The Western Financial System is simply pegged on the principle that an individual gets as much he/she invests. The more you have, the more you get. In simple terms, if you own little or nothing at all, then you are likely to get little or nothing respectively. This is perhaps the reason behind the shocking statistics that more than 50% of the global population is deprived off banking services. This banking system is solely based on collateral. It looks at what has been acquired by an individual and even take a ‘punishment’ mode in instances where borrowers take more time in repayment of the loan contrary to the agreed duration. Sadly, a western bank do not understand when clients get into trouble and madly rush in to recover their money, including take-over of collateral. In the western financial system, interest taking does not stop except for instances where there is a specific exception. In general, western banks are premised on interest which is against the Shariah laws. There are mainly two types of western financial institutions. These are investment and commercial banks.
Investment and commercial banks differ from each other in a number of ways which contribute to the emerging circumstances during crisis periods. Commercial banks are much more regulated as compared to the investment banks. The key reason for this difference is that they accept insured deposits from the general public, unlike their investment counterparts. Given that they are deposit takers the banks require a significant volume of capital and hence they are obligated to back the loans they provide with a large volume share of equity as compared to investment banks. To the contrary, Investment banks are not subjected to similar regulatory oversights. It is for this reason that such institutions may possess much lower capital ratios compared to commercial banks. This enables them to take on increased leverage.
Whenever banks are caught up in financial problems, and they face a lack of liquidity to meet their withdrawals and contractual obligations, they are allowed to borrow from the central bank. In the United States, the lender of last resort to the banks is the Federal Reserve Discount Window. However, on March 16, 2008 the Federal Reserve attempted to establish the discount window for investment banks as well as brokers and hence put in place the Primary Dealer Credit Facility. This facility allows the borrowers to pledge a substantially broad set of collateral.
In accordance with the opinion of various experts, there are two prime objectives for lending directly to the primary dealers. The first aim is enabling of short-term funding to investment banking entities. The resulting experience with respect to Bear Stearns, which suffered an unanticipated loss of short term funding but appeared to have maintained solvency, made Fed representatives come to the realization of the fact that the service of last resort lender required to be extended to entities beyond commercial banks. The second aim is that PDCF seeks to lower spread of interest-rates between the asset-backed securities which are usable for collateral in such loans and securities for U.S. Treasury, as a result enhancing the capability of persons investing to purchase and also sell asset-backed securities within the financial markets.
Characteristics Which Define Western Finance System:
- Both its functions and operations are based solely on artificial principles unlike Islamic banking, which deals with Koran teachings.
- For its investment product, investors are promised a fixed interest rate.
- Western financial system loan products put into application the system of issuing loans with multiplied interest. Compound interest is charged for loan defaults.
- Western financial systems focus on protection of the institution interest; they give no priority to equity development.
- Stresses on evaluation pegged on a borrower’s ability to repay the loan. It does not pay much attention to customer’s project progress.
- The institutions earn revenue from fixed interest, which is charged to clients.
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