CREDIT SYSTEM

Chapter 4
 Objectives:
• Understand the concept of credit
• Enumerate and explain the following
aspects of credit; foundations, nature,
characteristics, classes and kinds, sources
and bases.
• Enumerate and explain the kinds of credit
instruments
• Differentiate the kinds of credit instruments
 CREDIT?
• Is the ability to obtain a thing of value in
exchange for the promise to pay with
money or something equally satisfactory to
the seller at some future time.
• The ability of a customer to obtain goods
or services before payment, based on the
trust that payment will be made in the
future.
 Credit
• From Latin ‘creditum’; ‘a loan, thing
entrusted to another’
• From Latin past participle of ‘credere’; ‘to
trust, entrust, believe.’
• In 1520s, From Middle French ‘crédit’;
"belief, trust,”
 Foundations of Credit
• Absolute confidence in the personal
character and in the ability and willingness
of the debtors.
• Existence of proper facilities
• Stability of money standard
• Assistance of the government in enforcing
the payment of loan
 Nature of Credit
• Debtor- credit is both power and obligation

• Creditor- legal and moral right

– expectation of the fullfillment of
promise
 Characteristics of Credit
• Risk- probability of non-payment of
the borrower.
• Use of trust
• Elastic- in terms of amount (credit
limit) and time (grace period)
 Characteristics of Credit
• Creates creditor-debtor relationship

• Creates a legal obligation

• Involves time or futurity

CLASSES OF CREDIT

According to type of User

 Consumer Credit
• Also called consumption credit.
• A kind of credit extended to consumers in
order to facilitate the process of
consumption.
• Short-term loans made to enable people to
purchase goods or services primarily for
personal, family, or household purposes.
 Mercantile Credit
• Sometimes called commercial credit.
• Type of credit which one businessman
may extend to another when selling goods
on time for resale or commercial use.
• Credit relating to trade or commerce
 Commercial Bank Credit
• Credit given by commercial banks to
businessman intended to assist them in
the operation of their business.
 Investment Credit
• Utilized by a business organization for the
purchase of fixed assets or to carry
minimum business operations.
CLASSES OF CREDIT

According to what is given

• Merchandise Credit- products/ goods /
items are given.

• Borrowing Money – money/ cash is given

CLASSES OF CREDIT

According to Purpose
 Agricultural Credit
• A credit financing vehicle, such as a loan,
banker's acceptance or letter of credit,
that is designed specifically for agriculture
producers.
• Credit use for pre- and post –harvest costs
like seedlings, fertilizers, farm machineries
and equipment and etc.
 Export Credit
• Loan extended to an importer by a bank in
the country of the exporter in order to
finance an export operation.
 Industrial Credit
• Loan granted to a particular industry like
oil, mining, farming, manufacturing and
service industry.
 Commercial Credit
• Also known as ‘business credit ’.
• Pre-approved amount of money issued by a bank to
a company that can be accessed by the borrowing
company at any time to help meet various financial
obligations.
• Commercial credit is commonly used to fund
common day-to-day operations and is often paid
back once funds become available. Commercial
credit can be offered in either a revolving or non-
revolving line of credit.
 Real Estate Credit
• Loan extended for the purchase,
renovation or construction and
improvement of real estate
CLASSES OF CREDIT

According to Maturity
• Short-term- payable within one year or
less.
• Medium or Intermediate- payable from
one to five years
• Long-term-payable within five years or
more
SOURCES OF CREDIT
• Individual Money Lenders
• Retail Stores- the largest source of credit
in the Philippines
• Pawnshops- the jewelry or the thing of
value serves as a guaranty of payment
• Commercial Banks
• Commercial Paper House
• Savings Bank
• Rural Banks
• Development Banks
• Investment Banks
• Savings and Loans Associations
• Finance Companies
• Credit Unions
• Insurance Companies
BASES OF CREDIT
 1. Confidence
• The feeling or belief that one can rely on
someone or something; firm trust

