NATURE OF CREDIT

Credit is the ability to obtain a thing of value in exchange for a promise to pay a definite sum of money on
demand or at a future determinable time. This creates obligations and rights for both the debtor and creditor.
There is the obligation of the debtor to pay the debt and the right of the creditor to collect payment. From the
definition, the following elements are present:

1. It is the ability to obtain a thing of value. The thing of value may be cash form of credit or merchandise
form of credit. The debtor can apply for cash credit from several sources like banks, private individuals,
or other financial intermediaries. Merchandise form of credit is non-cash form, and its sources are retail
outlets and the like.
2. A promise to pay. The debtor makes a promise to pay to the creditor. For a promise to pay to be valid, it
should be acknowledged in writing by both the debtor and the creditor. The promise should specify the
principal amount, interest, and maturity date.
3. Definite sum of money. Credit involves an exact amount of money loaned or money value for non-cash
form of credit. The contract must identify the principal value of the loan and the corresponding interest
for the credit period.
4. Payable on demand or future time. A promise by the debtor for the settlement of obligation may involve
a future date, known as loan maturity, or any time the creditor demands payment.

CHARACTERISTICS OF CREDIT

 It is a bi-partite or a two-party contract. Two parties are involved in the agreement- the debtor or the
party requesting a loan and the creditor or the source of credit. The creditor demonstrates his faith in
the debtor by extending the loan or transferring ownership of the goods or service in exchange for a
promise to pay. To be legal, the contract must be in writing, specifying the amount, time of payment,
interest, and other terms agreed upon by both parties.
 It is elastic. It can be increased or decreased by the creditor. Loan limit or elasticity depends upon the
capacity of the debtor and the appraised value of his collateral.
 The presence of trust of faith. The basic element of credit is the creditor's reliance on both the
debtor's ability and willingness to pay his debt. This is also a risk factor in credit particularly when an
obligation remains unsettled during its maturity period. The debtor's ability to pay is dependent on his
assets and will to recall the maturity date for prompt payment, which measures his willingness to settle
obligations.
 It involves futurity. Maturity date for settlement of obligation is a future time. The creditor puts his trust
in the debtor's ability and willingness to fulfill an obligation when it falls due.

FOUNDATIONS OF CREDIT

 Confidence. The creditor must trust the debtor's personal character as a measure of the latter's
capacity to pay. The creditor must have confidence in the debtor's willingness and capacity to settle an
obligation.
 Proper facilities. In a credit contract, legal facilities must exist to make the agreement valid. These are
the credit information and credit documents. Credit information includes data about the debtor that are
a gauge of his paying capacity which can be gathered through a credit investigation. Credit document is
the written agreement signed by both parties identifying principal loan, interest, and maturity date or
other supporting papers to determine the debtor's credit rating such as a copy of income tax
return/withheld or employment certificate for personal loans and financial statements for business
loans.
 Stability of monetary standard. The purchasing power of money is considered when extending credit.
The more stable the value of money, the greater is the possibility of approving credit. Creditors may be
reluctant to part with excess income when there are wide fluctuations of money value.
  Government assistance. Regulations protecting both parties are highly considered for credit
transactions. When evaluating, debtors are given more protection since they cannot be imprisoned for
non-performance of obligation, that is, if they are insolvent or do not have any asset or property. In this
case, the creditors take the risk.
 Credit risk. This is the possibility that the debtor may not fulfill his promise for payment. Credit risk
shall be borne by the creditors.

FIVE C'S OF CREDIT

During credit evaluation, the following are the common areas examined:

 Character. This refers to the personality of the debtor, including his mental and moral attitudes that
determine his credit rating.
 Capacity. This signifies the person's willingness and capacity to pay. This is a measure of his income
level as basis of his paying capacity
 Capital. This consists of the person's real and personal property which can be a strong foundation for
credit approval. His capital can serve as his liquid assets in case of non-payment or non-fulfillment of
obligation.
 Collateral. This is something of value or the debtor's assets that can be used as pledge. The common
practice is for collateral to be 40 percent higher than the amount of loan. The collateral protects the
creditor in the event of the debtor's Inability to discharge his loan obligation.
 Conditions. This may include local business conditions or economic conditions during the time of loan
application. During wide fluctuations of money value, it is unwise for creditors to grant loans. When a
business or economy is facing periods of recession or depression, fulfilling loan payments may be
impossible, so creditors may not consider the application.

