Overview of Credit

Credit -The ability to obtain things of value in exchange for a promise to pay at a determinate future
time (debtor’s viewpoint)

 Willingness to accept the debtor’s promise based on trust and confidence (creditor’s viewpoint)

Significance of credit

 Credit plays a very important role in our present-day economy.

 The use of credit allows the possible production of goods.
 Credit plays an important role in the distribution of goods.
 It is also important that we must also recognize the endeavors of both the governmental and
the private businesses to promote full employment.
 Consumer’s credit is a vital link between production and distribution.

Elements of credit

1. Trust

From the origin of the word credit which is creditum, meaning trust, it is evident that the first
consideration in granting credit would be the presence of trust and confidence.

2. Futurity

A distinct aspect which sets apart cash transaction from a credit transaction is the element of time or
futurity. Whether the time is an hour, a day, a month or a year does not matter, provided that payment
is after the specified lapse of time.

3. Risk

Since the creditor has only to rely upon the debtor’s future performance, there is the element of risk.
This is due to the uncertainty of payment of the possible reduction of payment.

Characteristics of credit

1. It is bilateral or a two-party contract

Every debtor has his corresponding creditor; creditor his corresponding debtor. The creditor
demonstrates his faith in his debtor by transferring title or ownership of the goods or services solely on
his debtor’s promise to pay for them later. In turn, the debtor binds himself to pay and the same time
recognizes the right of the creditor to collect from his the price of goods and services transferred to him.

2. It is a personal contract

When a loan is extended, the debtor’s character is the primary basis. Although the debtor’s willingness
to pay may be beyond question, another personal element must be considered…his ability to pay
3. It is a pecuniary contract

In order to protect the rights of both parties, the debtor must know the exact amount of his obligations
and the creditor must also know the extent of his claims. The most accurate way of measuring these
magnitudes is thru the use of a reliable standard of deferred payments which is money expressing such
debts or clams by the price involved.

CASES WHERE CREDIT TRANSACTIONS ARISE

 Deferred payment for goods and services.

 Money loans
 For services rendered where individuals receive their wages or salaries after rendering their
respective labor and talents or sometimes workers may render their services after receiving
their money ahead of time.

Advantages of credit

1. Allows the immediate use of goods and services

Use now pay later so to speak. This is especially helpful for big-ticket items such as house and lot,
furniture, car, education which few people can afford to shell out cash for.

2. Shopping convenience

Credit and charge cards allow us to shop and travel without having to carry large amounts of cash.

3. Provides a temporary solution to unexpected financial difficulties

4. It is an agent of production

It is an accepted fact that idle funds do not help the economy. With the use of credit, these idle funds
are channeled to productive activity. Those people with excess funds deposit them in banks which in
turn lend them to businessmen to enable them to produce more goods.

5. Credit gives fluidity to wealth

Because of the presence of secured loans, credit turns fixed assets into current assets. For example,
one can get as a loan a certain amount in cash by using a real property as collateral for the loan.

6. Credit supplement the monetary system

The circulation of checks representing bank credit tends to supplement the monetary system by
providing other media of exchange.

Disadvantages of credit

1. It costs money
Purchases paid for over time cost more – often much more than cash

2. It encourages overspending

Credit makes impulsive buying easy. Some consumers go deeply into debt buying items they don’t
need for the simple reason that they haven’t used up their credit line yet

3. It ties up future income

Credit purchases mean less disposable income in the futures

4. It may result in losses

If you fail to make payments on time, you may lose the merchandise. For loans that require collateral,
you could lose valuable property

5. Liberal credit can lead to over-expansion or over-speculation

When a business is booming, credit is given fully. This further boosts prosperity. People become extra
confident and forgot the possibility of depression. They will be riding on the crest of prosperity. When
business suddenly slumps, they are caught unaware and will have to marshal funds to pay their debts.

