these forces act to put downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions than would otherwise be the case. And, if all else were equal, which of course is unlikely ever to be the case, monetary policy in the affected countries would have to adjust in response; policy would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation. To do otherwise would run the risk that monetary policy would be too accommodative, pulling resources from the future in a way that would alter the trajectory for the growth of the capital stock, perhaps amplifying the imbalances, and compromising the price stability. Finally, these aspects of global monetary arrangements and financial conditions have important implications for how we communicate about monetary policy. They strengthen the case for why central banks should be clear about their objectives and credible in their commitment to price stability.