Module 2: Credit and Collection / P2306

Credit Agreemen and Credit Instruments

(weeks 5,6 & 7)

OVERVIEW

Credit has been defined as an agreement between a borrower and a lender for
consideration of amount of money or goods, usually with interest payable at some future date.
In this module, students will be introduced to the “Credit Agreement” and the credit instruments
such that their understanding of credit will usher into an effective collection system. No amount
of works would compensate but understanding the instruments involved in a certain credit
transaction will be an effective tool for the students to collect effectively from its debtors.

LEARNING OUTCOMES

At the end of this module, learners would be able to:

1. Elaborate what is credit instrument

2. Classify the kinds of credit instruments used in credit transaction
3. Illustrate the different t types of credit and their importance

LET US EXPLORE

What Is a Credit Agreement?

A credit agreement is a legally-binding contract
documenting the terms of a loan agreement; it is made between a
person or party borrowing money and a lender. The credit agreement outlines all of the terms
associated with the loan. Credits agreements are created for both retail and institutional loans.
Credit agreements are often required before the borrower can use the funds provided by the
lender.
KEY TAKEAWAYS
A credit agreement is a legally-binding contract documenting
the terms of a loan agreement; it is made between a person or party
borrowing money and a lender.
A credit agreement is part of the process for securing many
different types of loans, including mortgages, credit cards, auto
loans, and others.
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)
Credit agreements are often required before the borrower can
use the funds provided by the lender.

How Credit Agreements Work

Retail customer credit agreements will vary by the type of credit being issued to the
customer. Customers can apply for credit cards, personal loans, mortgage loans, and revolving
credit accounts. Each type of credit product has its own industry credit agreement standards. In
many cases, the terms of a credit agreement for a retail lending product will be provided to the
borrower in their credit application. Therefore, the credit application can also serve as the credit
agreement.
Lenders provide full disclosure of all of the loan’s terms in a credit agreement. Important
lending terms included in the credit agreement include the annual interest rate, how
the interest is applied to outstanding balances, any fees associated with the account, the
duration of the loan, the payment terms, and any consequences for late payments.
Institutional credit agreements must be agreed to and signed by all parties involved. In
many cases, these credit agreements must also be filed with and approved by the Securities
and Exchange Commission (SEC).
Example of a Credit Agreement
Sarah takes out a car loan for P45,000 with her local bank. She
agrees to a 60-month loan term at an interest rate of 5.27%. The credit
agreement says that she must pay P855 on the 15th of every month for
the next five years. The credit agreement says that Sarah will
pay P6,287 in interest over the life of her loan, and it also lists all the
other fees pertaining to the loan (as well as the consequences of
a breach of the credit agreement on the part of the borrower).
After Sarah has read the credit agreement thoroughly, she agrees
to all the terms outlined in the agreement by signing it. The lender also
signs the credit agreement; after the signing of the agreement by both
parties, it becomes legally binding.

CREDIT INSTRUMENTS:
People talk a little regretfully of the good old days when everybody was honest and a
man’s word was as good as his written bond. They forget that now the area of dealings has
increased greatly.
Perhaps, man has become more selfish too, on account of the increase in the struggle
for existence; hence almost always some record of transactions is kept in black and white.

1. Promissory Note:
The simplest form of a credit instrument is the promissory note. A promissory note (or
pro-note for short) is a written promise from a buyer or a borrower to pay a certain sum of
money to the creditor or his order. It is what we call IOU (I owe you), i.e., an acknowledgment
of debt and an obligation to repay.

