CHAPTER 5

BANK CREDIT INSTRUMENTS

Negotiability of Credit Instruments

 Credit takes place when there is the creditor’s belief or faith in the borrower’s
willingness and ability to pay. Hence the borrower can command in exchange for a
written or oral promise to pay either money or goods.

 The banks use negotiable documents in plying their trade and the most common of
these are the bills of exchange, the promissory note, and the check. However, not all
instruments used by the banks are unlimited acceptance.

 To be fully negotiable, an instrument’s must contain essentials of negotiability. It

must be in writing and signed by the drawer or maker; it must be made payable to
order or to bearer; it must be payable on demand or at a future determinable time;
and there must an unconditional order or promise to pay.

General Divisions of Credit Instruments

In order to distinguish one instrument from another, the following is a short

description of each. A general division between the credit instruments is that of promise to
pay and orders to pay:

Promise to Pay

Promissory Note - is an unconditional promise for the maker to pay a sum certain in
money to order or to bearer on demand or at a future determinable time. When the note is
secured, it is called a collateral promissory note.

Bank note - is an unconditional promise of a bank to pay a sum certain in money on

demand. Such note is used as a substitute for money. Essential Features of a note:

a. It is a Direct Obligation of the issuing bank.

b. It is negotiated by simple delivery by reason of the fact that it is a bearer instrument.
c. The transferee acquires a clean title to it and becomes the creditor and the note can
be circulated for longer periods of time before it is finally redeemed.
d. The notes are also in handy sizes and convenient denominations.

Banker’s Acceptance - a bankers acceptance contains the banks promise to pay a draft that
is presented to it for acceptance. To constitute the bank’s intention of honoring the
instruments, the word “ACCEPTED” is stamped on the face of the draft and it is duly signed
by the bank’s representative.

Page | 1
Letter of Credit – a letter of credit is also a promise of a bank to honor drafts drawn against
it or for its account. A bank substitutes its credit for that of the accredited buyer and
promises to pay the beneficiary or his representative upon presentation of a draft, subject
to the condition in the letter of credit.

Bank Notes Distinguished from Standard Money

 Bank notes are practically like money the only divergence of the note from the real
money is the fact that the notes represent private bank credit rather than the state’s
credit.
 The note is declared as legal tender either fully or on a limited scale.
 Like money, bank notes are fiduciary in nature and their circulation is dependent
upon the credit of the issuing bank.
 Bank notes however, necessitate final redemption into standard money.
 Therefore, they merely represent the government’s notes.

Bank Notes Distinguished from Deposits

 The circulation of bank notes and deposits necessitates legal reserves. However,
where deposits are concerned,
Bank’s keep larger reserves because bank notes circulate longer while checks drawn
against deposits could immediately be presented for payment when endorsed.
 Deposits necessitate the use of the checks to circulate them; bank notes in
themselves constitute the means of payment.
 In the case of deposits as well as in issuing notes, the bank becomes a debtor to the
depositor or the note holder.

Orders to Pay

 Bills of Exchange - is an order of one person/bank (drawer) to another person/bank

(drawee) to pay a third person (payee) a sum certain in money or demand or at
some specified future time. A bill of exchange is also in the form of a check or a draft.

 Check - is the order of a depositor to his bank to pay a third person or himself a sum
certain in money on demand. Such is commonly known as a personal check. When
the bank’s cashier is the drawer of the check, it is known as cashier’s check. When
the manager of a business concern is the drawer, it is termed a manager’s check.

NOW Account. NOW stands for “Negotiable Order of Withdrawal”. It earns interest and
account holders can write as many NOW checks as they want on the account. It has a

Page | 2
 feature of a savings deposit as it earns interest. It is also like a current/checking account
as it offers depositors the convenience of issuing checks for payments.

Types of checks other than negotiable instruments:

 Rubber or Bouncing check – is one which is returned for insufficiency of funds.

 Crossed check- one which is intended only for deposit.

 Certified check- is one which is confirmed to have existing funds.

