FM 306
➔ The use of credit especially in the
The Emergence and Challenge of the
Credit Economy
The Birth of Credit
One of the unique features of our business
system is that it operates to a large extent on
promises, called credit. The word credit
comes from the Latin word credere, which
means “to trust.”
Nature of credit
● Insofar as the debtor is concerned,
credit to him represents power—the
ability to obtain goods without inactual
tender of payment. Since the grant of
credit by the creditor to the debtor is
accompanied by a promise on the part
of the latter to pay at a certain date, an
obligation arises which must be
discharged as promised.
● The creditor, as a seller of goods or
services on credit, has both the moral
and legal right to demand of his debtor
to pay the obligations when due.
Other Meanings of Credit
➢ In banking, credit is held refers to “an
entry in the books of a bank showing
its obligation to a customer,” that is,
for the deposits made by the latter.
➢ In bookkeeping, credit is “an entry
showing that the person named has a
right to demand something but not
necessarily money.”
➢ In another sense, credit may be held
synonymously with specific reference
to the buyer’s credit standing, that is,
the ability to obtain goods and
services, or even money against a
promise to pay for them at a latter
date.
➢ Likewise, the term credit may refer to
a credit instrument, that is, a
document which serves to evidence
the existence of a business
transaction anchored on trust.
Use of credit
business world is so common that, by
way of compliment, it is generally called
as “ the life-blood of business.”
Advantages of Credit
❖ Credit facilitates and contributes to the
increase in wealth by making funds
available for productive purposes.
❖ Credit saves time and expense by
providing a safer and more convenient
means of completing transactions.
❖ Credit help expands the purchasing
power of every member of the
business community—from producer
to ultimate consumer.
❖ Credit enables immediate
consumption of goods thereby
providing for an increase in material
well-being.
❖ Credit help expand economic
opportunities through education, job
training and job creation.
❖ Credit spreads progress to various
sectors of the economy.
❖ Credit makes possible the birth of new
industries.
❖ Credit helps buying become more
convenient for customers.
Disadvantages of Credit
❖ Credit, at times, encourages
speculation. This happens when those
in charge of the savings of other
people throw caution to the winds and
thereby become careless and
unscrupulous in their eagerness and
desire to expand credit and make
huge profits.
❖ Credit also tends to contribute to
extravagance and carelessness on the
part of the people who obtain them.
❖ Credit causes one businessmen to be
dependent upon others.
Interest - Anyone who extends credit cannot
use the money loaned in some other way until
the debt is paid. Therefore, has a right to
charge for its use. This charge is called
interest. Interest is usually expressed as
percent. This is the interest rate.
Operating expenses - Business enterprises
that extend credit shoulder the same
operating expenses as other businesses.
Risk - Extending credit always involves a risk
for the lender since he can never certain that
the debt will be paid. When a lender is unable
to collect a debt, he takes a loss. Losses from
unpaid debts represent an added cost of
doing business. Needless to say, such losses
are highest among lenders who assume the
greatest risk.
CLASSES AND KINDS OF CREDIT
1. PERSONAL CREDIT - most personal
credit, by and large, is used by individuals to
buy consumers goods intended to
provide immediate satisfaction to their wants
and needs. They are also called consumer
credit.
KINDS OF CONSUMER CREDIT
1.) Charge Account - The oldest form of
sales or purchase credit. Other names for this
kind of credit are Open-book
Credit, Open Charge Account, and 30-Day
Credit
ADVANTAGES OF CHARGE ACCOUNT
• It is a very convenient way of shopping.
• It eliminates the inconvenience as well as
the danger of carrying too much money.
DISADVANTAGES OF CHARGE ACCOUNT
• Unless absolutely necessary, it should not
be made at all if the cost is not within the
budget allowance for such an item.
• The dangers in charge accounts, unless
carefully controlled, are that non-essentials
will be purchased w/o much consideration.