6. The government that borrows heavily may have to curtail important projects when most necessary

CLASSIFICATIONS AND KINDS OF CREDIT

As to maturity

Short-term - payable within one year

Medium-term - payable from one to five years

Long-term - payable for more than five years

Call-loan - with indefinite maturity, payable immediately upon the demand of the creditor

As to source

Public - granted by government institutions

Private - granted by commercial enterprises, banks and other financial institutions

As to payment of interest

Ordinary - interest is paid together with the principal on maturity date

Discount - Interest is automatically deducted from the principal at the time it is granted
As to method of release

Lump-sum - the principal is given once to the debtor

Installment - the principal is broken down in staggered releases

As to source of payment

Self-liquidating - repayment will come from the income derived from the use of the principal

Non-self-liquidating - repayment will come from the personal income salary) of the debtor

As to purpose

Agricultural - granted to finance agricultural needs such as for irrigation system, acquisition of seeds,
fertilizers, and others

Commercial - used to finance short-term working capital needs such as payment of maturing accounts
and purchase of inventories

Industrial - granted to finance long-term capital needs such as expansion expenditures and acquisition of
fixed assets

Real estate - used to finance the acquisition and improvement of real estates

Personal or consumer - granted to individuals to facilitate the consumption of goods and services

As to loan user

Agricultural - farmers, fishermen and others engaged in agricultural activities

Commercial - wholesalers, retailers, importers, insurers and brokers

Industrial - manufacturers, processors, and others engaged in the production of goods

Public Utility - franchise holders and operators of public utilities

Real Estate - developers, brokers, contractors, condominium owners, purchasers of lots and persons
contracting, repairing or renovating their houses

Export - exporters

Services - companies and persons rendering professional, educational, medical, recreational

services such as schools, hospitals, sports club, law firms and accounting firms

Personal or consumer - persons who will use the loan for medical, education or emergency needs or for
the acquisition of consumer goods such as household equipment and appliance

As to security
Secured - credit issued with collateral

Unsecured - credit issued without collateral, also known as character or clean loan (Loan
accommodations on a clean basis is usually granted to persons, firms, entities and corporations whose
credit worthiness, based on the evaluation of the 5 Cs of credit is highly favorable based on the
standards set. The financial capacity, cash flow, liquidity, business profitability and stability of the
borrower should be able to justify an accommodation, the repayment of which is solely dependent upon
the strength and capability of the borrower.)

LOAN CONSIDERATIONS

Purpose

It is important that the purpose for which the loan will be used be productive to enable the borrower to
repay the obligation incurred. It should also be useful to the community so it will contribute to the
economic development of the region. Speculative loans are frowned upon.

Type and size of loan

Lending involved risks, hence the need to diversify the loan portfolio as a means of spreading the risks.
Due consideration should be given to the amount involved because the larger the amount, the greater
the aggregate risk.

Maturity

It must always be kept in mind that the longer the time, the greater the risk. Maturity of the loan should
therefore be patterned to the duration of the financing needed by the borrower.

Security

To reduce the risks involved in lending, collaterals such as real estate, shares of stocks, receivables,
machineries and equipment, inventories and others should be required.

Interest

Several factors should be considered in establishing the rate such as the cost of funds and the account
relationship of the borrower with the lender.

Loan Liquidation

Repayment of the loan should be discussed thoroughly with the borrower and carefully considered
when the loan is made to avoid possible trouble later. Failure to repay the loan on time impairs the
liquidity of the lender’s loan portfolio and increases the risk

THE TEN COMMANDMENTS OF CREDIT: THE Cs OF GOOD AND BAD LOANS

The Cs of Good Loans

One of the first thing examiners and lenders is the five Cs of credit. They are the tried and true rules of
good loan-making, consisting of character, capacity, conditions, capital and collateral. The five Cs
represent the “Thou Shall” commandments of lending.

THE Cs OF GOOD CREDIT

Character – “Thou shalt make sure that the company or person you are lending to is of outstanding
character. “

 Character refers to the borrower’s payment habits and attitudes, that is, his willingness to pay.

Capacity – “Thou shalt be sure that the company or person you are lending to have the capacity to
repay the loan.”

 Capacity refers to the borrower’s ability to pay as reflected in his cash flows.

