CREDIT AND COLLECTION 1916 – The Philippine National Bank was established, to

remedy the short coming of the credit system.

Chapter I. CREDIT SYSTEM
In the various stages of economic development, not a Under the Republic
few former underdeveloped nations have achieved July 4, 1946 – The Philippines became a republic
higher levels of stability and growth in both economic October 29, 1946 – The Rehabilitation Finance
and social endeavors. It is most evident that the credit Corporation was established, to provide credit facilities
system, among other things, has been instrumental in for the rehabilitation of agriculture, commerce, and
the development and progress of nations. Needless to industry. It also provided in the reconstruction of war-
say, that the rate of economic growth of a country damaged properties.
depends on the availability of sufficient credit, and of 1949 – The Central Bank in the Philippines was
course the proper use of credit. established
1952 – The Agricultural Credit and Cooperative
NATURE AND CHARACTERISTICS OF CREDIT
Financing Administration (which later became
The Development of Credit Agricultural Credit Administration) was established.
1958 – The Rehabilitation Finance Corporation became
The Credit system reflects in many ways the degree of the Development Bank of the Philippines.
economic and social values and institutions pervading in 1982 – The Agricultural Credit Administration was taken
a particular society at a given point in time. Credit being over by Land Bank of the Philippines.
a tool of development and progress of people and
society, has, since ancient times to the present, served Basic Concepts of Credit
the specific and relevant needs of the economy. - The word “Credit” came from the Latin
Pre-Spanish Time word “creditum” which means trust.
The Philippines has been trading with the foreign - Credit is defined as a contractual agreement
countries such as China, Japan, Sumatra, India, Arabia, in which a borrower receives something of
Siam, Borneo, Java, the Moluccas and other East Indian value immediately and agrees to pay for it
Island, when the Spanish conquerors arrived. The barter later, generally with interest.
system then was used in the conduct of trade with the - There are two parties involved in a credit
foreigners. The Filipinos exchanged their native transaction:
products, such as cotton, pearls, betels, nuts, sinamay (1) Creditor (who provides the thing borrowed)
fiber, etc. with the goods of foreigners, like porcelain, (2) Debtor (who receives something of value and
silk, ivory, etc. assumes the obligation to pay)

Spanish Time Elements of Credit

During the initial years of Spanish rule, free trade was
encouraged. The goods of the Far East were marketed 1. Trust. It implies that the creditor or banker has
to America through Manila and then Acapulo, Mexico. faith in the ability and willingness of the debtor to
Manila was still a center of trade and commerce in the fulfil his obligations, be it an individual,
orient. corporation, or government.
A product of mercantilistic policy in the Philippines was 2. Time of Payment. The borrower has an obligation
the Galleon Trade. This was the Manila-Acapulo Trade. to pay his debt in a definite time or date.
It was called galleon trade because it was carried on by 3. Risk. It implies that the ability of the borrower to
transpacific galleons. Such trade was government fulfil his promise to pay may be reduced by
monopoly. circumstances beyond his control such as natural
Most of those who participated in the galleon trade calamities and personal misfortune.
secured their loans from the obras pias. These were the
forerunners of the banking institutions in the Advantages and Disadvantages of Credit
Philippines. The funds of the obras pias were donated
by the religious orders. Advantages
1. Credit benefits the entire economy.
American Era 2. Expansion of the purchasing power of consumers
The American administrators introduced a better 3. It has a multiplier effect.
banking and credit system to promote economic Disadvantages
development, especially in the rural areas. 1. Misused credit leads to disaster
1908 – The first agricultural bank for the benefit of the 2. Credit leads to over-speculation and overtrading
farmers was created 3. The pleasure of having consumption goods
1915 – The Rural Credit Law was enacted to ahead of time may be offset by the burden of
complement the agricultural bank forced savings or loss of consumption
 4. Credit is a threat to our private property. 4. Promotion of trade especially foreign trade
5. Governments with heavy borrowings may
The bills of exchange have increased the scope of
reduce future operations.
both internal and external trade as the trade-
payments can now be made without the transfer of
IMPORTANCE OF CREDIT SYSTEM
funds or gold. The commercial credit enables the
When consumers and businesses can borrow buyers to make payments for the value received at
money, economic transactions can take place efficiently
convenient times. So, the credit system enables the
and the economy can grow. Credit allows companies
access to tools they need to produce the items we buy. traders to tide over periods of difficulty.
A business that couldn’t borrow might be unable to buy 5. Expansion of bank credit
the machines and raw goods or pay the employees it The credit system enables the banks to create a
needs to make products and profit. large amount of credit out of a small amount of
Credit also makes it possible for consumers to deposit. This has resulted in the vast expansion of
purchase things they need. Many items, from cars to
bank deposits.
houses, are too expensive for most people to pay for all
at once. With credit, it’s possible to pay over time while 6. Financial accommodation to industries
accessing essential products and services when you Industries get short-term credit from some
need them. commercial banks and the long-term credit from
Specifically, the credit system creates an importance the development banks. This enables them not only
to the following: to tide over the temporary financial stringency but

