INTRODUCTION

The word "credit" has many meanings in the financial world, but it
most commonly refers to a contractual agreement in which a
borrower receives a sum of money or something else of value and
commits to repaying the lender at a later date, typically with interest.
Credit can also refer to the creditworthiness or credit history of an
individual or a company—as in "she has good credit." In the world of
accounting, it refers to a specific type of bookkeeping entry.
Credit represents an agreement between a creditor (lender) and a
borrower (debtor). The debtor promises to repay the lender, often
with interest, or risk financial or legal penalties. Extending credit is a
practice that goes back thousands of years, to the dawn of human
civilization, according to the anthropologist David Graeber in his book
Debt: The First 5000 Years.

"Credit" is also used as shorthand to describe the financial soundness

of businesses or individuals. Someone who has good or excellent
credit is considered less of a risk to lenders than someone with bad
or poor credit.
Why is credit important?
The efficient functioning and growth of the economy are facilitated
by the ability of consumers and businesses to access credit. Through
credit, businesses can acquire the necessary tools for production,
which in turn allows for economic transactions. Without access to
credit, businesses may struggle to purchase essential machinery, and
raw materials, or compensate employees, hindering their ability to
produce goods and generate profit.

In addition, credit enables consumers to make essential purchases,

such as cars and houses, which may be beyond their immediate
financial means. By utilizing credit, individuals can spread out their
payments over time, thereby gaining access to vital products and
services when needed.
Accessing credit is important for another reason in today’s society:
consumer credit reporting. When people borrow money, creditors
often report their behavior to credit-reporting agencies, including
Equifax, Experian, etc. Data on your financial behavior — such as
whether you make loan payments late or fail to pay — is aggregated
to create credit reports and evaluated to generate credit scores.
Those reports and scores are used by lenders when they assess how
risky it may be to lend to you.
What is a credit score?
A credit score is a prediction of people’s credit behavior, such as how
likely they are to pay a loan back on time, based on information from
their credit reports.
Companies use credit scores to make decisions on whether to offer a
mortgage, credit card, auto loan, and other credit products, as well as
for tenant screening and insurance. They are also used to determine
the interest rate and credit limit received.
Companies use a mathematical formula—called a scoring model—to
create credit scores from the information in the credit reports.

Factors that are typically taken into account by credit scoring models
include:
➢ Bill-paying history
➢ Current unpaid debt
➢ The number and type of loan accounts you have
➢ How long had your loan accounts open
➢ How much of your available credit you’re using
➢ New credit applications.
What is a credit report?
A credit report is a comprehensive document that provides details
about your credit history and current credit status. It includes
information about your loan payment history and the current status
of your credit accounts.

It's important to note that most individuals have multiple credit

reports. These reports are compiled and stored by credit reporting
companies, also referred to as credit bureaus or consumer reporting
agencies. These companies gather and maintain financial data from
creditors, such as lenders, credit card companies, and other financial
institutions. Creditors don't need to report to every credit reporting
company.

Lenders use these credit reports to assess whether to lend you

money and determine the interest rates to offer. They also rely on
the information in your credit report to evaluate whether you are
meeting the terms of an existing credit account. Additionally, other
businesses may access your credit reports to make decisions about
offering you insurance, renting a house or apartment to you, or
providing services such as cable TV, internet, utilities, or cell phone
service. In some cases, with your consent, employers may also use
your credit report to inform employment decisions.
What is a Credit Crunch?