Capital – “Thou shalt make sure that the borrower is adequately capitalized.”

 Capital refers to the borrower’s net worth position relative to his outstanding debts.

Conditions – “Thou shalt underwrite all loans understanding that business and economic conditions can
and will change.”

 Conditions refer to economic factors which may affect the borrower’s line of work or industry
and how changing economic conditions might affect the loan.

Collateral – “Thou shalt make sure that collateral does not drive lending decisions.”

 Collateral refers to any asset which may be pledged against the debt.

The Five Cs of Bad Credit

It is necessary to add the five Cs of bad credit – the five things to guard against. Consider these the
“Thou Shalt Nots” consisting of complacency, carelessness, communication, contingence and
competition.

PERSONAL CREDIT

Characteristics

 Character of the individual and his capacity to pay

 Non self-liquidating and constitutes a direst cut from individual’s earning
 The goods, services or funds borrowed is non-productive
 Usually unsecured and may either be evidenced or not evidenced

Types

Charge account
  Usually in the form of good or services rather than cash loans
 Small amount. Paid or cleared in full at a very short period of time
 No formal credit investigation is necessary (ex: credit card)

Installment Plan (Deferred)

 Payments are made in staggered amounts as specified periods

 There is usually a down payment and the subsequent payments are schedules at evenly-spaed
intervals
 May be applicable to goods and series and also money loans
 All installments are subject to the payment of interest. Added to the installment price offered
 Usually covered by installment contracts, which often come in the form of collateral promissory
notes. The security collateral is usually the object

Clauses contained in an installment contract

- Conditional sales agreement (buyer may take possession and use the same)
- Chattel mortgage (executed conveying to the creditor the title to the property)
- Acceleration clause
- Add on or open end contract
- Balloon contract (equal payment then big amount at the end)
- Wage assignment (employer is the one collecting)
- Hidden clause (getting something, has to submit to the provisions contained)

Factors to consider before you can decide whether to use installment selling

- Kinds of good sold

- Customer’s desire
- Financial resources available (charge acc & installment plan)
- Action of competitors (installment plan)

Reasons why credit business is a good business

- Credit customers ordinarily do most of their trading with the store where they have an account.
- Credit customers are not so price-conscious as cash customers.
- Credit customers do not shop around so much. They buy the article they need and move on.
- Credit customers can be sold more than cash customers. It is easy to say, “Charge it.”
- Credit customers (if selected well) are among the best people in town, and have more money to
spend.

Terms of sale – the conditions pertaining to the transaction. In the mercantile field, the restrictive
meaning is more appropriate and this usually includes two important aspects, namely, the
credit period and the cash discounts accompanying it.
Credit period - the length of time within which the credit is extended.

Factors affecting the credit period

- Nature of article
- Rate o stock turnover
- Locations of the ch
- Competitive conditions
- Nature of credit risk
- Stage of the business cycle
- Classes of customers
- Sectional differences
- Terms of sale by preceding sellers
- Attitude of the credit manager and policy of the owner