A typical promissory note is as below:

Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)

The words “value received” indicates that the document is the result of some purchase
or loan. Interest must be mentioned; otherwise the pro-note is not good in law. Such a
document can be used for any kind of transaction, personal or commercial.
2. Bill of exchange:
A bill of exchange is used in internal as well as foreign trade. It is an order by a seller to
a buyer or by a creditor to a debtor to pay a certain sum of money to himself or to bearer or to
another person named therein. The seller or the creditor who draws the bill is called the
‘drawer’; the purchaser or the debtor on whom the bill is drawn is called the “drawee.” The
seller may order the payment to be made to a third person called the “payee”.
Specimens of inland and foreign bills of exchange are given below:

In place of the payee’s name any of these forms may be used:

1. Pay to bearer,
2. Pay to Dr. J. D. Varma or order, or
3. Pay to my order.

When the bill of exchange begins with “On demand”, instead of “thirty days”, it is a
“demand bill’ or “sight bill’.

The drawer sends ‘he bill to the drawee who “accepts” it by signing it and putting his
office stamp on it. The bill now becomes a negotiable instrument and can be bought and sold
in the market. The drawer can now discount it and change it into cash on paying a commission,
called discount, at some firm or bank. It may pass through several hands before it ultimately
matures or falls due for payment, when the drawee pays his debt by honouring the bill.
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)
If the drawee is not very well known, he secures the services of an Accepting House to
sign and accept the Bill. Such houses or firms specialize in providing guarantees and charge a
commission for their services. To perform such services the Accepting Houses have to keep
themselves well informed of the financial position of the merchants on whose behalf they
accept bills.
Advantages of a bill of exchange:
A bill of exchange thus performs the following important functions:
(i) “Neither the exporter nor the importer has to go without his money while the goods
are in transit.—(Sayers) The exporter gets his money from a bank and the importer does not
have to pay immediately. He pays it after he has sold the goods, and has funds in hand.
(ii) Funds lying idle in banks are invested in Bills of Exchange and are profitably
employed. Banks particularly favour this form of investment, because money is not locked up
for long and can be withdrawn easily. It is said that a good bank manager knows the difference
between a bill and a mortgage. The bills discounted set up a regular stream of money flowing
in and out.
(iii) Gold and silver are saved from being transported between countries. Exports are
made to balance against imports through the bill market without movement of gold.
(iv) While the buyer pays in his own currency, the seller is paid in his own. Exchange
Banks undertake the whole work and individuals are saved from all bother and inconvenience.
3. Cheques: Definition
A cheque is the most common instrument of credit and almost works like money. It is a
written order on a printed form by a depositor (drawer) to his bank to pay a sum of” money to
himself or to somebody else, whose name is entered on it, or to the bearer, i.e., the man who
holds it (i.e., drawee). No bank ordinarily refuses to pay money for a cheque, provided it is
correctly filled in, and there is enough money in the drawer’s account with the bank. A
specimen cheque is given below. The counterfoil with the drawer serves as a record of the
payment.
Cheques are of the following kinds:
Bearer Cheque:
Any one, who happens to have the cheque, can get it cashed. In this case, the bank
need not worry as to who presents it at the counter. If a bearer cheque is lost, the finder can
cash it unless the bank is notified in time to stop the payment. The drawer runs the risk of
losing his money, and not the bank.
Order Cheque:
The word “bearer” after the payee’s name is crossed out, as in the cheque form below,
and the word “order” written instead. It is a safer form of payment, because the bank is
responsible for paying the money to the right person. The person who presents the cheque at
the counter has to prove his identity, before the proceeds of the cheque can be paid to him.

Crossed Cheque:
This is the safest form of payment as it cannot be cashed .it the bank counter. The
payee cannot get the proceeds of the cheque in cash, lie can only get the sum transferred to
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)
his own or (after endorsing) to somebody else’s account. A cheque is “crossed” by drawing two
parallel lines across its face or in a corner and writing the words “& Co.” between them. The
specimen given above is crossed. If it is crossed “Payee’s A/c.”, then cash cannot be obtained
from the bank; the amount of the cheque can only be credited to the payee’s A/c.
Post-dated Cheque:
Such a cheque is a way of making payments sometime in the future. If you have to pay
a hundred rupees to a friend after a month, you may draw a cheque in his favour and put down
the future date. It can be cashed only on or after that date.
Blank Cheque:
It means an unlimited offer because the signature is put, whereas the space for the
amount is left blank to be filled in by the drawee. Such cheques are usually handed over in
romances or films! Nobody ordinarily signs a blank cheque.