A credit crunch is defined as a situation where it becomes difficult or

expensive for businesses and consumers to borrow money. The term
usually refers to a situation in which the availability of loans dries up,
making it more difficult for people and businesses to get the money
they need to finance economic activity. A credit crunch can be caused
by a variety of factors such as a rise in interest rates
Credit crunches have occurred throughout history, often leading to
recessions or depressions. For example, the United States
experienced a severe credit crunch in the early 1930s that helped
contribute to the Great Depression. More recently, the United States
and other countries experienced a credit crunch in 2008 that led to
the Great Recession.
Credit crunches can have a variety of negative consequences for an
economy such as the stalling of economic growth or a rise in
unemployment
Credit Crunch Causes:
➢ Low interest rates
➢ High interest rates
➢ Economic recession
➢ Fall in the availability of credit
➢ Loss of confidence in the financial system
➢ Fall in the stock market
➢ Geopolitical event
5 C’S OF CREDIT

What are the principles of the 5 Cs of credit that banks operate on?
The main principle behind the five Cs is to gauge the risk of extending
credit to a borrower. A lender needs to evaluate who they are lending
money to, why the borrower is asking for money, and the likelihood
of recovering loan proceeds.

Another principle of the five Cs is to determine how credit is priced.

Borrowers with more favourable five Cs may get better terms, lower
rates, and lower payments. Borrowers who are riskier with poorer
five Cs may face unfavourable terms
CHARACTER:
Character, the first C, more specifically refers to credit history, which
is a borrower’s reputation or track record for repaying debts. This
information appears on the borrower’s credit reports, which are
generated by the three major credit bureaus: Equifax, Experian, and
TransUnion. Credit reports contain detailed information about how
much an applicant has borrowed in the past and whether they have
repaid loans on time.
Prospective borrowers should ensure that their credit history is
correct and accurate on their credit report. Adverse, incorrect
discrepancies can be detrimental to your credit history and credit
score. Consider implementing automatic payments on recurring
billings to ensure future obligations are paid on time. Paying monthly
recurring debts and building a history of on-time payments help to
build your credit score.

CAPACITY:
Capacity measures the borrower’s ability to repay a loan by
comparing income against recurring debts and assessing the
borrower’s debt-to-income (DTI) ratio. Lenders calculate DTI by
adding a borrower’s total monthly debt payments and dividing that
by the borrower’s gross monthly income. The lower an applicant’s
DTI, the better the chance of qualifying for a new loan.
Improving the capacity can be done by increasing your salary or
wages or decreasing debt. A lender will likely want to see a history of
stable income. Although switching jobs may result in higher pay, the
lender may want to ensure that your job security is stable and that
your pay will continue to be consistent.
Lenders may consider incorporating freelance, gig, or other
supplemental income. However, income must often be stable and
recurring for maximum consideration and benefit. Securing more
stable income streams may improve your capacity.

Save

Lenders also consider any capital that the borrower puts toward a
potential investment. A large capital contribution by the borrower
decreases the chance of default.
Capital is often obtained over time, and it might take a bit more
patience to build up a larger down payment on a major purchase.
Depending on your purchasing timeline, you may want to ensure that
your down payment savings are yielding growth, such as through
investments. Some investors with a long investment horizon may
consider placing their capital in index funds or exchange-traded funds
(ETFs) for potential growth at the risk of loss of capital.

Another consideration is the timing of the major purchase. It may be

more advantageous to move forward with a major purchase with a
lower down payment as opposed to waiting to build capital. In many
situations, the value of the asset may appreciate (such as housing
prices on the rise). In these cases, it would be less beneficial to spend
time building capital.

COLLATERAL:
Collateral can help a borrower secure loan. It assures the lender that
if the borrower defaults on the loan, the lender can get something
back by repossessing the collateral. The collateral is often the object
for which one borrows money: Auto loans, for instance, are secured
by cars, and mortgages are secured by homes.
Investigating collateral can be done by entering into a specific type of
loan agreement. A lender will often place a lien on specific types of
assets to ensure that they have the right to recover losses in the
event of your default. This collateral agreement may be a
requirement for your loan.
Some other types of loans may require external collateral. For
example, private, personal loans may require placing your car as
collateral. For these types of loans, ensure you have assets that you
can post, and remember that the bank is only entitled to these assets
if you default.

