CREDIT AND

COLLECTION

BEA CARMONA
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 2

CHAPTER OUTLINE

INTRODUCTION
CONCEPT OF CREDIT
CREDIT DEFINITIONS
CREDIT INSTRUMENTS
ADVANTAGES / DISADVANTAGES OF CREDIT
CREDIT PROVIDERS
ROLE OF CREDIT IN ECONOMY
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT
INTRODUCTION
Why is credit important?
• Helps finance business when short on funds.
• Transfer of funds from system to productive
purposes promotes economic growth.
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The process:
• Borrower takes from bank in form of loan; pays
back principal amount with interest.
• Bank manages credit process to avoid non
performance loans.
• Bank should deploy credit in such a way that
every sector of economy can develop.
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 4

INTRODUCTION •
Credit Management Aspects
Distribute credit among all sectors of economy
so all sectors can develop; banks get profit.
• Grant credit to various sectors, individual, and
individual to avoid credit risk
• Maximize efficiency in terms of productivity and
profitability to achieve preferable economic
growth
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT
CONCEPT OF CREDIT
Etymology and Meaning
• Derived from Latin word “Credo”; means “I
believe or trust”
• In economics: trusting a person to pay back
after some time of lending money and receiving
of deposits.
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• Credit is trust which allows A (creditor) to
provide resources (financial, goods, services)
to B (debtor) where B is bound to repay or
return resources at a later date.
• Credit encompasses any form of deferred
payment
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 6

CREDIT DEFINITIONS

Prof. Kinley
“By credit, we mean the power which one person has to induce another to put economic
goods at his deposal for a time on promise or future payment. Credit is thus an attribute of
power of the borrower.”
Prof Gide
“It is an exchange which is complete after the expiry of a certain period of time”.
Prof Cole
“Credit is purchasing power not derived from income but created by financial institutions
either as on offset to idle income held by depositors in the bank or as a net addition to the
total amount or purchasing power.
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 7

Prof. Thomas
“The term credit is now applied to that belief in a man’s

CREDIT probability and solvency which will permit of his being

DEFINITIO NS
entrusted with something of value belonging to another
whether that something consists, of money, goods,
services or even credit itself as and when one may
entrust the use of his good name and reputation.” On
the basis of above definitions, it can be said that credit
is the exchange function in which, creditor gives some
goods or money to the debtor with a belief that after
sometime he will return it. In other words, “Trust” is the
“Credit”.
Vasant Desai
”To give or allow the use of temporarily on the
condition that some or its equivalent will be returned.”
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 8

CHARACTERISTICS OF CREDIT

Confidence Capacity Security

• Person or authority must have • Before granting advance, creditor • Before extending credit, bank
confidence on debtor should evaluate debtor’s capacity must ensure debtor’s security

Goodwill Credit Size Credit Period

• If debtor has good reputation • Generally smaller size credit is • Long term credit is not easily
of repaying in time, credit easier to obtain; Also depends obtainable; More risk involved
approval will be easy on above factors • Involves futurity and maturity
date
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT
TYPES CREDIT
Cash Credit
• Credit given to business firms
• Bank allows customer to borrow up to a certain limit
against tangible securities
• Borrowing limit is allowed to continue for years if
there’s good turnover in account and goods
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Overdraft
• Customer with current accounts is allowed to draw
more than his deposits up to certain extent
• Customer may pay when it is convenient
• Customer must pay interest on extra withdrawal
amount
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 10

Demand Loans
• Has no stated maturity period
• May be asked to pay on demand
• Silent feature is, entire amount of sanctioned loan
is paid to debtor at one time. TYPES OF
CREDIT
• Interest is charged on the debit balance.

Term Loans
• Advance for fixed period to person engaged in
industry, business or trade to meet requirement
(acquisition of fixed assets, etc)
• Maturity period depends on debtor’s future earnings
• Next to crash credit, this is considered important in
an advanced portfolio of the banking system of
country
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 11

TYPES OF CREDIT
Bill Purchased
• Bankers may sometimes purchase bills instead of discounting them.
• Generally done in case of documentary bills from approved customers only.
• Documentary bills accompanied by documents of title to goods
• In some cases, banker advances money in form of overdraft or cash credit against
security of such bills.
Bill Discounted
• Banker loans funds by receiving promissory note or bill payable at future date and
deducting that from the interest on the amount of the instrument
• Main feature of is the interest is received by the banker in advance.
• More or less a clean advance; banks rely mainly on the creditworthiness of the parties.
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 12

INNOVATIVE CREDIT PRODUCTS

Credit Cards Debit Cards

• Alternative to cash • Can be used as credit card for purchasing
• Banks allow customer to buy goods and products and drawing money from ATMs
services on credit • Upon swiping, money is debited from account
• Different facilities and features are based on
annual income of holder
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 13

