BASIC FINANCE Ctedit System: Its Fundamentals, Sources and Bases LEARNING COMPETENCIES After studying this chapter, the leamers ate expected to: L. Explain what is credit and its significance, 2. Cite te advantages and disadvantages of credit economy. 3. Discuss the social viewpoint of eredit, 4, Enumerate and discuss the foundations of credit, 5. ‘State the advantages and disadvantages of using credit card. 6. Explain the different classifications of eredit 7. Explain the sources and bases of credit.22 | Math in the Business World “Modern man drives a mortgaged car ayer. @ bond-financed highway on credit-card gas,” Earl Wilson. FUNDAMENTALS OF CREDIT ‘What is Credit? Credit refers to the ability to obtain a thing of value in exchange for a promise to pay with money or something equally satisfactory to the seller at some future time. It can also be described as the parting of resources by one party called the creditor to another pariy called the debior where the latter does not give the money back to the first party immediately thereby generating a debt. Instead of immediate exchange it arranges either to repay or return those resources of equal value or more at some future date. Flows of financial resources are, a8 a rule, dependent on either credit or equity transfers. Credit is dependent on the reputation or credit worthiness of the entity which takes responsibility for the funds. It is not necessary that credit be based on formal monetary systems. The credit concept can be applied in barter economies based on the direct exchange of goods and services. This explains why some would go so far even to the point of suggesting that the truc nature of money is best described as a representation of the credit-debt relationships that exist in society. . It can be conctuded therefore that, with or without money credit can still exist for as long as there was a parting of something of value and recognition of obligation by the other party. Credit can be satisfied not just in terms of money but also in terms of goods and/or services that the debtor may us¢ in payment of his obligation. Credit is denominated by a unit of account. Unlike money, if we go by definition, credit itself cannot act as a unit of account, However, many forms of eredit can ceadily act as a medium of exchange. As such, various forms of credit are often considered as money and are included in estimates of the money supply collectively termed as money and its equivalents. Advantages and Disadvantages of Credit from Macro Perspective Advantages of a Credit Economy 1 Is generates additional funding. Credit allows business firms to acquire cash loans by using their existing fixed assets like machines or buildings as security instead of selling a part of theit physical properties to obtain money. They can alo sell debt instrument like bonds” to generate more funds for their investment ventures.Credit Systern: its Fundamentals, Sources, and Bases | 23 2. It presents opportunity. ; ; Credit gives chance to dynamic and enterprising men to capitalize the opportunity 10 put up their enterprises through credit, 3, Itcan increase government spending. Hallows the state to undertake deficit spending. Rational and timely government projects or programs can be funded through bonds or loans ike the present "Build, Build, Build” program by the Phitippine government. 4, It benefits the economy. Credit accelerates production, employment, income, and consumption. 5, It postpones financial outlay. It permits low-income consumers to enjoy the consumption of goods and services sooner, like house and lot, cars, appliances, and other consumer products. Disadvantages of a Credit Economy 1. Credit may lead to inflation. Heavy borrowings by the governments may likely lead into inflation. It requires competent and dedicated monetary authorities, economic planners, and the cooperation of top government officials to use properly locat and foreign loans. 2. It eam lead to wastage of resources. Borrowing by the government may result to extravagance and inefficiency. This has been noted by development economists on the credit performance of the developing countries. 3. Unlike cash, eredit has a pervasive effect, Business errors in the use of credit funds have unfavorable chain effects on the whole economy. Failure of some firms to settle their debts with other companies affect the latter te pay their bank loans. In ium, the banks will be having cash problems just like what the world experienced in 2008-2009. 4. Tt can burden the next gencration. Excessive loans from other countries by the government may likely be a burden to fusure generations, unless such loans are wisely invested in the economy for the benefit of the masses,24 | Math in the Business World 5. Teean reduce spending. In some cases, credit reduces fature consumption of debtors as bt consti confidence in consumption, sales and production slow dowa whic! te reduction of employment. . ‘The Social Viewpoint of Credit is the rich who use more credit Credit does not exempt even the rich. In fact, . facilitios because of theit ability to pay and their speciat personal connections wih the officials of the various financial institutions, There was a rick man who was able to purchase a hacienda through bank credit. Obviously, the tich become richer because they are given more opportunities to obtain loans for business of production purposes. “The investments of the rich would have been more significant if their benefits reach the poorest of the poor. Profits are still atainable without abandoning their social responsibility. Credit resources should be used not only to benefit the users but also society and the economy. This should be the guiding principle of the credit system in granting foans to applicants. Considering the scarcity of our financial resources, our government should be more careful and wise in the allocation of such resources. “The objective of the credit system authorized by the government is to improve the social and economic conditions more importantly of the poor, especially in the rura} areas and urban slums where conditions are more miserable. The chains of economic slavery should be broken. The poor need money for putting up income-producing projects or businesses like poultry, sari-sari store, piggery, or