CONDITION:
In addition to examining income, lenders look at the general
conditions relating to the loan. This may include the length of time
that an applicant has been employed at their current job, how their
industry is performing, and future job stability.
The conditions of the loan, such as the interest rate and the amount
of principal, influence the lender’s desire to finance the borrower.
Conditions can refer to how a borrower intends to use the money.
Business loans that may provide future cash flow may have better
conditions than a house renovation during a slumping housing
environment in which the borrower has no intention of selling.

Conditions are the least likely of the five Cs to be controllable. Many

conditions such as macroeconomic, global, political, or broad
financial circumstances may not pertain specifically to a borrower.
Instead, there may be conditions that all borrowers may face.
SOURCES OF CREDIT
Credit sources encompass diverse avenues through which individuals,
businesses, and governments can access funds for various financial
needs. These sources can be broadly categorized into two primary
types:
➢ FORMAL SOUCES {INSTITUTIONAL}
➢ INFORMAL SOURCES {NON – INSTITUTIONAL}
Institutional or Formal Credit Sources:
Institutional credit involves financial entities that are formally
established and regulated, providing credit services to borrowers.
This category further subdivides into the following categories:
1. Banks: Traditional banks are prominent sources of credit,
offering loans, credit cards, and lines of credit to customers.
They operate under rigorous regulatory frameworks and
provide a wide range of financial products to cater to diverse
requirements.
2. Credit Unions: Similar to banks, credit unions are member-
owned financial cooperatives that extend credit services, often
at favourable terms, to their members. They prioritize
community well-being and typically offer competitive interest
rates.
3. Financial Institutions: This category includes various specialized
financial entities such as savings and loan associations, which
primarily focus on providing home loans, and investment banks
that assist in capital raising through credit instruments like
bonds.
Non-institutional or Informal Credit Sources:
Non-institutional credit involves sources beyond formal financial
institutions. While these sources are often more accessible, they
might carry higher risks and costs. Non-institutional credit can be
classified into the following categories:
1. Peer-to-Peer (P2P) Lending: P2P platforms connect
borrowers directly with individual lenders, facilitating loans
without intermediaries. This emerging model offers flexibility
and the potential for competitive rates.
2. Microfinance Institutions: These organizations target
individuals with limited access to traditional credit, providing
small loans to promote entrepreneurship and alleviate
poverty.
3. Trade Credit: Businesses extend credit to one another as part
of commercial transactions. This form of credit is integral to
supply chains and business-to-business relationships.
4. Informal Sources: Family, friends, and informal moneylenders
are sources of credit within personal networks. While
accessible, these sources may lack formal agreements and
transparency.
5. Retail Credit: Retailers offer credit to consumers for
purchases through store credit cards and instalment plans,
encouraging sales and customer loyalty.

COVID 19 IMPACTS
Credit growth decelerates in almost all sectors from 3 years ago. As
the country went into nationwide lockdown due to the coronavirus
crisis, data released from the RBI showed the following analysis:
 1. Credit growth in the banking system decelerated to 76% in
March 2020 from 12.35 in March 2019.
2. Credit growth in agricultural and allied activities decelerated to
5.2% from 7.9 % in March 2019.
3. Credit growth in industries decelerated from 1.4% to 6.9% in
March 2019.
Within the industry, credit growth accelerated in mining, beverage,
etc. However, the chemical products have decelerated.

Conclusion:
In recent years, the banking sector has undergone significant
changes, particularly in the areas of credit availability and financial
services. This includes the rise of e-banking, expanded credit options,
investment opportunities in stocks and shares, and the growing
popularity of mutual funds.
Banks no longer focus solely on basic operational functions; they now
play a crucial role in providing credit and financial services to both
individuals and businesses. This shift has led to increased
competition within the industry, as financial institutions strive to
attract a larger customer base by offering a wider range of products
and services.
These developments have greatly improved customer convenience,
largely due to the increased accessibility of credit facilities.