Chapter 12

The Nature and Functions of Credit

c. Commendation and praises. This may be done through letters of commendation if not
through the awarding of plaque or certificate of merit.

Bank Appraisal Report. Generally speaking, a bank appraisal report contains, among others, the
following information:

1. Subject of appraisal
a. Name of registered owner
b. Location of the property

2. Land identity
a. TCT number
b. Technical description
c. Lot number
d. Block number
e. Land area

3. Description of land
a. Shape
b. Frontage

4. Neighborhood data
a. Commercial
b. Semi-commercial
c. Residential
d. Industrial
e. Raw land
f. Others

5. Public utilities
a. Electricity, water, telephone, gas, etc.
b. Kind of transportation facilities available

6. Improvements
a. Full description of improvements

7. Valuation
a. Market and appraisal values of land
b. Net value of improvements
c. Total appraised value
d. Recommended loan value.

8. Encumbrances
a. Names of mortgages and amount
b. Others that must be annotated in the Original or Transfer Certificate of Title

Credit Policy
In most Instances, a bank's credit policy evolves from an unwritten set of standards, sometimes
very nebulous, to more specific criteria covering the conditions under which loans are made.
Where a bank is small, such policies are seldom found in writing. However, the policy although
not expressed is given meaning and substance through practice and implementation. As the
bank grows in size and more bank personnel are involved in extending credit to customers, it
becomes very essential that appropriate guidelines and standards should be established in as
objective a manner as possible and expressed in clear and unmistakable terms.

A policy has been described as a "decision in advance”. Owing to the fact that the entire range
of loan function of a commercial bank is basically interwoven with the decision-making process,
it follows that any pre-made decision can but result in the elimination of flexibility and could
work against the interests of the bank. A sound credit policy with sufficient degree of flexibility
could help contribute to the successful operation of commercial banks insofar as loan functions
are concerned.

How Bank Loan Policy is Formulated. Any loan policy that may be formulated by a bank reflects
but one phase of the overall policy program of the institution. Such a policy must obtain the
stamp of imprimatur of the board of directors.

As is generally observed, as a common practice among banking institutions, the actual

preparation of policy statements is usually carried out by the president or senior loan and credit
officer, depending in large measure upon the size of the bank and the staff available.

A statement of loan policy, among others, includes reference to types of loans and the basis
upon which loan applications may be considered. Such, however, are circumscribed by the
provisions of the General Banking Act which governs the operations of commercial banks. Also,
the kinds of securities that are considered acceptable by the credit-granting institution are also
the subject of loan policy. And so, with amounts involved. In fact, when a certain amount
involved in a loan application does not exceed a certain ceiling imposed by the board of
directors, it is subject to the approval of the loan committee. Beyond such ceiling, approval is
lodged as the exclusive prerogative of the board.

Briefly noted, in the formulation of a loan policy, the officers are guided by two primordial
considerations First, the protection of the depositor’s funds. Second, the production of a fair
return for its lending and investment activities. The activities of the credit department
contribute a major portion of a bank's income. In fact, they represent one of the major areas of
top management concern and attention.

Setting a Standard for Control Purposes. It goes without gainsaying that no policy achieves
maximum effectiveness unless it is accompanied by a periodic check-up to insure its proper
implementation and ascertain its weak spots, if any. In fact, by having an established loan policy,
a program is made possible against which actual performance or practices can be evaluated for
purposes of determining variations, if any, and the necessary application of remedial action. As
already indicated earlier, a sound loan policy should be made flexible to provide for alternative
courses of action and thus enjoy the advantage of the policy serving as a guideline rather than
as a strait jacket.

The loan policy should be stated in clear and unmistakable terms so that its implementation by
the officers of the bank charged with such function will be easy. Moreover, such loan policy
should provide specific guidelines for particular types of categories of bank credits, such as the
following 1. Agricultural credits
2. Commercial loans
3. Industrial loans
4. Real estate loans
5. Consumer or personal loans
6. Term loans.

Dissemination of Loan Policy. The importance of effective communication to the success of any
undertaking has been stressed time and again. Its validity is not in any way diminished
regardless of whether the organization is small or considerably huge. Without it, the
organization would be engulfed in an ocean gap that would act as a monkey wrench that will
ruin the entire machinery of the business organization.

In the particular case of commercial banks, its policies should be disseminated thoroughly and
well understood by all who are concerned with their implementation. Since loan policy is but
one facet of the over-all policy of the bank it follows that an internal information drive should
be launched from time to time, as the occasion demands, with the objective of inculcating upon
all those concerned the need, as well as the importance, of giving meaning the substance to
such policy through its effective implementation.