Advantages of Cheques:
The cheque has economized the use of money. No cash need be paid. Moreover, its
great convenience lies in that the payment can be exact to a paisa. There is no fear of loss
when the cheque is crossed. Thus it is safe method of payment, besides being convenient.
Again, the counterfoil of the cheque serves as a receipt and, therefore, ensures honesty.
The account of the transaction is with the bank and can be called for evidence, if
needed. But it requires confidence in the drawer as well as the bank for acceptance. Since
cheques are not legal tender, their acceptance is not compulsory.

4. Bank Drafts:
A cheque can also be used to remit funds to another place. But as the account is held
in a different place, from where the cheque is presented, the latter branch of the bank normally
gets in touch with the former before making the payment. To avoid this botheration, a banker’s
draft is used.
A bank draft is a cheque drawn by a bank on its own branch or on another bank
requiring the latter to pay a specified amount to the person named in it or to the order thereof.
The cheapest method of sending money is through a bank draft. A bank does not usually
charge more than 10 P. per hundred rupees if the amount to be sent is not less than a
thousand rupees, and if it has a branch at the place of payment.
The credit card is another example of a common credit instrument. Using a credit card
to pay for a purchase creates a contract between the buyer and the seller. Essentially, the
seller is extending credit to the buyer with the assumption that the company issuing the card
will cover the amount of the purchase.

Clearing House:
One great advantage that follows from the use of cheques is that we do not have to
carry a pocketful of notes or coins for our purchases. In countries, where people have
developed the banking habit, rarely is a purchase paid for in cash, unless it is a very small
sum. The people who are paid in cheques do not get them cashed but just pay them into their
accounts at their bank. Thus, if both the persons have a common bank, a mere change in their
bank balances completes the transaction.
When there are several banks in a locality and the two persons have accounts with
different banks, the process is not so simple. Every bank receives during the course of the day
cheques on other banks in favour of its customers. To send cash back and forth from one bank
to another every day would be very troublesome. To avoid this trouble, the device of a Clearing
House is used.
The representatives of the local banks meet at a fixed place after the working hours and
balance their claims against one another. When simple book entries have cancelled most of
the obligations, a small balance may be claimed by one bank from the other.
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)
8 TYPES OF CREDIT
Credit is the arrangement where the borrower receives the money from the lender and,
in turn, agrees to pay the interest for the period during which money is held with the borrower
and promises to repay after a predetermined time. Credit is of many types, and some of the
examples include mortgage loans, letters of credit, bank guarantees, consumer credit, trade
credit, etc.

1. TRADE CREDIT refers to credit in business dealings like selling goods on credit
where the customer promises to pay money later, buying goods on credit where we,
the customer of the supplier, promise to pay to the supplier on a later date. It is
given based on the borrower’s financial capability, i.e., credit taker. In some cases,
it is given based on a relationship with the person asking for credit, or it depends
upon business rules. In a large organization, the credit rules are the same for all the
customers.

2. CONSUMER CREDIT refers to money, goods, or services provided on the

agreement with the consumer to pay later with the charges for using the credit.
Consumer credit is specifically designed for consumers to give them various
benefits. Consumer credit involves the hire purchase goods, personal loans, credit
insurance, vehicle finance, etc. consumer credit is given on the basis
creditworthiness of the consumer, and rules of credit are the same for all the parties.
Purchasing goods on EMI is also an example of consumer credit. The banks gives
the overdraft facility also falls under consumer credit..

3. BANK CREDIT Is an extension of consumer credit. In bank credit, the bank gives
loans and credit facilitates to clients. Consumer credits are given based on
creditworthiness, analysis of financial statements, and value of the asset given by
consumers as security. Examples of consumer credit are mortgage loans, cash
credit facility, housing loans, etc., letter of credits, bank guarantee, discounting
of bills of exchange also falls under the bank credit facility.