CLASSIFICATIONS OF CREDIT

According to Type of User

Consumer credit. This is credit used by individuals to help finance or refinance the purchase of commodities
for personal consumption.' This is different from business credit in terms of the borrower's purpose, which may
be for personal or household use. Consumer credit may be used in the following ways:

a. as a convenient form of payment. A typical charge account involves purchases from a retail store that
are paid once or twice a month.
b. as aids in financial emergencies. Consumer credit helps consumers through periods of financial stress.
Some people may not have liquid assets to meet emergencies, so consumer credit can tide a family
over during financial difficulty.
c. for buying durables on installment. It helps consumers purchase durable goods that they cannot afford
to buy through a single cash payment.

Consumer credit can be in the form of a charge account, an installment account, revolving credit, or a
layaway plan. Charge accounts are for non-durables, payable within two months (or 60-day term) in four
payments. Installment accounts are for durables, payable over more than six months to one or more years.
Payment is monthly, and a down payment is needed before the unit purchased on credit is delivered.
Revolving credit is a combination of charge and installment accounts with a credit period of 90 days. Under this
plan, the debtor can avail himself of loan renewal after or within 90 days for the paid portion, provided he has
not been delinquent in payment of the original loan. A layaway plan is consumer credit that requires full
payment of the product within a period before it is delivered.
 Under an installment account, replevin is applied. Replevin is the creditor's right to repossess the item
under contract, that is the durable good, when the debtor fails to fulfill his obligation. In this case, the debtor
has to return the item to the creditor. Other forms of consumer credit may require a co-maker to serve as
guarantor for the loan. Commercial credit is extended by one businessman to another businessman. Objects of
credit are merchandise or goods which are delivered on a consignment basis or under a credit term.

Commercial bank credit differs from the preceding in terms of the parties concerned. The creditor is a
commercial bank while the debtor can be a business firm or private businessman. The debtor may consider a
commercial bank for loans to assist him in business operations or expansion.

According to Purpose

 Investment credit is extended by banks to the company that intends to purchase fixed assets like land,
buildings, or equipment for business use.
 Agricultural credit is a loan intended for the acquisition of fertilizers, pesticides, seedlings,
transportation of agricultural products, and farm improvements. Debtors are farm breeders and
creditors are rural banks, and loans can be of short-term or long-term maturity.
 Export credit uses letters of credit, or LC, as a tool for financing international trade. The LC is issued
by the importer's bank, and it guarantees the exporter payment of a specified amount of money. With
this, the exporter is protected by a substitution of the bank's good faith and credit for that of the
importer. There are two general types of LC-the import letter of credit, which requires payment to be
made in the importer's currency, and the export letter of credit, which requires payment to be made in
the exporter's currency. Parties to this loan are the importer, the importer's bank, the exporter, and the
exporter's bank.
 A real estate loan is intended for the purchase of a house and lot, for house construction, or home
improvement.
 Industrial credit is intended to finance industries like logging, fishing, mining, and quarry.

According to Maturity

 Short-term loans are payable within one year. Intermediate-term or medium-term loans are payable
within one to five years.
 Long-term loans are payable beyond five

According to Form of Credit

 Cash form of credit.

 Merchandise form of credit.