SOURCES OF CREDIT

1. Individual Money Lenders

2. Retail Stores - The retail stores are one of the biggest sources of personal credit. Almost every
sari-sari store in the country has its own sphere of customers. They give personal consumer
loans to their customers on an open book account basis.
3. Commercial Banks - They are engaged in the grant of loans not only to businessmen, but also to
individuals for personal purposes. . Generally speaking, in case of personal loans, borrowers are
required to furnish the bank with the written guarantee of two or more responsible persons that
the contract will be faithfully performed. These guarantors of the credit of the borrower are
called “co-makers”.
4. Savings Banks - 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 forms of security. However, in accordance with Sec. 31 of the General
Banking Act, as amended, loans and investments of savings banks include mortgage banks as
well as savings and loans associations which are established in the form of cooperation.
5. Savings and Loans Association - A corporation engaged in the business of accumulating the
savings of their members as stockholders, and using such accumulations, together with their
capital in the case of stock corporations, for loans and/or investments in the securities of
productive enterprises or in securities of the Government, or any of it’s political subdivisions,
instrumentalities or corporations”.
6. Rural Banks - In the rural areas of the Philippines, rural banks provide the chief sources of credit
especially for those engaged in agricultural that need facilities badly.
7. Development Banks - Like those of rural banks, development banks from an important part of
our banking system extending the necessary funds for purposes of hastening development.
They have been largely responsible for the birth and development of certain industries that are
now quite common on the Philippine scene.
8. Investment Banks - Investment banks, at times termed as investment houses, bridge the gap
between those who have idle funds not knowing where to invest them and those in dire need of
such funds.
9. Pawnshops - In the Philippines, pawn broking is also one of the oldest credit institutions and is
believed to have been introduced by the Spanish friars when we were under the crown of Spain.
10. Commercial Paper House - It is a financial institution that brings together the buyer and seller of
short-term commercial paper, that is, the lending institution and the borrowing business
enterprise. The commercial paper includes notes, banker’s acceptances, trade acceptances, and
foreign exchange bills.
11. Finance Companies - The general development and operation of finance companies are well
known. They have developed into a major source of funds for consumer, sales and commercial
financing. It may be divide in three categories:
 the installment sales finance companies, which discount consumer installment notes
arising through the sale of merchandise;
 the consumer finance companies, engaged in lending cash directly to the consumer and
 commercial finance companies, which through various types of loans serve business and
industry.
12. Credit Unions - They are corporate organizations which lend savings of members to some of the
members of the group. However, in order that credit unions can be successfully operated, they
should consist of closely knit, cohesive, natural group of employees with low labor turnover
13. 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. They receive premiums
and pay out money on the occurrence of the particular contingencies covered by the contracts.
They must accumulate insurance premiums to build up funds to meet policy claims, and they
must meanwhile employ these funds in loans and investments.
14. Social Security System (SSS) - It has launched an P800 million special corporate housing program
to bolster public housing projects and get private business involved in low cost housing. It
makes available developmental loans to qualified employers at concessional rates of interest so
the latter could offer housing units exclusively to their employees at very affordable
amortizations. The developmental loan is for land improvement and housing.
15. Government Service Insurance System (GSIS) - GSIS Powers and Authority
GSIS is empowered and authorized to do the following:
 engage in the business and operation of all kinds of insurance and reinsurance and all
other forms of undertakings to indemnify any person or property against loss, damage,
or liability, including third party liability, arising from unknown or contingent events;
 reinsure with and accept reinsurance from insurance and reinsurance companies in the
Philippines and abroad;
 issue policies denominated in any foreign currency;
 issue surety and/or performance bonds both in Philippine peso and/or in any foreign
currency;
  insure all insurable assets serving as collaterals for loans extended by government
financial institutions; and
 apportion among the governments any disposable surplus that it may declare from the
operations of the Fund.

GSIS Functions

 Identify and provide promptly all government property and projects with the proper risk
analysis and adequacy of insurance cover thru effective strategies and operational
tactics;
 Adopt at all times the correct rates, terms and conditions, clauses and warranties on all
tariff and non-tariff business;
 Settle all justifiable claims judiciously and within specified timeframes and quality
standards;
 Reinsure the appropriate amounts with stable and credible reinsurers at the proper
time; and
 Collect all money due the Government Insurance Fund when these become due and
demandable.
16. Kilusang Kabuhayan at Kaunlaran (KKK) - Kilusang Kabuhayan at Kaunlaran (KKK) Marketing
Coordinating Center. The KKK Coordination Center is hereby established to institutionalize the
linkage between livelihood enterprises and its buyers and to bring about coordinated marketing
enterprises and its buyers and to bring about coordinated marketing support to the national
livelihood program.
KKK aims to:
 Monitor livelihood production and evaluate its demand in both domestic and foreign
markets;
 To assist in providing timely and comprehensive marketing information to livelihood
enterprises; and
 Encourage the establishment of more private marketing facilities and services.

