NATURE OF CREDIT

Credit is the ability to obtain a thing of value in exchange for a promise to pay a definite sum of money, on
demand or at a future determinable time.

Elements:

1. It is the ability to obtain a thing of value, cash form of credit or merchandise form of credit.
2. A promise to pay
3. Definite sum of money
4. Payable on demand or future time

Characteristics of Credit

1. It is a bi-partite or a two party contract, the debtor and the creditor. The debtor is the party
requesting for the loan and the creditor is the party extending the loan.
2. It is elastic. It can be increased or decreased by the creditor. Loan limit or elasticity depends upon the
capacity of the debtor and appraised value of his collateral.
3. The presence of trust or faith. The basic element of credit is the creditor’s reliance on both the
debtor’s ability and willingness to pay.
4. It involves futurity. Maturity date for the settlement of obligation is a future time.

Foundations of Credit

1. Confidence. Creditor must trust the debtor’s personal character as a measure of his capacity to pay.
2. Proper facilities. Includes the credit information and the credit document. Credit Information includes
the data about the debtor as a gauge of his paying capacity. Credit document is the written agreement
signed by both parties.
3. Stability of monetary standards. Purchasing power of money is considered. The more stable the value
of money, the greater is the possibility for approving credit. In periods of wide fluctuations of money
value, creditors are more reluctant in extending credit.
4. Government assistance. Debtors are given more protection since they cannot be imprisoned for non-
performance of obligation, that is, if they are insolvent. In this case the creditor bears the risk.
5. Credit risk. The possibility that the debtor may not fulfil his promise to pay.

C’s of Credit

1. Capacity. This signifies the person’s willingness and capacity to pay.

2. Capital. This consists of the person’s real and personal property which can be a strong foundation for
credit approval.
3. Collateral. This is something, of value, the debtor’s assets, as pledge. Common practice is for collateral
to be 40% higher than the amount of loan
4. Conditions. This may include local business conditions or economic conditions during time of loan
application. During wide fluctuations of money value, it is unwise for creditors to grant loans. On these
periods, ability to fulfil loan payments may be impossible.
5. Character. The personality of the debtor, including his mental and moral attitudes determining his
credit rating.
Classifications of Credit

A. Type of user
1. Consumer credit. Credit used by individuals to help finance or refinance the purchase of
commodities for personal consumption.
a. Functions of Consumer credit
a.1. Convenient form of payment. Typical charge account involves purchases from a retail
store that are paid once or twice a month
a.2. Aids in financial emergencies. Helps consumers through period of financial stress
a.3. Buying durables on instalment. Aids consumers in financing the purchase of durable
goods by paying for them in instalments.

b. Types of Consumer Credit

b.1. charge accounts. For non-durables, payable within two months in four payments
b.2. instalment accounts. For durables, payable for more than six months to one or more
years.
b.3. revolving credit. Combination of charge and instalment accounts. Replevin is applied
which is the creditors right to repossess the item under contract when the debtor is
unable to fulfil his obligations.
b.4. lay-away plan. Full payment of the product is required within a given period before the
delivery of the item.

2. Commercial credit. Extended by one businessman to another businessman. The debtor and creditor
are both businessmen and the objects of credit are merchandise or goods which are delivered on
consignment basis or under a credit term.

3. Commercial bank credit. The creditor is a commercial bank while the debtor can be a business
firm or private businessman.

B. According to Purpose
1. Investment credit. Extended by banks for a company who intends to purchase fixed assets.
2. Agricultural credit. Loan intended for the acquisition of fertilizers, pesticides, seedlings,
transportation of agricultural products and farm improvements.
3. Export credit. Uses letter of credit as tool for financing international trade. This is issued by
importer’s bank; it guarantees payment to the exporter up to some specified amount of money. In
this procedure, the exporter is protected by substitution of the bank’s good faith and credit for
that of the importer.
4. Real estate loan. This loan is intended for the purchase of house and lot, for house construction
or improvement.
5. Industrial credit. Intended to finance industries like logging, fishing, mining, quarrying and the like.

C. According to Maturity
1. Short term loans. Loans payable within a period of one year
2. Intermediate or Medium term. Payable for a period of one to five years.
3. Long term. Payable for more than five years
 D. According to form of credit
1. Cash form. Applied from several sources like banks, private individuals or other financial
intermediaries.
2. Merchandise form. Non cash form of credit, where sources are retail outlets and the like.
Sources of Credit
1. Private individuals. These are the individual money lenders who loan surplus income to those in
immediate need of cash. They usually do not require collaterals but charge higher interest rates.
2. Retail stores. These outlets offer merchandise form of consumer credit. It offers a book account
(“palista”) for customers of the store and collection period is during paydays of the month.
3. Pawnshops. Pawnbrokers extend loans in exchange for a collateral pawn. Pawns acceptable are
personal or movable property.
4. Savings and mortgage banks. Any corporation organized for the purpose of accumulating the savings
of depositors and investing them, together with its capital, in readily marketable bonds and debt
securities.
5. Mutual savings bank. These are mutually owned by their depositors and either pay out their profit to
savers in interest dividends or retail them as a reserve cushion against loss.
6. Savings and loan associations. These are organized to obtain funds for home construction, and
majority of their savings are placed in home mortgages.
7. Credit unions. They are small non-profit, thrift and lending institutions organized around some
common bond, such as employment in the same company.
8. Insurance companies. They receive funds from policy holders and place the funds in loans, both
individually to home buyers and other small borrowers and also through security purchase in the
organized money and capital markets.
9. Pension funds. The procedure for pension fund is the reverse of that for insurance companies. It
involves the accumulation and investment of employer and employee contributions of these funds.
10. Bond and money market funds. These are companies which accept savings and place them in a pool
for investments that allows diversification of assets.
11. Sales finance companies. This includes sales and personal finance companies which make loans to
individuals for the purpose of buying automobiles.
12. Banks. These are commercial banks, savings banks, rural, development and investment banks. They
approve loans based on collaterals presented. They are the major sources of credit particularly for
businessmen and for the development of certain industries.

Credit Instruments

These are promises or orders to pay, a definite or determinable sum of money to bearer or order, on demand
or at a future specified time.

Characteristics

1. Payable to bearer
2. Payable to order
3. Payable on demand
4. Payable at future time

Credit instruments can be classified as investment credit instruments, those which earn income in the form of
dividends and interest, and commercial credit instruments, which are substitutes of money in business
transactions in the form of checks, promissory notes, bill of exchange and bank deposits.