1. Economy in the use of money also to maintain continuity in their activities.

The credit system economises the use of metallic 7. Consumers
money and paper notes. The credit instruments like Bank credit to the consumers enables them to buy
promissory notes, bills of exchange, cheques, credit durable consumer goods, especially household
cards, etc. are used in the modern society as goods on instalment basis.
money-substitutes, and so they have reduced the
8. Government sector
cost of issuing metallic money and paper notes.
Likewise they have minimized or eliminated the The credit to the government also helps them to
risks and inconveniences involved in cash meet both temporary necessities and growth
transactions. requirements.
2. Easy exchange and remittance 9. Stability
The credit instruments minimize the cash If the issue of credit is properly regulated, it tends
transactions and thereby make the scope of
to stabilise trade and reduce fluctuations in prices.
exchange wider and the remittance of funds easier.
They permit wealth to be transferred to places
where more economic use can be made of it. CLASSES AND KINDS OF CREDIT ACCORDING TO
3. Production
THE TYPES OF USER, PURPOSE, AND MATURITY
The credit system facilitates large- scale production. According to the types of user
It stimulates and finances production in anticipation 1. Consumer credit. Consumer credit also called
of demand. Producers nowadays very often obtain consumption credit is that kind of credit extended
credit from banks to begin and expand their to consumers in order to facilitate the process of
operations. Even the farmers and the small artisans consumption. This type of credit exists in those
cases where an individual acquires funds intended
depend on bank credit for production. The
for personal consumption or enjoyment in return
wholesale and retail traders conduct their trading
for a promise to make appropriate payments in the
with bank credit. future.
It is rightly said that the credit system lubricates the
production processes and keeps the wheels of Types of Consumer Credit
production constantly moving. There is a steady Instalment credit – Instalment credit is a type of
flow of goods from the wholesaler to the retailer loan in which you borrow one lump sum and repay
and from the latter to the consumer with the help it with interest in regular fixed payments, or
of credit. instalments, over a certain amount of time. Once an
instalment credit loan is paid off in its entirety, the
 account is considered closed. Examples of Unsecured – Unsecured credit is not tied to any
instalment credit accounts include mortgages, auto collateral. This means the lender won’t be able to
loans, personal loans, and student loans. claim any of your assets if you default. It can,
however, report your failure to pay to credit
Revolving credit – Revolving credit accounts allow bureaus and put a negative remark on your credit.
you to repeatedly borrow and repay amounts from Because unsecured credit is riskier for a lender than
a single line of credit up to a maximum limit. You’re secured credit, it’s usually more difficult to obtain. A
in control over how much you borrow (and few examples of unsecured credit are student loans,
ultimately need to pay back). Interest is charged on personal loans, and credit cards.
any balance remaining after each statement’s due
date, so it’s possible to avoid ever paying interest if 4. Investment credit. Investment credit is utilized by a
you pay your balance in full each month. As long as business organization for the purchase of fixed
you make all your payments on time, the account assets or to carry minimum business operations. It
will remain open indefinitely until you choose to consists of advances intended for the purchase or
close it. Credit cards are the most common type of construction of necessary plant and equipment.
revolving credit, but HELOC (home equity line of Briefly stated, the funds obtained are generally
credit) is another example. intended to be spent on equipment which the
borrower expects to use continuously until it is
Open credit – Open credit is unique in that monthly worn out, or suffers from obsolesce.
payments vary, and balances are due in full at the The soundness of an investment contract
end of each billing cycle. Your electricity bill is a depends mainly upon the continuous and profitable
great example of open credit; the amount due operation of the borrowing enterprise. Investment
depends on how much electricity you used that credit is evidence by negotiable bonds or long-term
month. You’re expected to pay the entire bill within notes. Still, in some instances, they may also be
a certain number of days after receiving it. Many evidenced by real estate mortgages.
utility bills — such as gas, electricity, water, cable,
and cell service – are considered open credit
According to Purpose
accounts.
1. Agricultural credit. Consist of loans which are
2. Mercantile credit. Mercantile credit, sometimes intended for the acquisition of fertilizers, pesticides,
also called as commercial credit, which may be seedlings, and any instruments, machinery and
described as that type of credit which one other movable equipment used in the production,
businessmen may extend to another when selling processing, transformation, handling or
goods on time for resale of commercial use. Parties transportation of agricultural products.
to a transaction involving the use of mercantile
credit may be merchant distributors like 2. Export Credit. Credit in some form and to some
wholesalers, jobbers, and producers or extent is always involved in all sort of transaction
manufacturers. for which cash is not paid on or before shipment of
Mercantile credit may be distinguished from goods out of the country. Credit risks in
consumer credit in the sense that the former is international trade differ materially and in several
brought about by transactions involving transfers of respects from domestic risk.
goods for business purposes, unlike the latter which As is generally observed, export trade may be
is intended specifically for consumption purposes. pushed by means of extension of credit to buyer, as
is the common practice, but before the buyer takes
3. Bank Credit. Bank credit is extended when a lender possession of them. Still, export sales can be done
such as a bank or other financial institution offers on the basis of payment when the goods are
money to a borrower who agrees to pay it back with shipped through cash deposit by the buyer or bank
interest in a definite period of time. The two types guarantees and particularly by letters of credit and
of bank credit are: the use of drafts.
Secured – Secured credit is backed by collateral,
which is a valuable asset, like your house or car. In 3. Industrial credit. It is intended to finance the needs
the event you fail to repay your debt, the lender of industries like logging, fishing, manufacturing and
may seize your collateral. Secured credit may be others, and which involves big amounts of money.
offered in the form of a mortgage or a home equity Generally speaking, as may be expected, the
loan, for example. maturity of this type of credit is long term.
4. Commercial credit. This type of credit, which is
sometimes termed as mercantile credit, has already
been indicated in a foregoing discussion.