Sec. 2 The functions and powers of KKK:

 To develop and adopt a national marketing strategy supportive to the livelihood program;
 To assist in providing basic information that shall give guidance to livelihood enterprises, in
the marketing of commodities or services, both domestic and foreign;
 To give support services to the National Council on Livelihood, its secretariat as well as the
regional, provincial and municipal development councils on matters pertaining to marketing;
 To assist, through the mass media, market information to livelihood enterprises, the
prospective buyers and the various institutional components of Kilusang Kabuhayan at
Kaunlaran;
 To assist in showcasing livelihood produce in consumption centers in the country and at the
Philippine centers abroad; and
  To call upon other ministries and agencies of the government and other private persons,
entities or organizations to provide support services to the Center
17. PAG-IBIG Fund - PAG-IBIG is an acronym which stands for Pagtutulungan sa Kinabukasan: Ikaw,
Bangko, Industriya at Gobyerno. In effect, PAG-IBIG harnesses these four sectors of our society
to provide its members with adequate housing through as effective savings scheme.
Coverage of PAG-IBIG Fund - These guidelines shall cover the development and construction of
low cost housing units in Metro Manila and highly urbanized cities, and socialized housing units
in the provinces by PAG-IBIG Fund.
Objectives of PAG-IBIG
 To provide low-cost and socialized house and lot package/condominium units either for
rent or for sale to low income PAG-IBIG members who cannot afford the housing
packages available in the market.
 To enable PAG-IBIG Fund to perform its mandate by using its funds to provide decent
and affordable condominium units as well as house and lot packages for sale to eligible
PAG-IBIG Fund members nationwide.
 To stimulate competition that will bring about better housing packages in terms of price
and development that will redound to the benefit not only of PAG-IBIG Fund members
but also of the public in general.
 To help solve the housing backlog by generating further demand for housing through
the provision, and in the process, stimulate stability brought about by economic
development.
 To provide an opportunity for Local Government Units (LGUs) to comply with R.A. 7279
by identifying and providing land for socialized housing.
 To simplify and facilitate the processing of end-user financing for eligible PAG-IBIG Fund
members, given that the projects are owned by PAG-IBIG Fund.
 To develop further sense of ownership, pride and confidence among members of the
Fund, knowing fully well that the projects being constructed are direct investment s
made from their savings with the institution.
 To generate more membership to PAG-IBIG Fund.
 To develop and dispose acquired properties of the Fund.

TYPES OF DEBTORS

1. THE COOPERATIVE DEBTOR.

This individual and others of his kind not infrequently pass sleepless nights trying to find ways
and means by which they could discharge their obligations soon, if not soonest. Given the time
they do not constitute much of a problem to bill collectors.
2. THE CHRONIC COMPLAINER.
It is not uncommon for creditors to be recipients of repeated but nevertheless baseless
complaints from debts for this or that grievance which are generally the product of their fertile
imagination. They do not feel happy unless they are able to air certain grievance or complaints,
fabricated, filmsy or otherwise. Of course, it cannot be denied that some complaints are
 legitimate and therefore must be listened to and acted upon promptly if the company is not to
lose its consumers.
3. THE POLITICIAN-TYPE.
This type of debtor does not deny the existence of his obligation which arose from previous
transaction of his. Neither does he shun away from the presence of bill collectors. However,
like the politician, this type of debtor has a number of reasons kept under his sleeves which
explain one way or the other why he cannot pay on time or should not pay at least for the time
being.
4. THE UNCOOPERATIVE AND INDIFFERENT DEBTOR.
This type of debtor does not pay on time, not because he cannot pay but rather because he
finds it difficult to part with his money.
5. PARANOIAC.
Some people feel on top of the world even when their world is crumbling to pieces. They suffer
from delusions of grandeur. Psychologists call them as the paranoid. . At times, they make it
appear as if they are wallowing in wealth although in fact they are hard up. This type of debtors
need to be made to feel important and moreover put into humor by inflating their egos in order
to induce them to pay soon, if not soonest.
6. BELLIGERENT OR PUGNACIOUS TYPE.
Just as there are individuals who think that society owes them a living, so it is equally true that
there are those who think they are entitled the use of credit regardless of their poor credit
standing. How, these individuals were able to obtain the use of credit in the first place is very
bluffing indeed. This type of debtors whenever reminded of their existing indebtedness always
exhibits an air of defiance. They become haughty and arrogant.
7. THE ELUSIVE TYPE.
Some debtors are as elusive as an eel. It is hard for bill collectors to find them in their offices or
in their homes. Many of them maintain two doors, one to gain entry – and the other as an exit
without being detected by those who are waiting for them. They generally leave their homes
very early in the morning and comeback late at night.
PAYING HABITS
PROMPT PAYORS.
- This group consists of their financial obligations which they discharged promptly without the
need of being about them. Such individuals and business entities are those of proven
probity and possessing high integrity and thus, they require minimal attention, if at all, from
the collection department. They are rated as good, if not excellent risk.