4. REVOLVING CREDIT involves the continuous credit in which the lender gives the
extension of credit to the borrower so long as the account is regular and open by
regular payments like in case of credit card the credit is given regularly and limit of
credit is given and payment to be made on monthly or quarterly basis. And the
account will continue till it is closed, i.e., credit is extended every month.

5. OPEN CREDIT has a feature of both installment credit and revolving credit. If an
open credit limit is not set, the credit card is given, and then one will use it
throughout the month, and at the end of the month, the bill will be given to the
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)
cardholder to re-pay and continue the service. Electricity bills, gas bills, telephone
bills, etc., are examples of available credit, i.e., use first and then pay later and
available for all.
6. INSTALLMENT CREDIT is the extension of bank credit. When we obtain credit
from banks by way of loan, the bank sets the fixed monthly installment as
repayment type of loan along with interest up to a certain period till the loan gets re-
paid along with interest. The bank or finance company charges a penalty if the
borrower cannot pay the installment.

7. IN MUTUAL CREDIT, money is not used as in this case. If one person owes
another person for something that another person also owes to the first one, the
credit becomes mutual credit. So credit gets canceled with each other, and in case
a balance remains after that, then the same is settled by the mode of cash or
equivalent. Like in business, one person is a creditor and a debtor. Hence, they
mutually settle the payments.

8. IN-SERVICE CREDIT, the credit is given for services availed earlier. Like lawyers
ask for final fees once the case is over, the accountants charge after filing the
returns. Electricity bills, telephone bills, gas bills, and post-paid bills are examples of
service credit. Service credit borrowers can pay after availing of the service at fixed
intervals. But if the service receiver fails to pay at fixed intervals, it may cancel
services or charge a penalty for late payments.

CONGRATULATIONS! We end up discussing the basic information

needed for you to become responsible taxpayer. The rest lies in your hand,
as future entrepreneurs and graduate of this University: live up with the
Expectation the Palawan State University has laid on you!

LET US WRAP UP

1.
LET US ASSESS

Activity 1.3

1. Elaborate What is Credit instrument?

2. Explain the types of Credit Instruments

ANSWER KEY

Rubrics:
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)

Thought & Discussion ---------------------------------------------- 50%

Application to Current Events---------------------------------------- 40%
Transition & Arrangement--------------------------------------------- 10%
TOTAL ---------------------------------------- 100%

Description: This rubric will help you know exactly what I am expecting to find to your
assignment.
To assess student’s understanding for this activity, use this rubric:

SCORE/ DESCRIPTION
RANGE

81-100 Outstanding – The student has mastered necessary information needed for the
preceding lessons. He/she was able to understand the NATURE OF
INTERNATIONAL FINANCE.

61-80 Average-The student has understood the topic. There are some areas that the
student need to focus on and consult with the teacher for mastery.

41-60 Poor – The student has understood some minor parts of the lesson. There is a
need to deepen his/her understanding about the topic. Further conduct of
assessments is recommended.

0-40 For Remedial – The student has little to no understanding about the topic.
Remedial interventions should be enforced to aid student learning.

To assess student’s ability to write essay, use this rubric.

SCORE/ DESCRIPTION
RANGE

5 Outstanding – Well written and very organized. Excellent grammar mechanics.

Clear and concise statements. Excellent effort and presentation with detail.
Demonstrates a thorough understanding of the topic.

4 Good-Writes fairly clear. Good grammar mechanics. Good presentation and

organization. Sufficient effort and detail.

3 Fair– Minimal effort. Minimal grammar mechanics. Fair presentation. Few

supporting details.

2 Poor – Somewhat unclear. Shows little effort. Poor grammar mechanics. Confusing
and choppy, incomplete sentences. No organization of thoughts.

1 Very poor- Lacking effort. Very poor grammar mechanics. Very unclear. Does not
address topic. Limited attempt.
Module 2: Credit and Collection / P2306
Credit Agreemen and Credit Instruments
(weeks 5,6 & 7)
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REFERENCES