SOURCES OF CREDIT

1. Private individuals. These are the individual money lenders who loan surplus income to those in
immediate need of cash. They usually do not require collateral but charge higher interest rates. They
are sometimes called "loan sharks" or usurers because they lend money at an interest rate of 20
percent (5/6), which is over and above what the law allows.
2. Retail stores. These outlets offer merchandise form of consumer credit. It offers a book account
(palista) for customers of the store, and collection is during paydays of the month.
3. Pawnshops. Pawnbrokers extend loans in exchange for collateral or a pawn. Acceptable pawns are
personal property or movable assets. The pawner is given a 90-day grace period from the date of
maturity of the loan to redeem the pawn by paying the principal amount plus the interest that accrued.
On or before the expiration of the grace period, the pawnbroker should notify the pawner in writing that
the pawn shall be sold or disposed of through auction. If the grace period expires and the pawner fails
to redeem his pawn, the pawnbroker may sell or dispose of the pawn. However, the pawnbroker must
first publish a notice of public auction of unredeemed articles held as a security for loans in at least two
newspapers circulated in the city or municipality that is his place of business six days prior to the date
set for the public auction.
4. Savings and mortgage banks. Such includes corporations organized for the purpose of accumulating
the savings of depositors and investing them, together with its capital, in readily marketable bonds and
debt securities; commercial papers and accounts receivables; drafts, bills of exchange, acceptances, or
notes arising out of commercial transactions or in loans secured by bonds, mortgages on real estate
and insured improvements thereon and other forms of security or unsecured financing for home
building and home development; and such other investments and loans which the Monetary Board may
determine as necessary in the furtherance of national economic objectives.3
5. Mutual savings banks. Mutually owned by depositors, these banks pay out their profit to savers in
interest dividends or retail them as a reserve cushion against loss. They sell interest-bearing savings
deposits to the public and acquire assets largely in the form of urban residential mortgages.
6. Savings and loan associations. These are organized to obtain funds for home construction, and the
majority of their savings are placed in home mortgages. There are stockholders in these organizations
who receive dividends over and above what is paid out to savers. These are sometimes called building
and loan associations which sell financial services to the public and invest the funds acquired.
7. Credit unions. These are mutual institutions whose members have some common bond, such as
employment in the same company. They are small, non-profit, thrift and lending institutions organized
around some common bond of membership, typically a common employer. They accept deposits on
which they pay interest or dividends only to their members and extend small loans only to their
members, usually for the purpose of buying consumer-durable goods.
8. Insurance companies. These companies are both mutual and stockholder-owned. They receive funds
from policy-holders and place the funds in individual loans to home buyers and other small borrowers
and in security purchases in the organized money and capital markets. Service offered to the public
consists of financial protection against life's eventualities. To build up huge amounts of funds, they
place part of their assets in investments.
9. Pension funds. The procedure for pension funds is the reverse of that followed by insurance
companies. The person who lives the longest beyond retirement receives the highest return in the
investment through the periodic pension checks he receives. Today, most corporations offer their
employees a retirement plan as a benefit. The financial service offered to the public is, of course, the
accumulation and the investment of employer an employee contribution in these funds. Pension funds
may be insured or non-insured. Insured pension funds are managed by insurance companies, and the
investment of these funds is frequently subject to the same governmental restrictions like insurance
contracts. Non-insured funds have a wider range of the types of assets they may acquire.
10. Bond and money market funds. These are companies that accept savings and place them in a pool
for investments that allows diversification of assets.
11. Sales finance companies. These include sales and personal finance companies which make loans to
individuals for the purpose of buying automobiles. They obtain working capital from their own
stockholders, loans from commercial banks, and through sales of securities on the organized money
and capital markets. Typically, they do not lend directly to consumers or companies but buy sales
contracts or installment contracts from the retailer or dealer.
12. Banks. These are commercial banks, savings banks, rural, development, and investment banks. They
approve loans based on collateral presented, which may be titles for real property or securities. In the
absence of an available pledge, a co- maker is required, serving as guarantor for the loans. They are
major sources of credit particularly for businessmen and for the development of certain industries. A
commercial bank is any corporation which accepts or creates demand deposits subject to withdrawal by
check. These institutions also accept drafts and issues letters of credit in addition to discounting and
negotiating promissory notes, drafts, bill of exchange, and other evidences of debts, receiving deposits
by buying and selling foreign exchange and gold and silver bullion, and lending money against personal
 security or against securities consisting of personal property or mortgages on improved real estate and
the insured improvements thereon.

CREDIT INSTRUMENTS

Credit Instruments are promises or orders to pay a definite or determinable sum of money to the bearer or
order on demand or at a future specified time. This document is evidence of a credit obligation resulting from a
past transaction that establishes the responsibility of the debtor to his creditor. These instruments have four
characteristics:

 payable to bearer when the instrument does not specify the payee's name.
 payable to order when the instrument specifies the payee's name.
 payable on demand for an instrument with the current date, like an open check.
 payable at a future time for an instrument with a future time.