Draft- is also an order to pay and is a bill of exchange. Drafts are classified as sight or
demand, time, commercial or bank drafts.

Demand drafts–are instruments which are paid at sight upon presentation.

Time draft– those payable at a future determinable time.

Time sight draft- is payable also after a determinable time but the counting of its maturity
starts from the date of acceptance.

Time date drafts- maturity is counted from the date appearing on its face, or the date the
draft is made.

Commercial/trade draft- when the draft is drawn by a merchant against another.

Bank draft - if drawn by a bank against another bank.

Money Market Instruments

1. Treasury bill- areshort-term securities issued by the country’s treasury. The bill
consists of an obligation to pay the bearer the face value of the bill upon a given
date.

2. Banker’s Acceptance/ Letter of Credit- it I s a time draft and accepted bank. Before
acceptance, the draft is merely an order by the drawer to the bank to pay a specified
sum of money on a specified date to a named person or to the bearer of the draft; it
is not an obligation to the bank.

3. Negotiable Certificates of Deposit (NCD) – are liked fixed deposits except they are
bearer documents. They offer related rate of interest and are completely liquid
because they can be negotiated during the term of the deposit. Most NCD’s have a
term of less than a year. They usually offer rate of return higher than banker’s
acceptances.

4. Commercial paper – short-term commercial paper is a debt instrument commonly

issued by corporations to fund a temporary capital requirement. This form of

Page | 3
 corporate borrowing usually matures within one year. Commercial paper is
guaranteed by the company that incurs obligation.

5. Bank Guarantees- a guarantee by Bank (banker’s guarantee) is a written

undertaking wherein the ban agrees to make stipulated payments on your behalf
should you fail to fulfill or carry out specified terms of a contract.

Negotiation - means the transfer of the instrument from one person to another either by
endorsement and delivery, by mere delivery or by assignment. Such transfer will depend
on the tenor of the instrument, particularly to whom it is made payable, or to what extent is
the interest of the transferee.

- When the instrument is payable to order which means that there is a

specified name appearing the payee, the instrument is negotiated by
endorsement and delivery. When, however, the instrument is made
payable to bearer, which, means that there is no specified name as payee
or when payable to cash, then the negotiation is completed by mere
delivery.

Negotiation has certain conditions:

1. The credit instrument is complete and regular on face value.

2. The holder obtains possession of the instrument before it has become past due and
even without notice that it was previously dishonored.

3. The holder took the instrument in good faith and for value.

4. At the time it was negotiated to the holder, no defects in instruments or title were
detected.

Presentment - means the exhibiting of the instrument at the bank either for payment or
for acceptance. The check should be presented for payment within a reasonable period of
time after its issue according to the Negotiable Instruments Law.

Dishonor - means that the check is refused payment or a time draft is refused acceptance.
The refusal therefore may be termed dishonor by non-payment or non-acceptance. If this
happens, the holders of the instrument may file a protest in writing or orally. The law
prescribes the way a protest is to be made.

Endorsement - forms part of a negotiation of an instrument. It is simply indicated by the

signature of the endorser at the back of the instrument or on some paper attached thereto.
If such case, this is termed special endorsement.

Page | 4
 - When a specified person is named as the transferee, followed by the signature
endorser, this is termed special endorsement.
- An endorsement which restricts the further negotiation of the instrument is
deemed as a restricted endorsement.
- An endorsement is qualified when the words “without recourse” appears as part
of the endorsement.
- It transfers the title and warrant the genuineness of the instrument, but does not
guarantee the payment of the endorser in case the bills have defects.
- The liability of the endorser on the note or bill will then be determined
according to the type of endorsement made by him.

Significance of Bank Credit Instruments

- Besides facilitating to a great extent dealings in credit, such bills of exchange and
promissory notes might also bring about losses on the part of the bank. The bank
is also responsible to honor checks for payment, or bills or exchange in general,
it should see to it that its normal cash needs would always be enough to answer
the demands of depositors and customers.

“Let the Lord fight your battles, deal with your problems and direct your direction.
When you have done your best, trust the Lord to do the rest.”

Page | 5