PROF3: Banking and

Financial Institutions

Chapter 4:
Bank Credit
Instruments

Lecturer: Yvonne Hitty L. Mier,

Sacred Heart College
Agenda

Topics to be covered
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 Negotiability of Credit Instruments
What are credit instruments and how negotiable are they?

General Division of Credit Instruments

AGENDA
Promises to Pay vs. Orders to Pay; Checks and Drafts; Money
Market Instruments

The following are the topics to be Other Key Terms

covered in this chapter Negotiation, presentment, dishonor and endorsement

Significance of Bank Credit Instruments

Why are bank credit instruments important?

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Chapter 4: Bank Credit Instruments
Learning Outcomes

After assimilating this chapter, YOU should be able to:

▪ explain the role that credit plays in an economy;
▪ discuss the negotiability of credit instruments;
▪ identify the different kinds of credit instruments; and
▪ distinguish between the different bank credit instruments.

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Chapter 4: Bank Credit Instruments
INTRODUCTION

Banks, being dealers in credit, must handle

some credit instruments to facilitate and
enhance their functions. It is always best
that there is a written evidence of the
existence of credit. The written evidence
will help clear the dispute when the parties
involved are having a misunderstanding or
misinterpretation in the credit contract.

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 CREDIT
INSTRUMENTS
A credit instrument refers to a promise, or
order, to pay a definite or determinable sum of
money to the bearer, or to a specified person of
his order.
▪ In a broad sense, therefore, a credit
instrument may be defined simply as a
document which gives evidence of a credit
obligation resulting from a past transaction
which sets forth the responsibility of the
debtor to his creditor.
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Chapter 4: Bank Credit Instruments
 Negotiability

Credit Instruments

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Chapter 4: 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.
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Hence the borrower can command in
exchange for a written or oral promise to
pay either money or goods. In case of
bank credit, the object of credit
transactions is mostly money or
representations of money.
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Chapter 4: Bank Credit Instruments
When treating credit instruments, it
should be noted that not all are
negotiable instruments. To be fully
negotiable, an instrument must contain
the essentials of negotiability. To qualify
as such, it must be (1) in writing and
signed by the drawer or maker; (2)
Banks use negotiable documents in
made payable to order or to bearer;
plying their trade and the most common
(3) payable on demand or at a future
of these are the bills of exchange,
determinable time; and (4) there must
promissory note, and the check.
be an unconditional order or promise
However, not all instruments used by
to pay. Missing any one of these would
banks are of unlimited acceptance.
render the instrument non-negotiable.
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GENERAL DIVISION
OF CREDIT
INSTRUMENTS
Credit instruments are normally generally
divided into: (1) promises to pay and (2)
orders to pay. There exist similarities as well
as differences between promises to pay and
orders to pay.
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Chapter 4: Bank Credit Instruments
Promises to Pay
• In a promise to pay, there are two (2) parties: (1) the maker who
•
makes the promise and (2) the payee who is to receive payment.
The promissory note or promise to pay contains a promise and
has the personal element to comply.
Orders to Pay
• In an order to pay, there are three (3) parties: (1) the drawer, (2)
the drawee, and (3) the payee.
• The order to pay is a command and the execution may or may
not materialize.
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Promissory
Note
A promissory note is an
unconditional promise of
the maker to pay a certain
sum of 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.
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Chapter 4: Bank Credit Instruments
PROMISES TO PAY
Bank
Note
A bank note is an
unconditional promise of a
bank to pay a certain sum
of money on demand. Such
note is used as a substitute
for money. Years ago, PNB
and BPI issued bank notes.
Bank notes are a direct
obligation of the issuing
bank.
The following are examples of promises to pay credit
instruments
Banker’s
Acceptance
A banker’s acceptance
contains the bank’s promise
to pay a draft that is
presented to it for
acceptance. To constitute the
bank’s intention of honoring
the instrument, the word
“ACCEPTED” is stamped
on the face of the draft and
is duly signed by the banks’
representative. The date of
acceptance is also indicated.
Letter of
Credit
A letter of credit is also a
promise of a bank to honor
drafts drawn against it or
for its account. By virtue of
the letter of credit, a bank
substitutes its credit for hat
of the accredited buyer and
promises to pay the
beneficiary or his
representative upon
presentation of a draft,
subject to the conditions in
the letter of credit.
Bank Notes
distinguished
from Standard
Money
Bank notes are practically
like real money. The only
difference is that the note
represents private bank
credit rather than the
state’s credit. On a limited
scale, they are declared as
legal tender. Like money,
they are also fiduciary in
nature. However, they need
final redemption into
standard money. Thus, they
merely represent the 10
government notes.