These can be classified as investment credit instruments and commercial credit instruments.
Investment credit instruments are those which earn income in the form of dividends or interest such as
stocks and bonds. Commercial credit instruments are substitutes for money in a business transaction. These
are promissory notes, checks, bills of exchange, bank drafts, and bank deposits. Examples of instruments
having the four characteristics are shown here:
INVESTMENT CREDIT INSTRUMENTS

Bonds are promises to pay the principal as well as the interest to the holder at a certain specified time
indicated on the face of the instrument. They represent an indebtedness on the part of the issuing corporation.
In the issue, the corporation is called the bond issuer or the debtor, and the bondholder is the creditor. The
corporation has the obligation to honor its commitment to the bondholder redeeming the bond issue when it
matures by paying the principal as well as the interest earned. Bonds are advantageous because:

a. they represent a safe form of investment because the company must honor its obligation of paying its
indebtedness to the bondholder upon maturity regardless of whether it is losing or making profits.
b. they can be used as collateral to support loans sought by the bondholder from financial institutions.
c. they can be easily transferred to another holder by endorsement and delivery of the instrument.

Stocks are permanent invested capital of a corporation contributed by the owners (stockholders) who hold
certificates. It represents the stockholder's right to a certain portion of the assets of a corporation upon
liquidation and to certain shares of the profits after prior claims have been paid. Stocks are transferable to third
parties so that the holder may, in normal times, obtain immediate cash through the sale of said stock. Kinds of
stocks are common stocks and preferred stocks.

 Common stocks come with voting rights. One share is equivalent to one vote. The common
stockholder receives a portion of the corporate income, which remains after all other claimants have
been satisfied.
 Preferred stocks are given preference to assets, dividend declarations, and payments. They come
with the right to a fixed dividend, which is higher than that from common shares and secondary to the
interest on all classes of bonds and notes.

COMMERCIAL CREDIT INSTRUMENTS

These documents are used during business transactions to replace cash. These instruments include
promissory notes, checks, bank drafts, bills of exchange, and bank depositsExamples of these instruments are
presented in the succeeding pages.

Promissory Note

A promissory note is a written promise by a

person-the maker-to another party-the payee-to pay
a definite sum of money at a certain future time. A
note can be single-named or two-namedIn a single-
name note, the sole maker promises to pay, while, in
the two-name note, another party-the co-maker-
serves as a guarantor and assumes joint liability with
the maker. The payee is the party to whom payment
is due or promise to pay is given. The maker is the
issuer of the note or the party making the promise to
pay.

Promissory notes express a promise to pay a

definite sum of money at a future date. The following
are examples of promissory notes:
Check

A check is a written order drawn by a depositor or the drawer upon a bank or the drawee to pay on
demand or at a future determinable time a sum of money to order or bearer or the payee. A check is payable
on demand when it is an open check and the date on its face is a current date. It is payable at a future time
when it is a post-dated check bearing a future date or it is a crossed check. The instrument is payable to the
bearer when it simply states "Pay to the order of CASH.” This check does not identify any person or corporate
name to whom the instrument is payable.

Kinds of Checks

1. Open Check. This is payable to order or bearer. This instrument does not require presentation through
a payee's banking account. It has a current date on its face and can be encashed on demand.
2. Crossed Check. This is characterized by two parallel lines on the upper left-hand corner. It must be
presented through a payee's banking account for deposit. This instrument requires three days clearing
if it is drawn within the metropolis before it can be withdrawn by the payee. A crossed check can be
payable to order or bearer.
3. Certified Check. This is an instrument that has the word "certified" or "good for payment" stamped on
its face. This is commonly used for commercial transactions wherein the payee wants assurance of
fund sufficiency. This check may have a current certification equivalent acceptance which implies
negotiation the instrument. However, this does not apply to a check payment because, after the check
is paid, it is withdrawn from circulation. Acceptance may also be completed by delivery or notification. In
a real sense, checks are not to be accepted but presented at once for payment. The bank can
immediately fulfill its duty the depositor by paying the amount demanded
4. Manager's Check/Cashier's Check. This is an order drawn by the bank for the same bank signed by
the manager (for the manager’s check) or cashier (for the cashier's check), directing the bank to pay
the person designated by the depositor or the depositor himself a definite sum of money on demand or
at a future time. Since a bank manager or cashier cannot have cash on hand to pay clients, an
endorsement for this kind of check is needed. Upon receipt of this instrument, the payee simply goes to
the bank teller counter for encashment or payment of the manager's cashier's check
5. Traveler's check. This promise is to pay on demand. Even amounts are indicated on the face of the
instrument. This check is generally purchased by an individual before leaving for a trip outside the
country. This check is offered to banks, express, companies, or other agencies in denominations of
$10, $20, and $100. At the time it is purchased and presented for payment, the check must be signed
twice. They are sold at a face value plus a service charge.
6. Overdraft Check. This check is stamped “no sufficient fund” check because there are not enough
funds in the depositor’s account to cover the check. In this case, the depositor is notified by the bank to
resolve the insufficiency and is charged a penalty. Such a check can also be stamped "drawn against
insufficient funds."
7. Bouncing check. This is an instrument drawn against "no fund," for example, when the depositor has
closed his account with the drawee bank. The depositor can be charged with crime of estafa for
drawing a check without any deposit.
8. Stale-dated check. This check has date on its face or date of payment or encashment that is more
than six months old. For example, if the date on the check is January 1, 2002 and it was presented for
encashment on September 5, 2002, the check has become stale-dated. Banks dishonor this kind of
check to protect the interest of the depositor as the latter may have overlooked the issuance of the
check since it did not appear in the monthly bank statement. Drawees are requested to see the
depositor or drawer to ask for an open-check replacement. Under Section 186 of the Negotiable
Instruments Law, a check must be presented for payment within a reasonable time after issue or the
drawer will be discharged from liability thereon to the extent of the loss caused by the delay.
9. Post-dated check. This is an instrument where the date on the face is a future date for encashment or
payment. This may be issued by a drawer to coincide with the fulfillment of a future contract or
because, at the present time, the drawer may have insufficient fund in his current account.
NEGOTIATION AND ENDORSEMENT

