Islamic financial system initially evolved as a form of financial intermediation for the Muslim community to conduct financial transactions that conform to Islamic tenets.

Today, the Islamic financial industry has gained wider acceptance and appreciation and has expanded beyond the traditional borders of the Muslim-based economies into the major industrial economies to become an integral component of the global financial system.

In a global environment that has become increasingly challenging, an environment that is subject to the powerful forces of change, and that is characterized by volatile and unstable market conditions, Islamic finance has emerged as a competitive and resilient form of intermediation.

Although Islamic finance is still at the early stage of development, it has experienced rapid expansion and is fast emerging as a viable and robust form of financial intermediation with significant potential.

The development of an Islamic financial system needs to include the respective components comprising the Islamic banking, takaful (insurance) industry and the Islamic capital markets, given the strong linkages, interdependence and synergies among these components in the system. The spectrum of participants and the diversity of instruments are among the key attributes in creating the enabling environment for a dynamic Islamic financial system.

In the initial stage during the early years of the development of the Islamic financial system, the focus of attention was on the development of the Islamic banking system and to expand the number of players and volume of activity.

The evolution of an appropriate financial structure would need to take into account the role of the financial system in the economy and the objectives that need to be achieved.

In the context of an emerging market economy, the financial system is a means to an end. The appropriate financial structure, particularly in emerging market economies, need to be designed to meet the requirements of the economy. The financial system needs to be in a position to support the real sector, changing and evolving with the changing needs of the economy.

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 interdependent 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 insurance 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 insurance.

In addition, this framework needs to be reinforced by a Shariah framework to ensure that all financial transactions are Shariah-compliant. Islamic financial operations would thus need to be based not only on best practices, but also satisfy the tenets of the Shariah.

For Islamic banking and insurance to be sustainable, compliance with Shariah principles alone is not sufficient. Over the long run, customers and businesses demand for quality in the products and services that Islamic finance offers.

This is the challenge for Islamic banking and insurance, to be able to provide a comprehensive range of Islamic financial products and services that are not only innovative and competitive but Shariah compliant.

Takaful as a system of Islamic insurance, is based on co-operation and mutual help for the good of the society at large. Although takaful has been in the market for more than 20 years, it has yet to make significant inroads.

It should however, be noted that although the conventional insurance market is deeply entrenched in several of the Muslim countries, the percentage of the Muslim population that are insured is relatively low. The market penetration level is very low- less than 5 per cent in many Muslim countries.