NATURE & FUNCTIONS

OF CREDIT

Shirley Urmatam Espino, PhD

 Historical Perspective
 The origin of credit- the exchange of
current resources for an obligations to
pay in the future dates back to primitive
cultures and ancient civilizations.
 Historical…..

□ Numerous records show proof of

existence of credit transactions in the
form of gift giving or the redistribution of
material possessions thorough
authoritative channels
 Historical…..
□ As trade flourished and the division and
specialization of labour developed, there
likewise arose necessary financial
counterparts, such as commercial banks and
other institutions dispensing credit in
multifarious forms.
 Historical…..
□ Earlier these institutions were mere
instruments of the state rather than of
commerce, for they did not only promote
domestic agriculture and industry but also
financed military pursuits and made the spoils
of conquest the basis for expanded financial
activities
 Historical…..

□ The use of credit saw a slight decline

with the fall of Roman Empire but picked
up again as a result of stepped-up trade
during the Middle Ages. The use of credit
gain adherents in spite of the prohibition
of the Church on interest
 Historical…..

□ Credit transactions were even disguised

as partnership or foreign exchange
transactions to avoid the stigma of usury.
Subsequently, laws and accounting
systems were evolved to enforce these
contracts.
 Historical…..

□ The Middle Ages ushered in the origin of

European Deposit, banking and with it
the use of the bill of exchange which
preceded the check and other credit
instruments
 Historical…..

□ The bulk of credit is in the form of

borrowing by kings and nobles to finance
their courts and military campaigns. In
exchange, these authorities provided the
atmosphere of orderly credit transactions
through state protection and laws
 Historical…..

□ The Industrial Revolution, as well as the

advance in science and technology,
change the role of credit. The factory
system coupled with the roundabout
process of production, necessitated more
capital to finance operations.
 Historical…..
□ The credit economy, although gaining wider
scope and considered as a speedier means of
exchange, always presupposes the existence of
a money economy.
 THE CREDIT SYSTEM
□ The word “credit” is used in different ways in
everyday life and in the business world. A man
is said to have credit, for instance, if he is
known to be a man of integrity who always
pays his debt when due. Here credit means the
power to borrow or to get goods or services by
promising to pay in the future.
 CREDIT SYSTEM

□ To the bookkeeper the word credit means

the opposite of debt, namely that
something is owed to a person or to an
account
□ 
 Various Definitions of Credit

□ Borrower’s viewpoint- credit represents

the borrower’s ability to obtain goods and
services or money in exchange of a future
promise to pay.
 Definitions

□ Lender’s viewpoint- credit is a trust and

confidence of the lenders on the
borrowers ability and willingness to pay.
 Definitions

□ Economist viewpoint- credit is the

exchange of actual reality against a future
probability
 Definitions

□ Legalistic viewpoint-credit creates legal

right in favor of the creditor against the
debtor, who is under obligation to pay.
 Characteristics of Credit Contract
 
□ It is a bi-partite contract
Two parties involve
Creditor is giving away the things of value
for the present
Debtor is the person receiving the things
and promising to pay in the future.
 Characteristics
□ It is a pecuniary contract
Use of money is significant credit dealing
□ It creates a legal obligation
The debtor is obliged to pay his creditor
 Characteristics
□ It has a fiduciary element
The credit contract is based on trust.
Faith on the borrower’s ability to pay and
willingness to pay exists.
 Characteristics
□ Based on personal factors
Contract is based on the person’s degree of
moral as well as business competence
 Significant Aspect of Credit
Contract
□ The payment of interest for the use of the thing
borrowed.
□ The reduction of the oral agreement to a written
contract
□ The contract is stated in terms of money or
monetary unit.
□ The establishment of courts of law and machinery
as well as the legislation to enforce credit
contracts.
 Basic Elements of Credit

□ Trust and confidence

□ Futurity
□ Risk
 Foundations of Credit System

□ Creditors must have an absolute

confidence in the personal character and
in the ability, as well as willingness, of
their debtors to accept, honor and settle
their obligations.
 Foundations

□ Proper facilities must exist for performing

credit operations.

□ The money standard must be stable.