tricycle for that matter. However, most of them cannot borrow from financial institutions for lack of acceptable properties as collaterals. With such institutionat harriers in obtaining bank credit, the poor are somewhat impliedly excluded from the credit system. Thus, the credit program of the goverment for the poor, in the eyes of many has presented more challenges rather than opportunities. Clear proof of this is the fact that the small sari-sari store owners are now being financially slaved by the loan sharks (neighbors with money and the motorcycle riding Indian of ‘Turkish tenders). Going: informal is a clear choice for them because of the ‘very slim chance for them to be granted with credit, in the mainstream credit system. ____ There are improvements, however, being done at present to address the necds of micro enterprises. The government has allocated billions of pesos to fund micro loans in coordination with the Department of ‘Trade and Industry (DTI) with the help of other financing institutions whose requirements are more simplified and not as difficult as formal arrangement with banks. Tt should be known to all that, in the eyes of soine farmers in the countryside, wet market occupants and small “sari sari” store owners, any form given them to fill up is so intimidating moreso if they are required to process thick decuniental Tequirements when they try to obtain a bank loan. Simplifying credit for them to access start-uy vital as well it p . FameEp copie aswell as working capital needed isthe Key forthe entreprencural spit (0its Fundamentals, Sources, and Bases | 2S Foundations of Credit 1. Assistance . ‘There should be a credit environment that is ready to assist both the creditor and debtor. Typical exainple to this are commercial !aws like the law on obligations and contracts, These laws protect the creditor and debtor in enforcing their rights. Likewise, there should also be assistance for borrowers for them not to fall vietims of opportunist lenders tike the “foan sharks” who are capitalizing on their needs, These arc creditors who extend credit in an anchristian nianner imposing bigh interests further burying the debtor into the debt pit. 2. Confidence One of the corner stones of ctedit is confidence. Confidence can be described as the openness and willingness of one party (creditor) to be exposed to uncertainties by giving out money or property to the debtor in exchange of a promise that the same money or property or its equivalent will be paid in the future. Without confidence, 06 man would be willing to part any good or service in exchanges with just a plain promise to pay unless the creditor has confidence on the debtor/borrower. For collateralized credit like mortgage or on those credits that are evidenced by an instrament like promissory notes, confidence is partly anchored on the instrument and on the property and other assets deposited by the debtor as security im addition to his character. An example to this is pawning. Pawning in substance is barrowing of money with your personal property like jewelries serving as collateral. When the owner of the property fails to pay within ihe time specified, pawnshops are happy to sell the items pawned at obviously advantageous prices considering that the industry practice is to appraise them at values way lower than how much they can be sold for. 3. Facilities For credit system to function well there kas to be an environment conducive for credit transactions. Sources of credit information have to be present for creditor to evaluate the extension of credit, An environment in suck a way that credit contract is respected and protected should be present, and above all, the legal bases that will serve as the parameters of credit activities must be available. 4, Stability of Money For credit systom to propagate, the money standard must be stable to protect both the cieditor and debior. Value of money should not fluctuate widely since this will cause the purchasing power to be uncertain, For example, a decrease in value of money after the contract was executed will be disadvantageous on the part of the creditor since he once pacted something of grester value than what itis at present. This scenario will discourage financing institutions £ lend out further knowing that the value of money they are extending tv borrowers are.going downhill come payment tine, This kind of behavior and reservations can definitely affect the credit activities in & particular country or region which can have an effect on economic activities in general. Basic Characteristics of Credit 1. Bipartite in character Credit involves a meeting of minds between at least two persons or parties who agree on tems of the transaction; the creditor who lentds out his money of property and the Gebtor who receives and promises to pay the said obligation at sonte future time. A credit transaction by description is actually reciprocal in striet substance which springs from the trust and confidence of the creditor and Ue duty to fulfill the obligation by the debtor, 2, Ikis fiduelary, Credit is based on trust, Except for other monetary inerements, there js no other basis on why in the first place one would give someone money oF property today for the simple reason of getting the said money back in che furure; it is trust. In the entire web of business and economics. credit is playing a0 important role in giving more thrust tothe economy and it would not have been like this ifthere is mo special trust and confidence by any party into a ctedit transaction. The parties involved in this transaction are actually the counterparts of the merchants of the old times. Their words are the unwritten contract that reminds-us the old idea that « good merchant's words are like an offer of gold, 3. It involves futurity. In credit, there is always a future time involved since by substance, a credit transaction is just a need today satisfied by one party with confidence of getting paid in the future, - 4, Financial in aature Credit involves something with economic subsiznce. In the old times, it is expressed in terms of volumes of goods or other measures of goods and services, In these modem times, credits are expressed in terms of volume of goods and/or its monetary equivalents and in this context, eredit is now fully financial in nature. 