Bills of
Exchange
A bill of exchange is an
order of one person/bank
(drawer) to another
person/bank (drawee) to
pay a third person (payee)
a certain sum of money
upon demand or at some
specified future time. A bill
of exchange is also in the
form of a check or draft.
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Chapter 4: Bank Credit Instruments
ORDERS TO PAY
Check
A check is the order of a
depositor to his bank to
pay a third person or
himself a certain sum of
money upon demand. Such
is commonly known as a
personal check. When the
bank’s cashier is the
drawer of the check, it is
known as a cashier’s
check. When the manager
of a business is the drawer,
it is termed as a manager’s
check.
The following are examples of orders to pay credit instruments
NOW
Account
Negotiable Order of
Withdrawals. NOW
accounts earn interest and
account holders can write as
many NOW checks as they
want. It is like a savings
deposit as it earns interest.
But it is also like a
current/checking a/c
because it can issue checks
for payments. There is no
need for a passbook for
depositing or withdrawing.
Draft
A draft is an order to pay and
a bill of exchange. They are
classified as sight or demand,
time, commercial, or bank
drafts. Those that are paid at
sight upon presentation are
demand drafts. Those
payable at a future time are
time drafts. When a draft is
drawn by a merchant against
another, it is a commercial
draft. If drawn by a bank
against another bank, it is a
bank draft.
Checks and
Drafts
Distinguished
Both checks and drafts are
bills of exchange since both
are negotiable instruments. A
check is drawn against
deposits; a draft may be
orders to pay. There are 3
parties involved in a check or
draft. A check is payable on
demand while a draft may be
payable either on demand or
at a future determinable time.
A check is drawn on a bank; a
draft may be drawn on a
merchant or a bank. 11

MONEY MARKET INSTRUMENTS
Apart from savings accounts, fixed
deposits and the like, a number of
other instruments are frequently used
in the money market.
Treasury Bills
▪ TBs are short-term securities issued by
the country’s Treasury. This reduces a
bank’s ability to lend to its clients
leading to a contraction of the money
supply. The bill consists of an obligation
to pay the bearer the face value of the
bill upon a given date. The bill is
tradable so the purchaser does not have
to hold it until the due date. If interest
rates decrease during the term of the bill,
the holder can sell the bill at a profit
before the due date.
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Chapter 4: Bank Credit Instruments
Bank Guarantees
▪ A bank guarantee is a written
undertaking wherein the bank
agrees to make stipulated
payments on your behalf should
you fail to fulfill or carry out
specified terms of a contract.
▪ Guarantees may also be issued in
Commercial Paper respect of the purchase of a fixed
property and against cash cover.
▪ The bank’s liability is restricted to
▪ Short-term commercial paper is a
the payment of a sum of money
debt instrument commonly issued
by corporations to fund a
and under no circumstances
accepts responsibility for the
temporary capital requirement.
completion of the customer’s
▪ This form of corporate borrowing
contract.
usually matures within one year.
▪ Commercial paper is guaranteed
by the company that incurs the
obligation.
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 OTHER KEY TERMS
There are four other key concepts or terms to
understand.

Negotiation Presentment
▪ Without prejudice to legal concepts, negotiation means the ▪ Presentment means the exhibiting of the instrument at the
transfer of the instrument from one person to another
either by endorsement and delivery, by mere delivery or by bank either for payment or for acceptance.
assignment.
▪ The check should be presented for payment within a reasonable
▪ Negotiation has certain conditions as follows: period of time after its issue according to the Negotiable
1. The credit instrument is complete and regular on Instruments Law.
face value.
2. The holder obtains possession of the instrument ▪ A draft, on the other hand, may be presented for payment after
before it has become past due and even without its last negotiation within a reasonable period.
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 instrument or title were detected.

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Chapter 4: Bank Credit Instruments

Dishonor
▪ Dishonor means that the check is refused payments or a
time draft is refused acceptance.
▪ The refusal, therefore, may be termed dishonor by non-
payment or non-acceptance.
▪ If this happens, the holder of the instrument may file a
protest in writing or orally.
▪ The law prescribes the way a protest is to be made.
▪ However, the protest may also be waived.
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Chapter 4: Bank Credit Instruments
OTHER KEY TERMS
There are four other key concepts or terms to
understand.
Endorsement
▪ 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 is the case, it is termed blank endorsement.
▪ When a specified person is named as the transferee, followed by
the signature of the endorser, this is called special endorsement.
▪ An endorsement which restricts the further negotiation of the
instrument is deemed as a restricted endorsement. For
example, the check is endorsed as “For deposit only” followed
by the signature of the endorser.
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 Significance of Bank
Credit Instruments
Besides facilitating to a great extent the dealings in credit, such
bills of exchange and promissory notes might also bring about
losses on the part of the bank.
▪ Therefore, care should be taken in the preparation of these papers. For
example, a check may be forged not only as to signature but also as to other
material parts such as the date, the amount, and the payee.
▪ In such cases, the bank may become liable for payments on these.
▪ A check issued by a person implies his promise to pay. In order not to destroy
the trust of the public on banks, depositors should see to it that they have
sufficient funds to cover the checks they issue.
▪ Since banks are also responsible to honor checks for payment, or bills of
exchange in general, they should see to it that their normal cash needs would
always be enough to answer the demands of depositors and customers.
▪ This way, the public’s confidence on the soundness of banks and their
patronage of the banking system as a whole shall be strengthened considerably.
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Chapter 4: Bank Credit Instruments
 THANK
YOU!
Questions?

Email: Website:
yhlmier@shc.edu.ph cbashc.wordpress.com
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Reference

❑ Leuterio, M. & Estepa, C. (2009). Banking: Theory and Practice,

Anvil Publishing.

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