 Foundations

□ The government must stand ready to

assist the creditors in enforcing payment
of loan extended to the debtors
 Nature of Credit

□ Credit signifies the existence of legal and

moral right as well as an expectation of
the fulfillment of a promise.
□ Credit enables the individual to stretch
his purchasing ability
 Nature

□ Credit represents a legal and moral

responsibility to honor his promise or
commitment, which has arisen out of a
past transaction
 Characteristics of Credit
 
□ The use of trust
□ Credit is elastic
Credit helps to expand the volume of
operations during periods of business
boom, while during dull periods of
business it could be contracted to
prevent future losses
 Characteristics

□ Credit gives rise to creditor-debtor

relationship
This relationship is evidenced by the
use of credit instruments
 Characteristics

□ Creation of legal obligation

The right of the creditor to compel the
debtor to make payment on the due
date has been always recognized by the
courts
□ Credit involves time or futurity
 CLASSIFICATION OF CREDIT
□ According to type of user
□ Consumer Credit/consumption credit/personal
credit
A kind of credit, which is extended to
consumers in order to facilitate the process
of consumption.
This kind of credit is usually extended to the
individuals rather than to business.
 CLASSIFICATION

□ According to type of user

□ Retail credit is a typical example of
consumer credit
Difference between Charge Account and Installment Credit
Charge Account
Confined to non-durable consumers
items.
The title passes immediately to the
customer covering goods bought on
charge account.
There’s no repossession, since the
goods purchased through this method
must have disappeared during the
process of their consumption or use.
Installment Credit
It is confined to durable consumer
goods
The title to goods purchased does not
pass to the buyer until the last payment
has been made
In the event of failure on the part of the
buyer to pay the monthly installment,
such a circumstances may constrain the
selling company to take back
possession of the goods.
 Difference between
Charge Account
The buyers who make use of charge
account, as in particular instance of
goods bought from retail store in this
country.
The goods on this account are not
covered by a written contract.
Installment Credit
Customers who buy on the installment
plan always have to pay a carrying
charge, not to say down payment,
which usually includes interest and
collection charges.
Formal credit investigation of the
would be buyer on installment plan is
undertaken by the selling concern
before it decides to grant credit.
Goods bought on the installment basis
generally on account of the
considerable amount involved.
 ADVANTAGES AND DISADVANTAGES OF CHARGE ACCOUNT

Advantages of charge account Disadvantages of charge account

Convenient method of making purchase People who buy on charge account are
induced to be careless in the selection
of merchandise.

The buyer can obtain and make use of Sometimes it encourages many persons
goods even before he has chance to pay to become wasteful and extravagant
for them

Customer of this account find it easier Purchases made on the charge account
to return unsatisfactory merchandise is much higher when the goods is on
cash basis
 ADVANTAGES AND DISADVANTAGES OF INSTALLMENT
CREDIT
Advantages of installment credit Disadvantages of installment
credit
The buyer is able to obtain, the use of goods he needs Cost more than articles purchased
even before he is able to save the amount covering for cash
the full price of the goods
It is considered one form of savings Some people do not know what to
buy, thereby overburdening
themselves with financial
obligations that they may find
difficult to meet
To a number of individuals it is not only a convenient In some case, individuals may be
but it is also a necessity encouraged to buy things, which
they actually do not need.

Many goods bought on the installment plan pay for

themselves
It makes possible for families to spread out
expenditures
 CLASSIFICATION
According to type of user

□ Mercantile/Commercial/Trade Credit
□ Type of credit, which one businessman may
extend to another when selling goods on time
for resale or commercial use.
□ It is used to secure goods for resale in
exchange for a promise to pay at some future
time.
 CLASSIFICATION
According to type of user

□ Mercantile/Commercial/Trade Cre
□ The prime elements of trade credit is that it is
used in an exchange for goods intended for
resale
□ The main function of trade credit is to
facilitate the exchange of goods from the
producer to the consumer
 CLASSIFICATION
According to type of user

□ Commercial Bank Credit

□ Credit given by commercial banks to businessmen
intended to assist them in the operation of their
business.
□ It is short- term credit to businessmen for working
capital purposes, that is, for the purchase of raw
materials, the payment of wages, and the other
expenses of a business incident to current operations.
 Types of Bank Credit Accommodation