Housing Loans

INNOVATIVE • Various type are offered for purchasing or

CREDIT
renovating a house
• Amount given depends on lending policies and

PRODUCTS •
repayment capacity of customer
Usually granted for a long period

Auto Loans
• Granted for purchase of vehicle

Personal Loans
• Excellent service provided by banks
• Granted to individuals to satisfy personal
requirements without any substantial security
• Usually with simple procedure; grants loan In
every short period with minimum documents
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INNOVATIVE CREDIT
PRODUCTS
Educational Loans Consumption Loans for Purchase
of Durables
• Granted to student to pursue higher education
• Banks fulfill dream by providing durable loans
• Available for inside and outside country
• Can be borrowed to purchase TV, REF, Laptop,
Loan Against Securities Mobile, etc

• Provided against fixed deposits, shares in Hybrid Loan Products

bonds, mutual fund, life insurance policy, etc. • Done to keep up with new technologies
• With fluctuating interest rates and inflation, banks
must protect interest of borrowers
• Has virtue of both fixed and floating interest rates
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 15

CREDIT INSTRUMENTS

Cheque
• Most popular instrument
• An order drawn by depositor on bank to pay certain amount money which is deposited
with bank
Bank Draft
• Used on either main or branch to send money from one place to another
• Cheaper, convenient and less risk

Bill of Exchange
• Enables seller to issue order to buyer to make payment either to him or person specified
either on site or within a specified time
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 16

CREDIT INSTRUMENTS

Promissory Note Government Bonds

• Instrument in writing • Issued by the government to support
• Contain unconditional undertaking signed by government spending
the maker to pay certain sum of money
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 17

Treasury Bills

CREDIT • Short-term debts issued by the government

INSTRUMENTS
• Issued in anticipation of the public revenue

Traveler’s Cheque
• generally used by people when traveling to
foreign countries.
• Used to avoid risk of having cash while
traveling
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 18

ADVANTAGES OF CREDIT

Exchange of ownership Increase consumption

• Enables debtor to use something
• Debtor is provided with control
Employment encouragement
• people can be encouraged to do some
creative business work
• helps increasing the volume of employment.
• Credit increases the consumption of all types of
goods.
Saving encouragement
• gives encouragement to the saving habit of the
people
• attraction of interest and dividend
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 19

ADVANTAGES OF
CREDIT
Capital formation
• makes available huge funds from able people to unable people to use some things

Development of entrepreneurs

• helped different entrepreneurs to fight with difficult periods of financial crisis

• One can borrow money and grow business at a greater return

Easy payment
• Credit instrument helped people pay without much difficulty and botheration
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT
ADVANTAGES OF CREDIT
Elasticity of monetary system
• Credit system provides elasticity to the
monetary system of a country because it can
be expanded without much difficulty
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Priority Sector Development
• Banks in developing countries are providing
credit for development in rural areas and
• other priority sectors too
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 21

DISADVANTAGES Encouragement of expenditure

OF CREDIT •
•
Credit encourages wasteful expenses by the
individuals as well as commercial institutions

Encourage weakness
• shortcomings are met by the borrowed capital

Economic crisis
• Recession and depression in an economy

Dangers beyond limit

• Over issue credit takes beyond safe limits
that result in over investment, over
production and rise of prices.
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 22

DISADVANTAGES OF CREDIT

Evil of monopoly Encourage inefficiency

• monopoly—the domination of a market by a • Credit gives encouragement to certain
single entity inefficient and worthless producers.
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 23

CREDIT PROVIDERS
Bank
an organization licensed to take deposits and extend loans

Building Societies (Savings and Loan Companies)

provides banking and other financial services to its members.

Finance Houses
broad range of lending institutions licensed to provide consumer credit.

Credit Unions
they are member-owned, and funds contributed by members are used to provide credit
services to other members
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CREDIT PROVIDERS

Utility Companies Pawnbrokers

• most utility supplies (water, gas, electricity and • Pawnshop
telecoms) are provided on a credit basis, with bills • secured loans to people, with items of personal
being issued in arrear at regular intervals, usually property used as collateral.
monthly or quarterly.
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Government Agencies
• federal government offers several types of loans,
including: Student loans. Housing loans, including
disaster and home improvement loans.

Licensed Moneylenders
CREDIT
• Any individual or organization who has obtained a
credit license PROVIDERS
Unlicensed Moneylenders
• Loan shark
INTRODUCTION TO CREDIT AND COLLECTION AND MANAGEMENT 26

ROLE OF CREDIT IN
ECONOMY
• Bank credit provides assistance to production and business process.
• Credit provides financial ability to use advanced technology in the production.
• Credit makes it easy and convenient for the consumers to purchase or hire durable
goods.
• Enables the entrepreneurs to run their business and day to day transactions very
smoothly
• It makes possible the financing of the agricultural, industrial and commercial activities of
the country
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YOU