• Less care will be used to get the most value
for the money spent than when the purchase
is made for cash.
USE OF CREDIT CARDS- This type of device
serves to identify credit customers as those to
whom the store has given
a symbol of its confidence in them.
✓ INSTALLMENT CREDIT
This is the most common type of consumer
credit. A number of individuals term it as
"buying on time".
Through this method, the buyer is often asked
to make a partial payment at the time of
purchase, termed "down payment". The
balance is is expected to be paid with a series
of regular payments.
As a policy and practice, a buyer of goods on
installment credit is required by the selling
company to sign a company agreement
known as an "installment contract".
PRECAUTIONS IN BUYING INSTALLMENT
1.) Never allow yourself to be rushed or
pressured into signing a contract until you
became conversant
with all the facts.
2.) Always insist for an extra copy of the
contract.
3.) Never sign any contract before all the
blank spaces are filled in.
4.) Read again after signing.
✓ REVOLVING CHARGE ACCOUNT
The amount a customer can owe the store at
any one time on a revolving account is limited-
the limit based on how much the customer
earns and what other expenses he has to
meet.
✓ PERSONAL LOAN
A person may borrow for a number of
purposes, such as to pay cash, for an
appliance, for the repair of the
house, to pay for medical expenses or to
cover one's expenses to travel abroad.
✓ ECONOMICS OF CONSUMER CREDIT
When credit is extended, an individual or a
business house buys goods in return for a
promise to pay for these goods at some future
time. Credit then, as repeatedly stated before,
on future promise to pay. That promise may
either be "implied" or "expressed."
✓ SALE OF GOODS ON CREDIT TO THE
POOR
This was laid down for the expansion of
economic opportunities with the approach
ranging from making
education within the reach of the masses to
such proposals as job training and job
creation.
2. MERCANTILE CREDIT - It is equally
known as "commercial credit." Sometimes, it
is also called "trade credit." It is granted by
manufacturers, wholesalers, and jobbers as
an accident of sale.
UNDER MERCANTILE CREDIT
1.) Mercantile Credit/Retail Credit
2.) Raising Money On Accounts Receivable
3.) Credit Terms
3. BANK CREDIT - Bank credit comprises the
aggregate of all the funds advanced in various
ways by banks to other members of
the community.
TYPES OF TRANSACTIONS COMMERCIAL
BANKS FINANCE
1.) Commercial Loans
2.) Agricultural Loans
3.) Industrial Loans
4.) Real Estate Loans
5.) Personal Loans
6.) Packing Credit Advances
7.) Trust Receipts
8.) Limit to Expansion of Bank Credit
4. INVESTMENT CREDIT - This consists of
advances that have been made to a business
enterprise to enable it to purchase or
construct
the necessary plant and equipment.
5. AGRICULTURAL CREDIT - With hunger
and starvation haunting the lives of segments
of the world's population, increasing focus is
made on the need to increase food
production, accelerating agricultural
development
6. EXPORT CREDITS - The ability of the
man, whether he be an export executive or a
special credit manager, who extends credit to
customers in other countries of the world,
depends upon willingness to assume
responsibility to a reasonable extent in
extending such credits to enlarge business of
his concern w/o unreasonable risk.
7. PUBLIC CREDIT
1.) Financing Government Expenditure
2.) Public Borrowing in Developing Countries
3.) Philippine Government's Authority to
Borrow
SOURCES OF CREDIT
1. Individual Money Lenders - the
money lender may be constrained to
collect a very high rate of interest over
and above the legal one in order to
protect his personal interest and thus
become what is known as “loan-
sharks”
2. Retail Stores - Easily the biggest
source of merchandise credit in the
Philippines is the retail store, more
particularly known as the “sari-sari”
store. After May 15, 1954, in
accordance with the provisions of the
Retail Trade Nationalization Law, no
alien is permitted to engage in this
type of business
3. Pawnshops - The present-day
pawnshops owe their origin from the
Montes Pietatis which were
established by Franciscans (Friar
Minor as they were invariably called
then) in Italy.
