The first and and only Islamic bank in the Philippines, the Al-Amanah Islamic Bank, began its operations in 1973 and was recently bought by the Development Bank of the Philippines.

What sets this bank apart from the traditional banks in the country? Similar to any Islamic bank, it religiously abides by the Shariah, zeroing in on its transaction rules. Most people bridge this type of banking to the concepts of prohibited interests (usury) and profit sharing.

For example, profit, according to the Qíuran, is only warranted if it yields additional values in the economy and society; unwarranted profits are surplus values 'without a counterpart.' Working under such a definition, Islamic banking minimizes exploitative contracts and unjust transactions.

Early Islamic doctrines emphasize interest as a surplus value without an equivalent real value, thus making it unacceptable. Sukuk, as an example, is an Islamic financial instrument. It is the counterpart of bonds, but differing in the aspect that these types of bonds are non-interest-bearing and is utilized without fixed income.

Islamic banking also prohibits transactions related to alcohol and pork, in deference to common Islamic doctrine. Ethics and morality are at its pedestal; thus, gambling and other games of chance are also restricted.

How then can this financial service be highly profitable?

In Islamic banking, loans either carry service charges or entail absolutely zero costs. Loans with service charges do not impose interests but asks for service compensation. This amount is further restricted by the price ceiling decided upon by authorities. Loans with no charges, meanwhile, provide a more socially responsible view made by the agents of Islamic banking. These loans are granted to farmers, to the needy, and to the other unfortunate sectors.

Clearly, these loans do not provide for a big percentage of bank profits. Hence, trade and investment financing dominate the scene. The catch, though, is to operate these activities under PLS or the profit and loss sharing scheme.

For example, in compliance with PLS, Mudaraba provides a venue to put together resources, monetary or not, in erecting a financial plan or activity. Profits and risks are shared by the bank and entrepreneur. Similar to a venture capital, the financial risk gives justification for the profits that it will rake.

This very activity is an innovative way to integrate and benefit the society by providing funds to plausibly efficient and relevant projects. A probable dilemma lies in the associated expenses in measuring and examining participants and risks, as well as negotiations and further transactions costs.

Rooting from the fact that Islamic banks are 'keepers and trustees of funds', another source of profits are gifts. These gifts lure in more customers to open savings accounts, increasing their capital. Gifts are portions of profits from the bank investments using the savings as capital source. A concept of a 'goodwill loan' is also utilized, stating that the debtor is only asked to pay the principal. An option to give a token of appreciation is placed on the table, without any form of promises. This transaction is the epitome of the Islamic interest-free loan.

The estimated rate of return concept, on the other hand, states that the bank estimates profit before financing an activity. If in actuality the project earns more that what was gauged primarily, the bank gives the excess to the client. This truly reflects their concept of profit with actual value or counterpart.

Are the Islamic banking schemes effective?

It may come as a surprise that some of the biggest companies in the world utilize Islamic banking for funding. These companies reportedly include IBM, Daewoo, GM (General Motors) and Alcatel.

The main difference between traditional and Islamic banking lies in their concepts of profit. The maximization goal of traditional banks targets the shareholders; on the contrary, Islamic banks hurdle the interest of all economic agents.

A study conducted by Celent concluded that assets under these Islamic banks grew more rapidly than those under the conventional ones. Generally, assets linked to Islamic banking experienced a growth of over 10% for the past decade. The Economist also estimates that such assets amount to US$822. This system also remained formidable in the face of the recent financial crisis.

Trends are geared towards the untapped markets with a relatively high potential for growth. These locations include Turkey and the majority of North Africa. According to Standard and Poor's, however, the profits of Islamic banking may be grabbed by conventional banks once they start offering a vast array of Islamic financial services.

Islamic Banking : A global perspective

Hotspots for Islamic banking are found all over the world, with the Middle East taking almost two-thirds of the entire pie. Mature markets in this region include Saudi Arabia and Kuwait. The former houses Al-Rajhi Banking & Investment Corp., the world's largest Islamic bank, while the latter invests on project finance.

Services offered by these Islamic banks include current accounts, credit cards, money transfers and mortgages. Although these banks collide under a unitary belief, practices may vary depending on the laws of land where they are located or their special objectives.

Moreover, the political climate and numerous circumstances pave the way for novelty and unique techniques and treatments. Specializations within this system are apparent. UAE focuses on trade financing, and Bahrain, on corporate finance and investment.

Current trends and issues

At present, conventional Western banks are establishing subsidiaries which are Islamic in nature. Otherwise, they create special divisions to cater to the needs of their clients. The other side of the banking system coin counteracts this by developing ways and means to provide cost-effective packages to Muslims and non-members alike.

Truly, competition urges economic agents to innovate and design efficient services to benefit everyone, big or small, regardless of religion and beliefs. Even the Vatican stated that Islamic finance can be a 'cure for ailing markets.'

The current issue of excess liquidity calls for rule reviews regarding the matter. Rules on financing in Islamic banking hinder trade, making the entire system inefficient. One of the main functions of financial institutions is to channel financial resources or money from those who have it to those who need it.

In conclusion, the probable secret formula of Islamic banks is that they cater to the special needs of their clients, especially the members of the Muslim community. It is their special need and task to do bank-related activities in accordance to the Qíuran, and Islamic banks simply does that.

In the Philippine case, Al-Amanah is continually in existence due to the unique services that it provides to our Muslim brothers and sisters, thus easing the banking process and including them in the financial scene and game.

The Institute for Development and Econometric Analysis, Inc. (IDEA) is an economic think-tank based in the University of the Philippines - Diliman. For inquiries on IDEA, please contact Eduard Robleza at edjrobleza@idea.org.ph.