A check is negotiated when it is transferred from one person to another in such a manner as to assign
the transferee as the holder thereof. If payable to order, it is negotiated by the endorsement of the holder and
completed by delivery. Endorsement must be written at the back of the check or on a separate note or
detached endorsement. The signature of the holder or endorser alone is a sufficient endorsement.
Endorsement is the signature of the payee on the back of the negotiable instrument. The original payee
becomes the endorser in negotiating the instrument.

KINDS OF ENDORSEMENT

1. Special endorsement applies to a check payable to order. Endorsement by the payee at the back of
the instrument is said to be a special endorsement since it is his name specified as the payee on the
face of the check.
2. Blank endorsement applies to checks payable to the bearer. In this case, the instrument was drawn
against no specified payee. Whoever is the holder in due course must endorse the check at the back
for encashment.
3. Restrictive endorsement prohibits further negotiation of the check when endorsement is in favor of a
particular person only. It carries the words "for deposit only." It limits further negotiation of the
instrument and lessens the risk on the part of the payee in cases when he transfers the instrument to
another holder. This is commonly used when the instrument issued by a drawer is payable to the
bearer.
4. Qualified endorsement makes the endorser as a mere assignor of the title to the check. It may be
done by adding the phrase "without recourse" or words of similar import.

USES AND LIMITATIONS OF CHECK

 Safety and convenience. It is safer to bring along checks for large payments rather than cash. If the
check is lost, the payee may request a replacement from the drawer
 "Stop payment" notice. A drawer may ask his bank "for stop payment" of certain checks issued due to
some default in the performance of any obligation on the part of the payee.
 For odd amounts. Some transactions may require odd amounts which can be easily paid by simply
writing a check.
 As a receipt. Checks serve as official receipts for business transactions, particularly when received by
"the drawer together with his monthly bank statement. For large amounts. Checks are convenient to
use as instruments for paying large amounts in business transactions.

Because it is a negotiable instrument, a check must conform to the following requirements:

 It must be in writing and signed by the drawer

 It must contain an unconditional promise or order to pay a certain amount of money.
 It must be payable on demand or at a fixed determinable future time.
 It must be payable to bearer or order.
 When the instrument is addressed to a drawee, the drawee must be named with reasonable certainty.

Five basic items are on a check's face, namely the date, the amount, the drawer, the drawee, and the
payee. The amount is usually stated both in figures and words. In case of discrepancy, the sum identified in
words shall be honored. The drawer is the person or entity that issued the check directing the drawee to pay
the payee named therein. The drawer is the bank that shall pay the party. The payee is the party entitled to
receive payment.

When the check is payable to two or more persons who are not partners, all must endorse when
negotiating the check. When the payees are designated "and/or," either may endorse and negotiate the check.
LIABILITIES OF GENERAL ENDORSER

A party who endorses without any conditions or qualification makes the following warranties

 that the check is genuine and all respect what it purports to be;
 that he has good title to it;
 that all prior parties have the capacity to contract;
 that the check is, at the time of his endorsement, valid and subsisting. It will be paid, and, if dishonored,
he will pay the amount thereof to the holder or any subsequent endorser who may be compelled to pay
it.