□ Straight loan- involves one approval, one

release, full payment at maturity, unless
otherwise renewed or extended.
 Straight loan-

□ It maybe classified into:

□ Demand loan-clean/secured- it is payable
upon call by the bank. There is no fixed
maturity date although to comply with BSP
requirements, a demand loan has to be called
within one year’s time, unless renewed or
extended
 Straight loan-

□ Time loan-clean/secured-it could be a short,

medium, long -term loan. Interest is usually
not discounted and the principal are payable in
periodic amortization
 Straight loan-

□ Bills discounted-clean/secured- it is a short-term

loan with fixed maturity date. Interest is
discounted for the term loan and the face amount
of note payable is payable in full maturity.
□ 
 Types of Bank Credit Accommodation

□ Discounting line- this is a revolving credit

facility available for drawings against
submission of short- term promissory notes.
 Other Special Types of Financing Offered by
Banks
□ Export advances/Export packing credit- a
type of financing wherein the bank grants
advances up to 50% export value of the letter
of credit for a term of 15 to 30 days. Within
this period, the borrower must ship his
merchandise and the loan is repaid from the
proceeds of the export negotiation.
 Other Special Types

□ Crop loans- are commonly granted to sugar

planters and millers. The loan is made
available from the start of the planting to the
end of the milling season in staggered releases
depending on actual needs.
 Other Special Types

□ Syndicated loan- is an arrangement whereby

several banks agree to jointly finance a
borrower’s requirements. The lending bank
participates either as a member or a syndicated
manager. A syndicate is often organized
because of the limitations of a bank’s
resources and also because of BSP regulations
as regards single borrower’s limit.
 Other Special Types

□ Loans for marginal deposits-it evolved when

BAP required 50% marginal deposit
requirements on all import L/Cs to be opened.
The face amount of the note is exactly
equivalent to the marginal deposits
requirements on the L/C.
 Other Special Types

□ Receivable financing, the borrower assigns to

the bank notes receivables and the bank
discounts from 50-75% of its present value.
Repayment on the loan is also by way of
monthly installments, the assumption being
that payment will come from collections of the
assigned receivables by borrower.
 Other Special Types

□ Salary loan line- is established for employees

of certain companies. An arrangement is made
whereby an employee can borrow against the
joint and several signatures of a co-employee
or guaranty of the company.
□ 
 Other Special Types

□ Loans against postdated check-the borrower

lodges with the bank an equivalent amount of
postdated checks
 Other Special Types

□ Terms loans- are usually granted for plant

expansion or acquisition of fixed assets
involving substantial financing. A repayment
schedule is drawn up based on projected
financial statement and cash generating ability
of the borrower.
 CLASSIFICATION
According to type of user
□ Investment Credit – is utilized by a business
organization for the purchase of fixed assets or
to carry minimum business operations. It
consists of advances intended for the purchase
or construction of necessary plant and
equipment.
 CLASSIFICATION
According to Object of Exchange

□ Merchandise Credit- the customer obtain

goods or merchandise in exchange for his
promise to pay them at a later date.
□ Money
 CLASSIFICATION
According to Purpose

□ Agricultural Credit- these are loans granted

to finance the cultivation, development and
improvement of agricultural land.
 Types of agricultural credits

□ Time loan. This is a short-term loan secured

by ordinary and regular collateral, usually
farm land used to finance the development and
improvement of the land.
 Types of agricultural credits

□ Crop loan. This is a form of agricultural

credit, which is utilized for the production of
crops. Aside from being secured by ordinary
collateral, it is further secured by a chattel
mortgage on the standing crops being financed
as well as other crops, which may be grown by
the borrower.
 Types of agricultural credits

□ Commodity loan. This is a loan, which is

used to finance the marketing and distribution
of harvested crops. It is also granted to farmers
who have stored their crops in warehouses.
This credit is secured by quedans or
warehouse receipts
 CLASSIFICATION
According to Purpose