➢ Monte de Piedad - oldest saving bank
➢ According to Lien Sheng Yang, a
Harvard professor of Chinese history,
pawnshop is the “oldest credit
institution in China”
4. Commercial Banks - Commercial
banks are engaged in the grant of
loans not only to businessmen, but
also to individuals for personal
purposes.
➢ These guarantors of the credit of the
borrower are called “co-makers”.
➢ character loan -. this is being granted
by the PNB.
5. Savings Banks - mortgage banks as
well as savings and loan associations
6. Rural Banks - provide the chief
source of credit, especially for those
 engaged in agriculture who need
these facilities badly.
➢ RA 720, known as the Rural Banks
Act.
7. Development Banks - for
government employees and can
borrow up to 1M
8. Commercial Paper House - short
term debts or loans and term loan 270
days.
➢ A commercial paper house also buys
issues outright at a discount and resell
the notes at a
slightly higher price to investors.
➢ The commercial paper includes
notes, bankers’ acceptances, trade
acceptances, and foreign exchange
bills.
9. Finance Company - As an industry,
it shares with government the
universal goal of achieving a strong
and healthy financial system. Given a
conducive regulatory environment,
finance companies can effectively
mobilize the resources needed for
productive investments. They have
developed into a major source of
funds for consumer, sales, and
commercial financing.
10. Credit Union - a financial institution
that is owned and controlled by its
members rather than shareholders.
The members of the credit union pool
their deposits and provide loans and
other financial services to each other.
C'S OF CREDIT
1. Character - is the most important
consideration in the proper
determination of the credit rating of an
individual.
2. Capacity - As a basis of credit,
capacity signifies the ability to pay
when a debt is due.
3. Capital - For credit purposes, credit
represents the financial strength of the
risk, that is, it consists of the amount
and quality of goods and property,
expressed in terms of money, which
an individual or firm possesses over
and above, his financial obligations
4. Collateral - Speaking of collaterals,
creditors as a general rule would
prefer loans or credits to be backed up
by collaterals as much as are
necessary for their self -protection.
5. Conditions - Economic conditions
exert a profound effect upon the grant
of oans and credits. It may be rightly
mentioned that loans and credits may
be extended at certain times and may
be denied at other times.
6. Country. Since, as had been stated
time and again, the sale of goods and
services in any part of the world on
credit involves risk, it follows that
every factor should be carefully
considered and scrutinized insofar as
they affect credit risk.
7. Currency. Not only is the stability of
the country of importation an important
factor to reckon with in the
consideration of credit risk in
international trade transactions but,
equally so is that which pertains to
that of currency. The risk of exchange
must also be taken into account.
8. Confidence - After having indicated
and discussed the various bases of
credit, one is led to conclude that, in
the ultimate analysis, credit is founded
on confidence – which by far is the
principal C of credit.
CREDIT INSTRUMENTS
Credit Instruments
➔ may be described simply as
documents which evidence the
existence of credit transactions.
➔ refers to all various kinds of written
instruments that, by large, are
customarily used to embody the terms
of a credit contract.
Commercial Credit Instruments
❖ Open Book Account
➔ Also called “book credit”.
➔ The instrument covers
transactions whereby the
seller bills the buyer for the
 amount of goods at the time
agreed upon and at the time of
sale, which is recorded in the
book of original entry.
❖ Trade Acceptance
➔ A trade acceptance may be
described as an
acknowledgement of a debt by
the buyer, in favor of the
seller, for merchandise that
the seller had placed in the
hands of the buyer with which
to pay this debt.
❖ Promissory Note
➔ Written promise by a person
called the maker, to another
party, the payee to pay a
definite sum of money at a
certain future time.
➔ Promissory notes may partake
of two kinds: negotiable and
non-negotiable.