GUIDELINES IN ACCEPTING CHECKS FOR PAYMENT

1. Date must be current (examine month, day and year).

2. Amount in words must tally with the amount in figures.
3. The payee must be the name of the company (corporate accounts).
4. It must be signed by the drawer;
5. Any erasure or adjustment must be validated by the full signature of the drawer;
6. If it is a company check, the corporate title must be indicated. Also, all required signatories must have
signed the check.
7. Whenever more than one receipt is issued for a single check, the amount of the check must be written
after the check number on all receipts covered by it;
8. When payment is part cash and part check, the amount in cash and the amount on the check must be
noted.

BANK DRAFT AND BILL OF EXCHANGE

A bill of exchange orders the bank to make payment to a specified party, usually either the exporter or
the exporter's bank. If the documents are drawn correctly and other terms of the letter of credit, an instrument
to finance import-export, have been met, the importer's bank will then comply with the order.

Two main types are the sight draft and time draft. A sight draft is payable on demand, that is, as soon as the
importer's bank receives it. A time draft is payable at some future date. In the latter case, the importer's bank
typically accepts the obligation to pay the draft in the future, making it a banker's acceptance, which then
becomes a highly liquid money market instrument that may be sold by the exporter.

In a bank draft, the drawer is a bank directing another bank to pay at a specified time the payee
named in the instrument.

TYPES OF BANK DEPOSITS

The different needs of bank customers have given rise to a variety of services that a bank may offer.
Over the years, for instance, different kinds of deposit accounts have been introduced not only to encourage
saving, but also to provide maximum returns to bank depositors. Among the more common types of bank
deposits today are savings, time, demand (or checking/ current account), and the NOW account.

A savings deposit is an interest-earning deposit. Depending on the bank, savings deposits earn
interest at a given time rate computed on the daily or monthly balance of the deposit. On the last day of the
month or quarter, this computed amount is credited to the depositor's account to become part of the principal in
computing the interest for the succeeding period. Normally, savings deposits or a part of it may be withdrawn
upon presentation of a withdrawal slip and the depositor's passbook or through an automated teller-machine
(ATM)

A time deposit is another interest-earning deposit that may be withdrawn only after a stipulated period
of time. The rate of interest on time deposits is higher than on savings accounts, but it usually depends on the
amount of the deposit and the time or maturity period which may be any time from 30 days to five years as
specified by the depositor. The interest may be paid in advance or at the end of the time period agreed upon.
The bank issues to the depositor a "Certificate of Time Deposit," which serves as evidence of deposit and
which, upon maturity, the depositor presents to the bank for encashment or for redeposit of principal and
interest. In case of emergencies or when an immediate need for funds arises, the time deposit certificate may
be pre-terminated or encashed before maturity at a lower rate of interest.

A demand deposit also referred to as a checking or current account, generally does not earn interest.
To withdraw money from this type of deposit, the depositor issues a check or written order to pay, which is why
the demand deposit account is also referred to as a checking account. This type offers safety and convenience
to the depositor who otherwise may have to carry large or bulky amounts of cash to pay for purchases or
services or to settle financial obligations as well as business transactions.

A NOW account is also an interest-earning savings deposit account from which a withdrawal is made
by means of a check known as a "Negotiable Order of Withdrawal." No passbook is required. NOW accounts
offer the benefit of savings account (it earns interest) and the convenience of a demand deposit account
(withdrawals by check). However, not all banks offer NOW deposit accounts.

All banks have their own set of policies, rules, and practices that are designed to protect not only the
interest of the depositors but the banks' as well. These fall under two broad categories: operational controls
and credit controls.

On the operational side, each bank maintains established procedures in the conduct of day-to-day
business. The procedures presume that the risk areas have been identified and that they are designed to
ensure that transactions are conducted in such a manner that management is constantly aware that preventive
measures are taken against the occurrence of risks.

Banking is a business that cannot be conducted without taking risks. Banks take risks, not only when
lending money, but also in all aspects of operations where money is involved, such as deposit-taking, money
transfers, and safekeeping of valuables. It is the responsibility of management to exercise prudence and good
judgment in taking such risks. This is why the control function is very important.

One simple internal control that is practiced by banks, for example, is the surprise audit of cash held by
tellers. The purpose is to check whether the amount of cash, checks, and other monetary instruments in the
custody of the teller tallies the record of transactions. Control systems become more sophisticated as the
scope of the employee's responsibility widens.