To ascertain the effectiveness of such a policy, it is essential that a review of its effects upon the
organization be made as well as its impact upon the bank's customers in the light of existing
business conditions. Only then can it be determined whether the policy is sound and judiciously
necessary or not.

The Credit File

So important is the credit file to any firm extending credit that it behooves upon it to adopt a
system of gathering and putting every information about customers and applicants into a folder
which is filed in proper order. Hence, the term credit file.
As credit information is received by the credit man, he goes over it carefully to make sure it is as
complete as possible. Then he puts it into the credit folder (a large envelope) bearing the
customer's name and address. Necessarily, one folder is assigned to each customer or applicant
for credit.

In this manner, through the course of time, there is accumulated eventually a complete credit
history of each customer, to which immediate reference may be made at any time when the
need arises. Arranging the folders in alphabetical order enjoys the advantage of providing easy
location.

Experienced credit managers also keep a card record on which are noted the different kinds of
information. Two dis tinct advantages are obtained from this method. One, a card record could
be examined quickly without taking the time to go through the papers in the folder. Second, in
the event that some records are found missing from the folder for whatever reason or reasons,
the company will not be left in the dark. since it has another means which could help serve its
purpose.

It is important that credit files be kept up to date. In some banks, the responsibility for constant
revision of such file as needed by circumstances falls upon the credit department. Others place
it under the charge of the loaning officer.

Regardless of where the responsibility falls, it is a good policy to revise such files not more than
once a year unless unusual circumstances prevail. Since credit files tend to get big and bulky, it
is necessary that those with inactive status be transferred to other folders.

A major problem common among credit-granting institutions pertains to keeping track of credit
folders when they are removed from the credit file especially so when time is of the essence
and there is immediate need for a particular credit folder.

A very practical method, if not to say the best method. to solve such problem and thus serve
the interest of the company is by inserting a board the same size as the credit folder in its place
with the following information, name of the folder, date it was removed from the file, and the
person who has the folder.

Maintenance of credit files with utmost confidentiality should be the over-riding concern of the
officials charged with this responsibility. Because of the confidential nature of the information
contained in the credit files, folders can only be withdrawn upon prior authority granted by the
responsible official.

Credit files give historical account of transactions and are generally observed subdivided into a
number of sections. For instance, the first section is used for statements. As may thus be logical
to expect, the latest financial statement of the company is found with the bank's comparative
statement form. The second section contains a compilation of reports on interviews conducted
by the loaning officer of the bank and his staff. Correspondence and other related matters with
banks and business firms are contained in the third section.
The fourth section contains an up to date file record of borrowers as well as prospective ones. In
the case of the former, also their latest balance is included. The fifth section contains reports
from credit agencies whose services and assistance have been sought by the bank.

Credit Policies of Commercial Houses

To say that a credit department is essential in every organization engaged in the grant of credit
is to elaborate on the obvious. On the part of small concerns, a credit department may exist
merely as a section. Or it may seem not to exist at all. At any rate, even in the absence of any,
credit functions are discharged by a responsible official in the organization. In fact, in the
particular case of sari-sari store which sells goods on credit, owing to its size and the close
contact between the owner and his customers, the existence of a credit department appears
superfluous. However, the owner himself performs the credit investigation and evaluation of his
customers.

Credit policies may vary from one business enterprise to another. One relates to the type of
customers who are to be granted credit. One firm may be primarily interested in increasing the
volume of sales. It therefore grants credit to all applicants and runs the risk of some losses.
Others take extraordinary precautions in granting credit that could reduce their sales volume.

It could be stated categorically that there is no single yardstick or criterion that could be used to
guide the business enterprises in the formulation of their respective credit policies. Be that as it
may, certain fundamental principles could prove helpful when taken into account and applied
accordingly. Their observance operates as an instrument of control.

Scope of Credit Policy. After adopting a credit policy, the business enterprise must deride just
what are its credit terms and what credit period it will adopt as well as Its credit limits.

By credit terms is meant the terms or conditions under which the credit is granted It includes
the time when payments must be made and the discounts, if any, that will be allowed for
prompt payment. In other words, credit terms pertain to the period when credit obligations will
remain subsisting, for instance, payment shall be made one week after delivery, of 30 days as
the case may be in accordance with company policy. In many instances though, this is not
strictly enforced thus resulting in considerable delay in payment of credit obligations.

By credit period is meant the length of time within which the customer is expected to remit in
part or in full. If this period expires before such payment has been made, the account becomes
delinquent.