□ Export Credit- it is similar to trade credit except that

the procedures and documentations are different.
Export credit arises because of foreign trade.
Although the risk in export credit are greater than
those of retail trade credit, the percentage of bad
debts losses in export credit is lower than domestic
trade credit for the simple reason that export credit is
more secured in nature.
 CLASSIFICATION
According to Purpose
□ Industrial Credit- is intended for financing
the needs of industries like logging, fishing,
manufacturing and others, and which involves
big amounts of money. Generally speaking, as
may be expected, the maturity of this type of
credit is long term.
 CLASSIFICATION
According to Purpose
□ Commercial Credit- sometimes termed as
mercantile credit. This is a type of short-term
loan granted to finance the production and
distribution of commodities either by
wholesale or retail, whether in storage or in
transit to foreign or domestic markets.
 CLASSIFICATION
According to Purpose
□ Real Estate Credit- when credit is secured
purposely for construction, acquisition,
expansion or improvement of real estate
properties. Before this credit was extended by
Rehabilitation Finance Corporation. Today it is
GSIS, SSS and Home Financing Corp. grant
this credit apart from other financial
institutions.
□ 
 CLASSIFICATION
According to Maturity
□ Short-term- payable within one year from the
date of acquisition. This type of credit usually
covers the purchase of consumers’ goods.
Character loan fall under this type.
 CLASSIFICATION
According to Maturity
□ Medium-term- it may also called intermediate
credit, ranges from one year to five years in
maturity. Installment buying is a good example
of this.
□ Long-term- intended from five years up
belong to this category. This type of credit
covers those loans intended for investment
purposes
 Government or Public Credit

□ Public credit is a branch or a form of credit in general

and, as such, is subject to rules and principles that
govern the use of all credit.
□ However, unlike other forms of credit, public credit,
which means a pledging of the good faith and the
resources of the nation for the repayment of a debt
incurred on behalf of the people, could not have
emerged until certain other definite developments had
occurred.
 Government or Public Credit

□ Public debt consists of all claims against the

government which may be payable in goods
and services, but usually in cash, to foreign
governments or individuals or to persons,
natural or juridical.
□ 
Thank you for your participation
 Instruction

□Write TRUE if the statement

is correct and FALSE if
incorrect
 Q# 1

□ Crop loan is made available from the start

of the planting to the beginning of the
milling season in staggered releases
depending on actual needs.
 Q#2

□ In Receivable financing, the borrower

assigns to the bank notes receivables and
the bank discounts from 50-70% of its
present value.
 Q#3

□ Discounting line- is a revolving credit

facility available for drawings against
submission of short- term letter of credit
 Q# 4

□ Straight loan- involves one approval, one

release, full payment at maturity, unless
otherwise renewed or extended
 Q#5

□ Trade credit used to secure goods for

resale in exchange for a promise to pay at
some future time
 Q#6

□ In legal obligation- The right of the

debtor to compel the creditor to make
payment on the due date has been always
recognized by the courts
 Q#7&8

□ In history the use of credit flourish in the

fall of Roman Empire.

□ The credit fall down during the Middle

Ages.
 Q9

□ Credit is a trust and confidence of the

lenders on the borrowers ability and
willingness to pay.
 Q 10

□ To the bookkeeper the word credit means

the opposite of debt, namely that
something is owed to a person or to an
account
□ 
 Important Sources of Credit

□ Individual Money Lenders

The unlicensed money lender, who is often
referred to as a “loan-shark”, does a thriving
business in the grant of loans at very
exorbitant rates of interest.
 Sources of Credit

□ Retail Store
□ The biggest source of merchandise credit in the
Philippines is the retail store, known as 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.
□ 
 Sources of Credit

□ Pawnshops
It owes their origin from the Montes Pietatis,
which are established by Franciscans in Italy.
Mons referred to any form of capital
accumulation and pietatis from the latin
“pietas” meaning pious
 Sources of Credit- Pawnshop

□ According to Lien Sheng Yang, pawnshop is

the “oldest credit institution in China.
□ In the Philippines, pawnbroking is also one of
the oldest credit institutions and is believed to
have been introduced by the Spanish friars.
 