On the credit (lending) side, the controls are contained in a checklist that every lending officer must
observe. Most banks have risk asset reviewers or internal auditors that evaluate the lending officer's
performance based on this checklist. One area of immediate concern to the reviewer is the credit worthiness of
a borrower whether individual or corporation. The risk asset reviewer looks into the account manager's
knowledge of the borrower's financial condition. Often, lending officers look into the character of the key
officers of the borrowing firm because of the fundamental importance of honesty and sincerity of borrowers. It
is particularly essential to consider prevailing economic costs, like shortage of foreign exchange and high
borrowing costs, which would affect the borrower's capacity to meet his obligations.

The risk asset reviewer also checks the proper documentation of a loan and the way the account
manager has administered it. The goal is to make an independent judgment of how closely the account
manager adheres to credit policy and how good every portfolio is relative to the standards of the bank. When
managers make decisions, they put into play both their initial training as bankers and their wealth of experience
in weighing risks and looking into the future.

THE UNPAID SELLER

The unpaid seller assumes the position of a creditor to whom full payment has not been paid. Only
partial payment has been tendered or a credit instrument was issued but conditions have not been fulfilled,
causing the instrument to be dishonored.

Under such circumstances, the unpaid seller is entitled to any of the following rights:

 The right to retain possession of goods until full payment or right of possessory lien. This is
applicable when the goods have not been delivered or are still in the seller's possession.
 The right to stop the goods in transit or stoppage in transit. This shall be available in cases where
the seller has parted with the goods but the buyer becomes insolvent and can be no longer paying his
lawful obligation.
 The right to resell the goods. The unpaid seller may re-sell the goods when he stops the goods in
transit, when the goods are perishable, or the buyer has been in default in the payment of the price for
an unreasonable length of time.
 The right to rescind transfer of title and resume ownership of the goods. The unpaid seller may
exercise his right to possessory lien or stop the goods in transit when the buyer has been in default in
the payment of the price for an unreasonable period of time.

RIGHTS AND REMEDIES OF CREDITOR

Possibility of a debtor's incapacity to pay is great, and a creditor suffers bad debts. Allowance for bad
debts must always be provided by creditors but to a minimum. Before an account can be totally declared
uncollectible, legal means can be sought by the creditor. A civil case for collection can be filed with the proper
court, depending on the amount of the claim. The barangay is given the mandate to seek justice for creditors in
settling small accounts. If the amount claimed is Php 10,000 or less, the municipal or city court is the proper
venue. For greater amounts, the proper court is the Court of First Instance"

Under Philippine laws, aside from the creditor's right to collect, he has also the right to seek the
property of the debtor in order to satisfy his claim. On the other hand, the creditor, to forestall the debtor's claim
to his property, may resort to certain provisional remedies that can be applicable on the condition that the
debtor has property or assets to satisfy the claim of the creditor. Attachment, garnishment, and receivership
are rights the creditor may invoke in case he cannot collect the cash loan he extended to the debtor. The right
to replevin is exercised by the creditor who extended merchandise form of credit. Composition is the sole right
of the debtor during the litigation of the case. Under this legal claim, the debtor is called the defendant and
the creditor is the plaintiff.

Right to attachment is a provisional remedy by which the property of the defendant is taken into the
custody of the law as a security for the satisfaction of any judgment which the plaintiff may recover. Right to
garnishment is the creditor's option to request from the court a third party-the garnishee-to hold and control the
property of the debtor during the legal proceedings.

Right to receivership is a remedy wherein the claimed property is placed under custody of a third
party called the receiver. The receiver has the right to hold, control, and dispose of the subject property per
court direction. The receiver is appointed by the court, and the property may be disposed of at an auction. The
amount in excess of claim shall be given back to the defendant.
 Right to replevin is a provisional remedy compelling the defendant to deliver to the plaintiff any
personal property claimed or merchandise loaned for non-payment of obligation. Delivery of the item shall be
per court order.

Right to composition is the will of the debtor at his own motion to voluntarily pay his creditors certain
portions of their claims in exchange for release from his liabilities.Right to composition shall be valid under the
following conditions:

 There must be a list of debtor's property and other creditors.

 Acceptance of the creditor must be in writing.
 Bank deposit certificates must be presented by the debtor.
 Terms and conditions must be approved by the court.

