BANK CREDIT

INSTRUMENTS
 NEGOTIABILITY OF CREDIT
INSTRUMENTS
The bank use negotiable documents in plying
their trade and the most common of these are
the bills of exchange, the promissory note, and
the check.
Not all instruments used by the banks are of
unlimited acceptance. The check for example,
does not possess general acceptability
although it may vary desirable medium of
exchange.
To be fully negotiable, an instruments must
contain the essentials of negotiability. To
qualify as such, 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 future determinable
time; and there must be an unconditional
order or promise to pay.
GENERAL DIVISION OF CREDIT
INSTRUMENTS
• Promises to Pay
• Orders to Pay
 PROMISES TO PAY
Promissory Note- It is an unconditional promise of the
maker to pay a sum certain of money to order or to the
bearer on demand or at future determinable time.
Bank Note- A bank note is an unconditional promise of
the bank to pay sum certain of money on demand.
Such note is issued as substitute fro money.
Banker Acceptance- A bankers acceptance contains
the banks promise to pay a draft that is presented to it
for acceptance.
Letter of Credit- A letter of credit is also a promise of a
bank to honor drafts drawn against it or for its
account.
Bank Notes distinguished from
Standard Money
The bank notes are practically like money.
The only divergence of the note from the real money is
the fact that the note represents private bank credit
rather than the state’s credit.
The note is declared as legal tender either fully or on a
limited scale.
The bank notes however, necessitate final redemption
into standard money. Therefore, they merely represent
the government notes. Their issue is limited to the
extent of lawful restrictions on the issuing bank’s
capital as well as the amount of trust and confidence
the public has on it.
 Bank Notes Distinguished
from Deposits
• The circulation of bank notes and deposits
necessitates legal reserves. However, where deposits
are concerned, banks keep larger reserves. This is
because bank notes circulate longer while checks
drawn against deposits could immediately be
presented for payment when endorsed.

• The banks issuing notes as well as receiving deposits

increase their loaning capacity. When writing a check,
any amount covered by existing deposits may be
drawn (except in overdrafts); while in the case of bank
notes there are uniform denominations.
Cont.…
Deposits necessitate the use of the checks to circulate
them; bank notes in themselves constitute the means
of payment.

In case of deposits as well as in issuing notes, the bank

becomes a debtor to the depositor or the noteholder.
But where a check is endorsed for negotiation, a bank
note is on to the next holder without documentation
 ORDERS TO PAY
 Bill 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 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. A 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.

 NOWAccount, NOW is an acronym that stands for “Negotiable

Order of Withdrawal”. NOW accounts earn interest and account
holders can write as many NOW checks as they' want on the
account, It has a feature of a savings deposit as it earns interest
Cont.…
Draft. A 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. Such instruments
which are paid at sight upon presentation are known
as demand drafts. Those payable at a future
determinable time are time drafts. Furthermore, it may
be a "time sight" or a "time date" draft.

When the draft is drawn by a merchant against another, it is

termed a commercial or trade draft. If drawn by a bank
against another bank, it is a bank draft.
BILLS OF EXCHANGE
CHECK/CHEQUE
Promises to Pay Versus Orders to Pay

In a promissory note there are two parties—the maker

who makes the promise and the payee who is to receive
payment

In an order to pay, there are three parties—the drawer,

the drawee, and the payee.

The promissory note contains a promise and has the

personal element to comply while the order to pay is a
command and the execution may or may not
materialize.
 Checks and Drafts
Distinguished
Both checks and drafts are bills of exchange since both
are negotiable instruments.
 A check is against deposits; a draft may be orders to
pay.
There are three parties involved in a check or in a 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 subject to certification to ascertain whether
it is backed up by funds; a draft is subject to
acceptance when payable at a future determinable
time so that it can be used even without existing
deposits.
MONEY MARKET INSTRUMENTS
Treasury Bills. Treasury bills are short-term securities
issued by the country's Treasury. This will reduce 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.
Banker's Acceptance/Letter of Credit. Although BAs,
as they are known, have their origin in trade bills issued
by merchants, today they are an important money
market instrument. It is a time draft and accepted by a
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 of the bank.
Cont.…
• Negotiable Certificates of Deposit. NCD are fixed
deposits except they are bearer documents. They offer
a market related rate of interest and are completely
liquid because they can be negotiated during the term
of the deposits. Most NCD’s have a term of less than
one year.
• Commercial Paper. Short-term commercial paper is a
debt instrument commonly issued by corporations to
fund a temporary capital requirement. This form of
corporate borrowing usually matures within one year.
Commercial paper is guaranteed by the company that
incurs the obligation.
Cont.…
• Bank Guarantees. A Guarantee by Bank (banker's
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 respect of
the purchase of fixed property and against cash cover.
The bank's liability is restricted to the payment of a
sum of money and under no circumstances accepts
responsibility for the completion of the customer's
contract.
 Negotiation
Without prejudice to legal concepts, 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.
Cont.…
Negotiation has certain conditions. These are as follows:

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 instrument or tide were detected.
 Presentment
 
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. A draft, on the other
hand, may be presented for payment after its last
negotiation within a reasonable period.
 Dishonor
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 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.
 Endorsement
Endorsement forms part of a negotiation of an
instrument. It is simply indicated by 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
termed 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.
Cont.…
• An endorsement is qualified when the words "Without
recourse" appear as part of the endorsement. This
does not impair the negotiability of the instrument,
however. It transfers the title and warrants the
genuineness of the instrument, but does not
guarantee the payment of the endorser in case the bill
has 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

• Since 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. In this way, the public confidence in the
soundness of banks and their patronage of the
banking system as a whole shall be strengthened
considerably.