If a long term of payment is allowed, a greater number of prospects can be appealed to, but
more capital will be required and tied up for quite some time. On the other hand, if a short term
of credit is made, the number of customers is reduced, but less capital is needed.
Some credit granting companies impose a limit with respect to the amount or value that a
customer can obtain from the firm This is known as credit limit. In other words, a seller places
upon a customer's credit standing an indicated limit insofar as it relates to his own firm.
Expressed in another way, it indicates the seller's judgment of the amount of debt that a
customer can incur and pay his firm.

As a sound practice, the credit limit of every customer Is recorded in the ledger card. This
eliminates the necessity of reviewing the customer's file each time an order of goods is placed
(or a loan is sought). In the particular case of a loan, many important considerations exert
profound bearing on the amount that may be granted by the creditor company.

Doubtlessly as conditions are constantly changing. it would be unwise for any company selling
goods on credit to establish too definite limits as to the amount of credit which will ordinarily be
extended to a customer. The capacity to make money and promptness in paying one's
obligations will by and large, be significant factors in deciding the matter. Obviously, the
customer who can sell the goods which are shipped to him, and can promptly make payment,
therefore, is a very safe credit risk.

At this point, it should be pointed out that the problem of mercantile credit is somewhat
different from that of bank credit. This is so, since under mercantile credit, each transaction may
be self-liquidating. On the other hand, loans obtained from a bank are liquidated out of a
composite or series of individual transactions. Thus, bank loans generally cover a longer period
of time than those of mercantile credit.

Purpose and Advantages of Credit Limits. As aptly pointed out by Theodore N. Beckman and
Ronald S. Foster in "Credits and Collections," although limits are sometimes used as absolute
maxima of credit. nevertheless, their general use is in the nature of danger signals, just like the
warnings posted at approaches to railroad crossings.

By and large, the principal purpose of credit limits is to serve as guides to credit management
and control. In fact. through its use, before the determination of credit limits, there is the need
for careful investigation and comprehensive analysis of the elements composing a given risk. In
a nutshell, then, this is conducive to improved credit granting.

From the foregoing, it appears quite evident that credit limits operate as an overall device for
the control of credit extensions. More specifically, credit limits ad in reducing the cost of credit
management and in enhancing its efficiency. Limits also work to the advantage of debtors. It
serves as a check against reckless buying spree which if un checked could ruin the lives, of
debtors and as such suffer the disgrace of being labelled as poor debtors.

Principles of Controlled Credit. The following fundamental credit principles could serve as the
cornerstone of a controlled credit policy. They are:
1. Only after a thorough investigation of the credit worthiness of the customer seeking credit
may credit be granted.
2. Each new customer should be made acquainted with the terms and conditions as
promulgated and implemented by the business firm with respect to terms of payment,
discounts, if any; credit period, and credit limit.
3. It is necessary that the first reminder be sent immediately, I, e... the next day after bills
become past due.
4. Continued use of the credit privilege should be suspended in respect to slow paying
customers. Such privilege may be given back to them only after they have paid their existing
indebtedness.
5. Decisions and actions sli0Vld be characterized by firmness but short of being rude and
arrogant. 6. When it becomes absolutely necessary, the services of collection agencies must be,
or legal services enlisted as the case may be.

The Problem of Credit Extension. Few merchants ever escape the problem involving the
extension of credit to customers. As previously pointed out, some use credit to increase
profitable sales. Others, however, incur losses due to unwise credit extension. Thus, due caution
and extreme care should De exercised in granting extension of the credit period to customers.
The longer the credit period is, the greater is the incidence of delinquencies. The credit
extension problem is by far one of the most difficult phases that confront many a businessman.

Granting Credit
Aptly observed, granting credit to the individual is one thing and to a business firm is entirely a
different matter.

Since, like most anything, credit could either be misused or abused, it behooves upon everyone
who extends credit to exercise proper care and caution and thereby be able to prevent their ill
effects not only to the parties concerned but to the nation's economy as a whole.

Careless and unjustified granting of credit merely serves to fan the strong desire to buy goods in
amounts one does not need nor could well afford to pay. In fact, while delinquent debtors are
largely to blame for their wrong doings however the creditors are not entirely without fault. At
limes, they are the culprits for making credit both easy and quite cheap.

The procedure by which a credit manager handles an order from an old customer of the firm
appears quite clear. However, it may be asked: What is his procedure with respect to a new
customer whose first order involves purchases on credit?