□ 
 Sources of Credit- Pawnshop
□ Under the New Society, in accordance with PD no.114,
known as the Pawnshop Regulation Act, the C.B. is charged
with the task and responsibility of regulating the operation of
pawnshop in the country. All pawnshops in the country are
required to register with the Department of Financial
Intermediaries of the Central bank. Before they are allowed
to engage in actual operations. The minimum paid-in capital
of which shall not be less than 100,000. Only Filipino
citizen may establish and own a pawnshop organized in the
form of a single proprietorship upon the effectively of the
decree.
 Sources of Credit-

□ Commercial Banks
□ The guarantor of credit of the borrower is
called “co-makers”
□ There is also known as “character loan”
wherein no guarantors nor pledges are
required
 Sources of Credit-

□ Savings Bank
□ Since savings banks accumulate the small
savings of depositors, such accumulated funds
are in turn invested in bonds or in loans
secured by bonds, real estate mortgages, and
other form of security
 Sources of Credit-

□ Rural Banks
□ Republic Act No. 720, known as the Rural
Banks Act.
□ Development banks
□ They have been largely responsible for the birth
and development of certain industries that are
now quite common on the Philippine scene
□ 
 Sources of Credit-

□ Investment Bank.
□ At times termed as investment houses, bridge
the gap between those who have idle funds not
knowing where to invest them and those in
direct need of such funds.
 Sources of Credit-

□ Savings and Loan Associations

□ Corporation engaged in the business of
accumulating the savings of their members as
stockholders, and using such accumulations,
together with their capital.
 Sources of Credit-

□ Finance Companies
□ They have developed into a major source of
funds for consumer, sales and commercial
financing
 Sources of Credit-
□ 3 Categories of Finance Companies
□ Installment sales finance company
Discount consumer installment notes arising through
the sale of merchandise.
□ Consumer finance companies
Engaged in lending cash directly to the consumer.
□ Commercial finance company
□ Through various types of loans serve business and
industry
 Sources of Credit-

□ Credit Unions
□ These are corporate organizations, which lend
savings of members to some of the members
of the group
 Sources of Credit-

□ Advantages: of Credit Union

□ There is a low cost of operations.
□ Losses are very small
□ Rates charged of interest are very much lower
□ Members borrowers also become entitled of
dividends
 Sources of Credit-

□ Insurance Companies
□ The business of insurance companies is to
enter into insurance contracts with those who
wish to provide for such contingencies as
death or fire
 Bases of Credit

□ Character
□ It is the most important consideration in the
proper determination of credit rating of an
individual
□ Character represents willingness to pay
 Bases

□ Capacity
Capacity signifies the ability to pay when
debt is due
□ Capital
A man’s ability to pay a debt depends on his
financial strength, which consists of the
amount and quality of assets he owns over and
above what he owes
 Bases

□ Collateral
□ The creditor’s confidence is strengthened by
the property of a borrower, which may be
mortgaged to secure loan.
 Bases

□ Conditions
□ Economic conditions exert profound effect
upon grant of loans and credits. It may be
rightly mentioned that loans and credits may
be extended at certain times and may be
denied at other times.
 Bases…

□ Country
□ In the field of international trade, exporters
who sell their goods on credit are exposed to
certain credit risk notwithstanding the fact that
their importers have for years have been
religious in the discharge of their obligations
 Bases

□ Currency
□ The risk of exchange must also be taken into
account.
Where the currency of a country fluctuates
quite markedly from time to time, such
circumstances may prevent the grant of credit
to the prospective buyer or importer of goods.
 Sources of Credit Information

□ Credit Information Sheet

□ This is a customer supplied information which is
usually obtained at the time of credit application.
□ Sales Representatives
□ They provide first-hand information about the
customer since they are in frequent contact with
him.
□ 
 Sources…

□ Personal Interview
□ This is one of the best occasions for promoting
goodwill and establishing rapport with the
customer
□ Telephone Contacts
□ The experienced credit executive makes
effective use of the telephone to communicate
with customers.
 Sources…

□ Bank Information
□ Banks provide an invaluable source of credit
information because of the varied services they can
provide to their customers.
□ Trade Information
□ This is information obtained from suppliers of the
customer. Trade information describes how a
customer pays his account regardless of his financial
ability
 Sources

□ Credit Agencies
□ Credit agencies usually incorporate a credit
reporting service that is designed to collect,
store, and retrieve credit information as the
need to make it available arises
 Sources

□ Credit Investigation.
□ Perhaps the most reliable source of
information is the company’s own credit
investigator, or one from a credit bureau
 Other Sources

□ Newspapers
□ Lawyers
□ Accountants