DELINQUENT DEBTORS.

- A delinquent debtor is not merely a poor prospect for further business. He is no prospect at
all. He will shun the creditor, if only from a sense of personal embarrassment. Moreover,
once he becomes that involved financially, he is all likely to go from bad to worse as a credit
risk. The job of the collection department is to catch him in time to get him back on the
 rails, at the same time restoring his potential as a future customer by restoring his
confidence in himself to pay his obligations if he only tries hard enough.

TYPES OF DELIQUENT DEBTORS

Fair credit

 Careless borrower – merely needs reminding regularly

 Complainer – has grievances after he falls behind
 Unforeseen problems – unemployment, shrunken income, medical expenses

Slow credit

 Poor manager of his finances, over-indebted

 Marital problems – may quit his job, skip, or hit the bottle
 Coward – afraid to face the creditors

No good credit

 Lives beyond his income. Credit passed unknown

 Gypsy – in residence or employment
 Crook – directly attempting to defraud

CREDIT MANAGEMENT

Effective management of the loan portfolio and the credit function is fundamental to a company’s safety
and soundness. Credit management is the process by which risks that are inherent in the credit process
are managed and controlled.

RISKS ASSOCIATED WITH LENDING

Risk – the potential that events, expected or unexpected may have an adverse impact on earning or
capital

 Credit risk – risk of repayment, the possibility that an obligor will fail to perform as agreed.
 Interest rate risk
 Liquidity risk – quality, pricing, scheduled maturities and conformity to market standards
 Transaction risk
 Compliance risk
 Reputation risk

Functions of credit department

- Gathering credit info

- Analyzing
- Credit checking and authorization
 - Filing and recording
- Credit adjustments
- Collection correspondence
- Others

Qualities of a cre Competence and Capability

- Communication
- Constructiveness
- Creativity
- Conscientiousness
- Consistency
- Certitude and Celerity
- Contact
- Cost-consciousness
- Character
- Confidence
- Considerateness
- Computer literate
- Congeniality, charming personality, courage
- Common Sense

Test of credit department Operations

- Bad debt loss index

- Credit sales index
- Collection Percentage, Days to Collect and Turnover of Receivables
- Number of acc opened
- Acceptance index
- Past due index
- Aging of accounts
- Cost analysis

FORMULATION, COMMUNICATION AND IMPLEMENTATION OF CREDIT AND COLLECTION POLIC

Credit policies are guides in the performance of the credit functions of the company – the granting of
credit terms to customers, approval authorities, criteria for credit granting, securities and collaterals,
treatment of delinquent accounts and other general guides.

Formulation of credit policies: External to the risk & factors inherent in the risk

External

- Business Cycle
- Monetary and Fiscal Policies
 - Political
- Regulatory
- Industry

Internal

- Over-all Company Objective

- Other Department Policies
- Financial Condition of the Company
- Accounting Procedure

TARGET MARKET IDENTIFICATION, PRE-SCREENING OF LOAN APPLICATION AND LOAN EVALUATION

- Target markets
- Origin (client request, outside referral) (market segmentation)
- Evaluation (purpose, business, character, capacity etc.)
- Negotiation (repayment, security, covenants)
- Approval
- Documentary (legal drafting, documentary, collateral)
- Disbursement (valid notes)