● Single-Name
Promissory Note -
one indicated maker
● Two-Name
Promissory Note-
have a co-maker and it
is more valid than
single name
❖ Bill of Exchange
➔ Witten Order
➔ The person who gives the
order is the drawer. The
person who is ordered to pay
is the drawee. The party
entitled to receive payment is
the payee. Thus, from the use
of bill of exchange, three
parties are involved.
➔ The drawer or maker of the
instrument is the creditor who
orders that payment made.
❖ Acceptances
➔ An acceptance is in the form
of a draft, that is, an order
drawn by one person upon a
bank or another party directing
it to pay a stated sum of
money either to the drawer or
to some third person.
❖ Credit Cards
➔ From both practical and
business point of view, credit
cards may be considered as
another form of credit
instrument.
❖ Checks
➔ Written order by the depositor,
the drawer upon the bank, the
drawee, to pay on demand or
at a future determinable time.
KINDS OF CHECKS
1. Open Check- there will be a one blank for
the drawee to state the info example is date
2. Crossed Check- has two parallel lines and
also much safer but strict regarding the
exchange of the principal amount
3. Certified Check- verifies by the bank itself
and can be exchange even 6 months
4. Manager’s Check- use for business
purposes
5. Traveller’s Check- you can acquire this in
banks and they will give you a check that
indicates the currency of your chosen country
6. Overdraft Check- can still accept by banks
even there is a insufficient funds but in the
form of credit
7. Bouncing Check- compare to overdraft
this check cannot be process by banks
example is when the account is closed or
insufficient funds
8. Post dated Check- drawer stated a date
later than the current date
9. Stale date Check- for 6 months but when
its over 6 months the date can be replaced or
request another check
Different form of credit instruments
➢ wherein stocks is form of ownership,
bonds is a form of liabilities and
 promissory notes as the oldest and
famous form of commercial credit
instruments. It can be classified as
single name promissory note or two
name promissory note.
UNDERWRITING PROCESS
UNDERWRITING
➢ is the process by which your lender
verifies your income, assets, debt and
property details in order to issue final
approval on your loan application.
What Does An Underwriter Do?
➢ They work for mortgage, insurance,
loan or investment companies. They
assess, evaluate and assume the risk
of another party for a fee. Often, you’ll
see this fee in the form of a
commission, premium, spread or
interest.
Possible Sources of Error the Credit Approval
Process Must Be Designed to Avoid
● Substantive errors: These comprise
the erroneous assessment of a credit
exposure despite comprehensive and
transparent presentation.
● Procedural errors: These errors lead
to an incomplete or wrong
presentation of the credit exposure.
On the other hand, procedural errors
can result from an incorrect
performance of the credit approval
process.
Four Risk Components
a. Probability of default (PD)
b. Loss given default (LGD)
c. Exposure at default (EAD)
d. Maturity (M)
The Steps of the Loan Approval Process:
1. The applicant submits a request for loan
pre-approval.
- Loan pre-approval is a preliminary
step where you ask the lender if they
might be willing to lend to you and on
what terms. You aren’t formally
applying for credit yet, and often
lenders can pre-approve you without a
hard credit check.
2. The applicant applies for credit.
- When you’re actually ready to apply
for credit, you’ll need to submit a credit
application for financing with your
lender. Most lenders now allow you to
apply online for loans, but you may
have to visit a local branch of a
financial institution.
3. The lender reviews your credit
application and assesses the risk of lending to
you.
- Your credit score
- Your credit report and borrowing
record
- Your income
- Your employment history
- The current level of debt you have
- The number of assets you own
- The amount you want to borrow
- Your income relative to your debt
4. The lender notifies you of loan approval or
denial
- If you have good credit and present a
low risk, the lender may decide that
you should be approved and may offer
you their most competitive rates.
CREDIT SCORE
➔ A credit score is a number from 300
to 850 that rates a consumer's
creditworthiness. The higher the
score, the better a borrower looks to
potential lenders.