Three major considerations immediately come into the picture all of which merit attention. The
first relates to the size of the order. Not infrequently, a number of business firms may be willing
to take certain risk, that is readily allow a small first order without a thorough and complete
credit checking than they will in the case of large order. However small losses may be due to
non-payment of obligations by debtors when accumulated together could turn out to be a
staggering sum. It must exercise caution and providence.
The second refers to the identity of the applicant for credit and his references. The business firm
should be sure of the reputation and integrity of the applicant as well as the references which
accompany the order. The seller must have some strong and intelligent basis for granting the
credit. Perhaps, a sound basis is - the experience of other firms in their relationship with the
new customer.
A first order from a new customer must necessarily be accompanied by the names and
addresses of other concerns who have sold him on open account. Usually, the name of at least
one bank is both necessary and desirable.

If a prospective customer is unable or does not provide the necessary trade references
requested of him, such a circumstance could be valid reason to deny the grant of credit which
must be clearly understood as a privilege conferred and never a right.

Third is the customer's rating appears in the register of some mercantile agencies This is not
always possible especially so when the customer is new in the business and therefore has not
yet established a name or reputation for himself.

If the applicant is an individual, the credit manager can look into the stability of employment of
the applicant and the length of time he has been residing in his present residence. Frequent
change of residence could be a cue as to the true character of the prospective debtor. When
coupled with other factors the request for purchase on credit may be turned down.

Wholesale and Retail Credit. Essentially, a big difference lies between wholesale and retail
credit. Wholesale customers usually buy for resale to others while retail customer" buy for their
own consumption.

Wholesale customers are able to realize income from the resale of their purchases which will
serve as major source in the settlement of their obligations. Retail customers on the other hand,
must pay for their purchases out of their income which generally consists only of salaries or
wages. Inasmuch as retail customers buy for their own consumption and not for resale it follows
therefore that the credit manager should exercise effort and caution to protect his store from
being imposed upon by unscrupulous customers. This is the very reason why the credit manager
generally prefers to conduct a personal interview of the applicant for credit so as to be able to
obtain the necessary and valuable information about him as, for instance, his honesty and
straightforwardness in answering questions and others which could be one gauge whether he is
worthy of credit or not.

If the applicant is a married woman, it must be ascertained from her whether she has a job of
her own from which she expects to pay her purchases on credit. If not, whether such purchases
carry with it the sanction and approval of her husband. Moreover, inquiring into the position
that the husband holds in the company where he is connected with, as well as the length of
service he has rendered in said company, would prove quite helpful.

SOUND CREDIT MANAGEMENT

Sound credit management principles revolve around three E's, such as:

1. Estimation
a. All available sources of credit information must be tapped and utilized so that a proper
estimation of the credit risk can be obtained.
b. For individuals who buy for consumption character and their ability to pay serve as important
bases of credit; for business concerns, it is the net worth and condition of the business as well
as reputation for paying their bills.
c. All credit information gathered and received must be kept in strict confidence. Only those
who are authorized must have access to it.

2. Enforcement
a. Granting credit is but one phase of the credit function, collection is another. Collection of
accounts should start from the moment they become due. There should be no room for
vacillation insofar as collection is concerned.
b. The task and responsibility of every collection department is to get the money due the
company. If the money can be collected without offending the customer, doubtless, this should
be done.
c. Collection records must be kept and maintained and should indicate when notices were sent
dates when calls were made by collectors; payments made, balances due; and action taken, if
any.

3. Evaluation
a. Sound credit management principles dictate that results must be evaluated against company
policies and procedures.
b. If a situation should arise in the future which preclude good-paying customers to discharge
their obligations on time, policies and procedures may be modified without losing sight of
company goals and objectives.
c. Records must be periodically reviewed and kept up to date.

Credit Frauds
If only all individuals are honest, then no credit manager would develop wrinkles or grow gray
hairs prematurely. But that is perhaps wishful thinking. While it is true that most credit
manager's relations are those with business firms and individuals who operate above board,
nevertheless, there are a few who do not.

These dishonest firms and individuals are known by various names and employ various tricks
Some of them become successful in their ""line of trade" while others fall by the wayside and
become apprehended even in their first try.

Some of them appear decent enough. Some of them in fact are married to men who are in the
top rung of the organization to which they belong just as others are wives of prominent
government officials. They appear in expensive clothes and ride in swanky automobiles and, as
such, create the impression of their respected as well as decency. Others are just plain Miss, and
Mrs. So and So. The mien in the same group are not different. I hey appear honest and reliable.

Some of these crooks operate alone because of the belief that it is much difficult to cover the
tracks of one man and thus escape apprehension. Others, on the other hand operate in a ring -
a big time syndicate - who victimize business firms involving large sums of money. As to so-
called business establishments - they operate through "fly-by-night" schemes. After obtaining
the loot (goods sold on credit), they disappear into dun air until they make their reappearance -
trying to victimize another business firm. And this goes on and on until the law catches them,
for crime does not pay.