CONTRACT OF LOAN

This is an agreement wherein a party delivers to another money or consumable thing upon the
condition that the same amount or the same type and quality shall be paid.

Contract of loan can be mutuum and commodatum. Mutuum is a contract where the subject is a
consumable thing. Commodatum is an agreement to deliver a non-consumable thing. In a commodatum, the
bailor is the creditor, and the bailee is the debtor.

INTEREST PAYMENT

When parties agree on an interest rate, their agreement shall be valid provided it does not violate
provisions of the Usury Law. When an agreement is made but the interest rate is not stipulated, the legal rate
of six percent (6%) per annum applies. Classes of interest are:

a. Legal interest. Interest rate prescribed by law and stipulated under the Usury Law.
b. Conventional interest. Interest rate agreed upon by both parties.
c. Usurious interest. Interest rate over and above what the law provides.
d. Compound interest. Interest on interest or accrued interest added to the principal sum.

PLEDGE AND MORTGAGE

A mortgage contract is an accessory contract that is dependent on a primary obligation. Primary

obligation may be a contract of mutuum or commodatum where pledge and mortgage serve as the collateral
for security of the loan. This is an accessory agreement used to secure a principal obligation. A mortgage
contract can be a real estate mortgage or a chattel mortgage.

Real estate mortgage involves non-movable property as collateral while chattel mortgage includes
movable property like personal property, fruit-bearing trees, future harvest, and livestock breeds. Under this
contract, the mortgagor is the person using or securing his property as collateral, the debtor is the financial
intermediary accepting such mortgage, and the creditor is known as the mortgagee.

CREDIT INSURANCE

This is protection against unusual losses resulting from the sale of merchandise on a credit basis. This
is written only on the trade credit accounts. In this contract, the insurer promises, in consideration of a premium
paid and subject to specified conditions as to the persons to whom credit is to be extended, to indemnify the
insured, wholly or in part, in case of loss that may result from the insolvency of persons to whom he may
extend credit within the term of the insurance. Credit insurance may be classified into five types:

 Credit Life, Credit Accident, and Sickness Insurance. A debtor may be unable to pay his debt
because of death, accident, or sickness. This covers the unpaid obligation of the debtor in case of his
death or liquidates payments on an installment debt during the time the debtor is disabled by an
accident or sickness.

 Accounts Receivable Insurance. This protects the creditor against inability to collect a bad debt
because records were destroyed by perils listed in the coverage. This policy includes additional
expenses for collection, reconstruction of documents, and interest on principal.
 Domestic Merchandise Credit Insurance. This insurance protects the creditor against incapacity of
local debtors or insolvency arising out of the sale of merchandise.
 Export Credit Insurance. This insurance covers losses from international trade transactions due to
insolvency of the importer or debtor or due to political or commercial risks.
 Government Credit Insurance. This includes the deposit insurance program of the Philippine Deposit
Insurance Corporation and the Government Service Insurance System and Social Security System
insurance for housing loans in the form of Mortgage Redemption Insurance.

Contracts for credit insurance are classified into back coverage and forward coverage and general
coverage or extraordinary / restricted coverage. Back coverage contract covers losses incurred during the
policy term, which may also include credit sales prior to the date of coverage provided these losses were
declared during the policy period. Forward coverage indemnifies the insured for losses made during the policy
term. The general coverage policy insures the company against unusual losses on all of its insurable accounts.
Extraordinary or restricted coverage offers protection against loss from a small portion of the firm's accounts
and often from a single account. In some cases, only debtors named are insured.

Bad debts are part of all credit sale operations, so it would be unreasonable to depend entirely on credit
insurance companies to recover losses. To be fair, the insurer charges a premium equal to normal loss to
offset the expected costs of the insurance and an additional premium to cover excess losses. This requires the
determination of primary loss and coinsurance clause. Primary loss is the amount of receivables normally lost
or anticipated in a business. Credit insurance is not intended to cover primary losses, only those which exceed
what is anticipated or unexpected. A coinsurance clause can also be included. This provides that the insured
must bear a portion of the losses. Participation of the insured is at least 10 percent. This minimizes complete
transfer of risk to the insurance company or laxity in extending credit.

The protection given to the insured is based on the maximum primary loss the insured is willing to
assume and the maximum losses which the insurer will assume. In determining the insurable amount, factors
include the determination of the applicant's line of business and past credit experience. Premium to be paid for
the coverage is determined by.