5. There is always an element of risk, Credit is exposed to uncertainties considering that it involves futurity, The danger of not being paid is always present and possible. There are so many things that could happen from the inception of the credit contract up to the agteed settlement date, the reason why interest is imposed us payment of risk. Others would ium to modern time sisk shielding anangenent such credit swapping and other hedging activities like account insurance or factoring to minimize the risk of the account,Credit System: Its Fundamentals, Sources, and Bases | 27 The Use of Credit Card ‘The plastic credit card with a magnetic strip ot chip that many people carry in their wallets or purses is the end resutt of a comyplex banking process, Holders of a valid card have the authorization to purchase goads and services up 10 a predetermined amount, called a credit limit, The vendor receives essential information fromm the cardholder, the bank issuing the card actually reimburses the vendor, and eventually the cardholder repays the bank through regular monthly payments. If the entire balance is not paid in fall, the issuer can legally charge interest fees and surcharges on the unpaid portion. Individual credit card companies and banking institutions have their own policies when it comes to credit card applications, Customers may Seek either 2 secured or unsecured card, depending on their individual repayment histories, or credit rating, Back in the days, there used to be secured credit card, A secured card requires the applicant to deposit an amount of cash equivalent to the credit limit desired. A deposit of 100,000, for example, should be enough to be issued a card with a P75,000 to P100,000 spending Linit, Ifthe customer fails to make sufficient payments, the deposited money will be used to satisfy the debt. At present, the system virtually uses an unsecured credit card. An unsecured credit card is generally issued to those wito have a good credit history and have demonstrated an ability to tepay the accrued debt on time. Credit limits are determined on an individual basis and may be raised or lowered based on performance. An unsecured card isessentially a pre-approved purchase or loan, with interest rates higher than a similar personal bank Joan. Credit cards ofien become problematic when the holder accrues more debt than a segular monthly payment can cover. The issuing bank does allow users to carty over balances every month, which is also called revolving credit, but significant interest rates may also acerue on those balances usnally 3% per month. If cardholder can only afford to pay the mininmim amount due every month, he or she will not be reducing the actual debt incurred. The minimal payments may only apply to the accrued interest and the principal payable may still be at the same amount, This is a financial spiral many cardholders may experience if they do not use proper spending restraint. It is therefore necessary to keep track how much are really up to in terms of spending. If it is not necessary or the purchase does not give you benefit if you use credit card, pa Itis good reminder that on spending you need to ask the question, do [ really need the item? Payment in cash is really a good test on the need because the pain level is different when you leave your cash behind at the counter, A credit card does give the holder an immediate credibility for services such as hotel reservations, car rentals and airline ticket reservations, Those without credit cards often have to guarantce their reservations with cash deposits or several forms of identification. Many credit exrd plans also include insurance coverage for theft or freud, Wa card is reported stolen and then used illegally, the cardholder would not be held sesponsible for unauthorized charges. A cardholder can authorize other people 0 use the acd for purchases or services, however Ultimately, the primary cardnofder is responsible for all charges placed on bis of her geeount,2 peepee ste 28 | Math in the Business Warld smsmamtasin Having a credit card ig nat a requitement for successful living, but even those whe ‘h often find it to be a convenient form of only pay for goods or services with available cas c at identification and instant credibility. In order tw avoid excessive debt, the bolder must decide if the goods or services are worth the added expenses, Advantages and Disadvantages of Credit Card to credit cards. Knowing Like most things, there are advantages and disadvantages a this plastic money, some of these can help you decide if you do or do not want to use Advantages ~ 1, . Ease of Purchase Credit cards can make it easier for you to buy things. If you don't like to. carry large amounts of cash with you of if it becomes impractical to do cesh purchases like in airlines (Piso fare promo), hotels, and vocational destination (dependent on platforms like booking.com, Agoda or Trivago) whose prices are volatile, putting purchases on a credit card remotely via internet can make buying things easiet and beneficial. 2. Protection of Purchases Credit cards may also offer you additional protection if something you have bought is Jost, damaged, or stolen. Both your credit ecard statement (and the credit card company) can vouch for the fact that you have made a purchase if the original receipt is lost or stolen. in addition, some credit card companies offer ingurance on large purchases. Building a Credit Line 4 * Having a good credit history is ofien important, not only when applying for credit cards, but also when applying for things such as loans, rental applications, or even some jobs, Having 2 credit card and using it wisely by making payivents on time and in full each month will help you build a good credit history. 4. Emergencies Credit cards can also be useful in times of emergency. While you should avoid spending outside your budget on money you do not have yet, but sometimes emergencies Jike if your car breaks down, flood or fire and natural calamities, credit card can help you go back to normal right away. Credit card is also useful during medical emergencies when you do not have enough cash on band, We should always be reminded that unless you have health insurance provided by #