The credit system is as old as a man’s desire to consume what he has not and has no immediate means of paying for it. This desire existed even during the nonmonetary system era called the barter system.
It has existed with business and continued to develop with it.
From the early civilization, credit has always been considered but the only disagreement has been on whether the rate of interest should be injurious to the borrower or not.
The complexity of the modern business environment and increased volume of transactions have conferred on credit a vital tool in the development of trade and industry.
It is therefore a factor that cannot be over-emphasized in a post barter economy as well as an essential part of business operation in local and international business transactions.
What is credit system
Credit system means all instruments and procedures which work together to bring about credit facilities.
It also means the methods of exchanging goods and services without immediate payment, and this exchange is based on deferred payment or promises to pay principle.
In order words, credit system or credit is a Latin word credo which means trust or beliefs. Credit means different things to different people but one of its definitions is that it is a right to draw or obtain a loan of money.
Credit system is also seen as the state of feeling in the financial community that makes loans easy or hard to get.
A system is a series of interrelated units or parts that work together for the attainment of a common goal.
Some other credit system definition includes the followings;
- The right to draw a loan of money
- A quality a borrower which enables him to get a loan of money
- The state of feeling in the financial community that makes loans easy or hard to get
- A deferred payment
- A loan of money
- A means of obtaining goods and services without immediate cash payment by the buyer
In each above credit system definition, there is a hidden fact that credit is a loan of money.
This is an important fact in any transaction where credit is involved.
For example, if goods are sold and the buyer is allowed to defer the payment to a future date, it is the same thing as lending to a buyer the equivalent monetary value of the goods represented by the goods.
It is based on this understanding that credit sales are often fixed at a higher price than cash sales.
The existence of credit creates a creditor – debtor(lender – borrower) relationship. The relationship continues until payment is made.
Once credit is offered, the purchaser takes possession of the goods for consumption or resale with a promise of paying at a future date.
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Parties in a credit system
There there two principal parties exist in a credit system, and they are as follows;
- The creditor/lender
- The debtor/borrower
The creditor/lender is the person who part with it’s goods/money in exchange for future payment or promise to pay, while the debtor/borrower is he who receives goods/money for immediate consumption on deferred payment or a promise to pay.
This is what credit system is all about, and a typical example of it is the southwest credit systems or the national credit systems.
Factors considered before credit is given
There are factors that need to be considered before credit is given in credit system, and they are as follows;
Character is the most important of all credit system in assessing a prospective borrower.
A person’s character which covers issues as his honesty, sincerity, level of responsibility, willingness to pay, self-denying and willingness to work hard for the success of the proposed business.
These have serious effect on a person’s Credit worthiness.
It is better to deal with a prospective borrower who has good character but has no collateral than a person who has collateral to give but has a dubious character.
Indeed, character is the first gactor any lender should consider in credit system before granting credit to any prospective borrower.
2. Capacity in credit system
The capacity of the prospective borrower answer so many questions about the borrower. First is a question of legal capacity to enter into the contract.
For example, in the UK, any person below 18 years of age is regarded as a minor and is not qualified to enter into any legal binding contract accept contract for necessities like food and continuing nature of Education.
Besides, a bankrupt and a mentally incapacitated person cannot enter into legal binding contract because they are legally incapacitated.
Apart from the legal aspect, capacity of a prospective borrower provide answers to the following questions among others;
- Can the borrower utilise the money he is asking for without misusing it.
- Is he capable of repaying the loan
- Is the business or project treble of generating profits
- Does the borrower have the capacity to control the business
- Does he have the capacity to make necessary decisions for the success for the business
- Is he an efficient business man who can keep records of the business operations.
These are the necessary to be ascertained before credit is given in a credit system.
This refers to the borrowers contribution to the business which is expected to commit him to ensuring the success of the Enterprise.
A businessman who wants to borrow is expected to provide part of the money by himself while a consumer borrower is expected to make initial down payment where the amount involved is large in a credit system.
It is necessary to ascertain the conditions available for the payment of the loan capital and interest when due.
Where the project has prospect of regular profit or the borrower has a regular source of income which is not encumbered, then repayment of the loan may be affected without difficulty but where otherwise repayment may be difficult in credit system.
Collateral refers to the assets deposited with the lender as security for the loan. Collateral is normally taken to serve as caution against default by the borrower.
Although it is necessary to ask for collateral in credit system, it should however not be taken where the character of the borrower remains in doubt.
In accepting assets as collateral, care must be taken to ensure that the assets in question must have values above the amount being lent.
This financial balance means that a lender should not lend to the hilt that is, a lender should not lend to the full value or above the value of the asset deposited as a collateral.
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This is where I wrap up the post on credit system in banking and finance. Right now you have understood credit system definition or it’s meaning, and remember, this is completely different from china’s social credit system.