• Having strong belief or full assurance; sure

 2. Character
• Sometimes called credit history

• Refers to a borrower's reputation or track

record for repaying debts.
 3. Capacity
• Refers to the borrower's ability to repay a loan
• Measured by comparing income against
recurring debts and assessing the borrower's
debt-to-income (DTI) ratio.
• Lenders look at the length of time an applicant
has been at his job and job stability.
 4. Capital
• Refers to the amount borrower puts
toward a potential investment.
 5. Collateral
• Anything of value pledged as security for repayment
of a loan, to be forfeited in the event of a default.
• It gives the lender the assurance that if the borrower
defaults on the loan, the lender can repossess the
collateral.
 6. Conditions
• Refers to how a borrower intends to use the
money
• The rules of an agreement or bargain.
• Example, if a borrower applies for a car loan or a
home improvement loan, a lender may be more
likely to approve those loans because of their
specific purpose
 7. Country
• In credit, the country is also a factor to
consider because of the accessibility of
the parties involved and the ease of
arrangement of the credit process.
 8. Currency
• In credit, currency is a factor to consider
because of the effect of movement in the
exchange rate.
CREDIT INSTRUMENTS
 Credit Instruments
• Are documents which give evidence of a
credit obligation resulting from a past
transaction which set forth the
responsibility of the debtor to the creditor
• Documents that serve as an evidence of
debt.
 Classes of Credit Instruments
• Investment Credit Instrument- documents used to
acquire additional capital or loan capital; also called
financing credit instruments.
• the promise to pay of individuals or business firms for the
loans they obtain in buying capital goods such as
machineries, lands and construction of plants and
factories.
• Commercial Credit Instrument- documents that are
used in the conducts of trade or day to day business
operations. A pre-approved amount of money issued by
a bank to a company
 Types of Investment Credit
Instruments
• 1. Bonds- These are promises to pay the
principal as well as the interest to the
holder at a certain specified time indicated
in the instrument.
 Parties in a bond issue
• Issuer- can be a corporation or a
government
–The debtor in the bond issue
• Bondholder- the investor-creditor
• Trustee- a third party that facilitates the
transfer of bonds between the issuer and
investor
 Retirement of Bonds
• Conversion- exchanging a new security
usually preferred stock
• Redemption- repayment of cash
• Refunding- replacing the outstanding
bonds with another issue of later maturity.
 Types of Investment Credit
Instruments
• 2. Short-term Notes- Obligations maturing
within comparatively short period of time
 Types of Investment Credit
Instruments
• 3. Stocks- Represent permanently invested
capital of a corporation contributed by the
owners termed as stockholders which are
evidenced by stock certificates.
 Types of Commercial Credit
Instruments
• [Link] to Pay
– Parties in Promise to Pay Instruments:
• Maker/ Payor- the debtor
• Payee- the creditor; the one receiving the
payment
 Types of Commercial Credit
Instruments
• 2. Orders to Pay
-Parties in Order to Pay Instruments
1. Drawer- party ordering that the payment be made
2. Drawee- party ordered to make payment
3. Payee- party to whom payment is to be made
 Kinds of Promise to Pay
Instruments
• 1. Book Accounts –
sometimes termed as ‘open
book account’
- an entry on the retailer’s
book is made debiting the
customer with the amount
involved.
 Kinds of Promise to Pay
Instruments
• 2. Bank Deposits-
represent
liabilities of the
banks to the
depositors
 Kinds of Promise to Pay
Instruments
Payee

• 3. Promissory Maker
Notes- a written
promise of one
person to pay
another a definite
sum of money at a
certain future time.
 Kinds of Order to Pay
Instruments
• 1. Check- written order drawn by a depositor
upon a bank directing it to pay on demand a
specified sum of money to the bearer or to the
order of some person or corporation na-ed on
the face of the check, the amount against his
deposit account.
CHECK EXAMPLE
Payee

Drawee Drawer
Kinds of Checks
 1. Open Check
• A check which does not have to be presented
through a banking account.
 2. Crossed Check
• A check which cannot be presented to the bank for cash
payment instead such check has to be deposited to the
account of the payee in his bank
• Distinguished by the two parallel lines appearing on the
top left hand corner of the check.
 3. Certified Check
• A check which certified by the bank official with respect
to the sufficiency of funds covering the amount indicated
on the face of the instrument
 4. Cashier’s Check
• It refers to the bank’s order to pay drawn upon itself and
signed by the cashier payable to the person or firm
designated by the depositor.
 5. Stale Check

• A check which is not presented to the bank for

encashment nor deposited to the payee’s account after
six months from the date it bears.
 6. Traveler’s Check
• Check not drawn on any particular bank but is payable
anywhere throughout the world.

A traveler’s check is a once-popular but now largely outmoded

medium of exchange utilized as an alternative to hard currency.
The product typically is used by people on vacation in foreign
countries. It offers a safe way to travel overseas without cash. The
issuing party, usually a bank, provides security against lost or
stolen checks. Beginning in the late 1980s, traveler’s checks have
increasingly been supplanted by credit and prepaid debit cards.
 7. Bouncing Check
• Checks returned to the issuer for lack or insufficiency of
funds.
 Kinds of Order to Pay
Instruments
• 2. Bills of exchange- oftentimes termed as bank or
trade/commercial drafts
- an order drawn by the
drawer directing the drawee to pay the payee sum
of money at a certain determinable date.
-is a non-interest-bearing
written order used primarily in international trade
that binds one party to pay a fixed sum of money
to another party at a predetermined future date.
Bills of exchange Sample
END OF THE
CHAPTER