Credit Analysis Basics Module 1 Credit Introduction

1. Credit Analysis BasicsModule 1Credit Introduction By Ajay Kumar Jhingan International Speaker/Trainer & Consultant Banking & Finance

2. Objective This module will help the learner to know the following Introduction to Credit Why Bank Credit is needed? Role of Credit

3. Introduction to Credit Credit is derived from Latin word Credere which means “to believe”. Credit is mainly based on trust which allows one party to receive money or resources (on certain lending terms) and pay the amount at a later date. It is a deferred payment facility provided by the lender or creditor (bank) to a debtor (borrower) on agreed terms. In other words, by credit, we mean the ability of a borrower to obtain goods or services before payment, based on the trust, that payment (with interest) will be made in the future. Credit enhances the borrower’s ability to purchase goods or services and enables companies to invest in projects which are normally not affordable by self means & attract large funds.

4. Introduction to Credit Credit generates a ‘source’ which can be put to meaningful ‘use’. In accounting, credit is also a journal entry that reflects increase in assets. You might have seen people largely dependent on using credit by way of credit cards. The purchases made through credit cards result in money due from card holder to be paid with some charges or interest, if any, which is just nothing but loan paid at a later date. It has no magic that credit cards give you free purchases. Credit cards are widely known as plastic money that transform purchases into loan repayable within the fixed short period say 50 days or so.

5. Introduction to Credit By way of using credit (loan) and paying the due money, your credit history is created. This credit history decides for you why good credit matters much and how bad credit cripples your future plans. Good credit helps landlords to ensure whether you have rent paying capacity or not, lender decides to determine whether you have house loan repayment ability or not before considering your any requestor for any other purpose which requires from you to establish basic upon past record that you will prove to be trustworthy in future also. If a person has never availed loan in the past and has no credit history, one has to establish the same up to the satisfaction of lender for the purpose of verification.

6. Why Bank Credit is needed? You must know that money is a dearest commodity being a powerful medium of exchange. There was a time in long past that this medium of exchange was lacking and people used to fulfill their needs by way of Barter exchange. For example, two bags of rice in exchange of one or two bags of wheat. Barter is a system of exchange by which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money. Barter, as a replacement for money as the method of exchange, was used in times of monetary crisis, such as when the currency remained either unstable (e.g., hyperinflation or deflationary spiral) or simply unavailable for conducting commerce.

7. An 1874 illustration from Harper's Weekly (American Civilization Magazine), showing a man engaging in barter : Offering chickens in exchange for his yearly newspaper subscription.

8. Why Bank Credit is needed? For barter to occur between two people, both would need to have what the other wants as can be seen in the last slide. This was one of the limitations in Barter Exchange, among others. However, you must have recognized from last picture that during Barter days, there was an absence of common measure of value. This feature of measure of value could be possible only if exchange had existed by using money. Hence, Money plays a vital role as has a feature of value of all goods. Facilitates exchange and reduces transaction costs. But being dearest commodity, availability of surplus money all times was not possible. This gap of surplus money was fulfilled by commercial banks by providing credit which is recognized as one of the most important drivers of a national economy or the whole world.

9. Role of Credit Now a days, almost all people use credit by way of credit cards which are issued to people who have established their creditworthiness. There was a time when credit cards were not available or otherwise, when there was a time of squeezed credit, people used to fulfill their needs by buying goods from local vendors or shopkeepers on future payment terms basis upon receipt of salaries. Credit had existed at that time also. It means the sellers used to ensure safety of their funds, liquidity and profitability as they need to enhance sales. This was just nothing but Cardinal Principles of Lending (safety, liquidity & profitability along with purpose, security & risk) which the banks follow now a days. Banks have played a very big role in providing credit to people and corporates, business entities basing upon above cardinal principles of lending.

10. Role of Credit However, situation remains even today that source of earning is limited. If you want to buy a house or car, you can do so if you have surplus funds to meet the cost or depend upon credit from banks. Likewise, for example, if a corporate in power sector intends to establish new power plants or modernize and renovate existing power plants or modernization and revamping of airports is needed, these projects can be handled only with the help of banks who can provide credit. Even the contractors who are offered such contracts have to depend upon bank credit upon award of contracts. It means that provision of credit by banks has played a vital role to create facilities in our lives & drive our economies. Banks, therefore, are recognized as backbone of economies & bank credit as Bread & Butter of banks being source of earning. You know now very well that banks mobilize funds by way of deposits and provide credit as part of their main business. Difference between interest paid on deposits and interest charged on loans is main source of bank income.

11. Role of Credit Credit through banks have helped to raise our living standards as we have now owned houses, vehicles, smart phones on credit terms and much more. Credit has helped real estate sector like shopping malls, housing units, micro small & medium enterprises (MSME), large industrial sector, infrastructure projects like airports, shipyards, roads, power sector, buying of aeroplanes and you name any sector, you will find role of credit provided by banks. Remember that banks ensure their lending procedures and credit assessment / appraisals through professionals who deal in credit like Credit Analysts etc. Credit has now become a part of one’s daily life. Go to Module 2

12. Sum Up You now feel confident as Module 1 has enabled you to know the following - What is Credit? Why Bank Credit is needed? What is the Role of Credit? (Let us switch over to Module 2 on Security Aspects)