5. Real Estate credit. When credit is purposely for

construction, acquisition, expansion or
improvement of real estate properties, it is termed
as real estate credit. This type of credit was
extended previously by the defunct rehabilitation
finance corporation which was expressly
established to assist in the rehabilitation program of
the government.

According to Maturity

1. Short-term credit. It is payable within one year

from the date of acquisition. This type of credit
usually covers the purchase of consumers’ goods.
The so-called character loan falls under this type.

2. Medium or intermediate term credit. Range from

one year to five years in maturity. This is usually
given for a number or purposes, like the financing
or improvements of a firm or industry.

3. Long-term credit. These are loans with a range of

five years and above before maturity. This type of
credit covers those loans intended for investment
purposes.

CREDIT MANAGER

Credit managers are responsible for overseeing the credit

granting process for a company. Their job is to optimize
company sales and reduce bad debt losses by maintaining
the credit policy. They do this by assessing the
creditworthiness of potential customers and conducting
periodic reviews of existing customers.

What Credit Managers Do

 Evaluate the creditworthiness of potential
customers.
 Create credit scoring models for risk assessments.
 Approve and reject loans based on available data.
 Calculate and set loan interest rates.
 Negotiate the terms of the loan with new clients.
 Ensure all loans and lending procedures comply
with regulations.
 Maintain records of all company loans.
 Monitor loan payments and bad debts.
 Review and update the company’s credit policy.
Chapter II. SOURCES AND BASIS OF CREDIT pawn broking with large amount of donated
wealth in their treasuries.
IMPORTANT SOURCES OF CREDIT - In the Philippines, pawn broking is also one of the
oldest credit institutions and is believed to have
1. Individual Money Lenders been introduced by the Spanish friars when we
- Individual money lender who may lend his surplus were under the Crown of Spain
to those in need so that it will bring some income
to him Monte de Piedad – the oldest saving bank, who
- No collateral is required on the part of borrowers was granted the privilege of lending money against
to secure the loan of whatever sum money pledge of jewelry.
- The money lender may be constrained to collect a 4. Commercial Banks
very high rate of interest over and above the legal - Serves as intermediaries between the Central Bank
one in order to protect his personal interest and and the ultimate money borrowers.
thus become what is known as “loan shark” - Commercial banks are engaged in the grant of
- The unlicensed money-lender, who is often loans not only to businessmen, but also to
referred to as a “loan-shark”, does a thriving individuals for personal purposes.
business in the grant of loans at very exorbitant - In the case of personal loans, borrowers are
rates of interest. required to furnish the bank with the written
- Usurious money-lenders are called as “loan- guarantee of two or more responsible persons
sharks” simply because once they get hold of a that the contract will be faithfully performed.
borrower, they rarely let him go. These lenders - These guarantors of the credit of the borrower are
are not interested in the repayment of the loan called “co-makers”. Legally, they can be held for
but in keeping the borrower continually in debt. principal and interest due, in the event that the
Most of them refuse to accept any payment borrower for whom they acted as guarantors fails
except the full amount, and all of them charge to discharge his obligations incurred with the
exorbitant rates of interest. They find their bank.
customers among those who are ignorant of, or - As a common banking practice, a charge of 6 to
unable to borrow from reputable sources. 12% of the entire loan is deducted in advance to
represent the interest.
2. Retail Store
- It is the biggest source or merchandise credit in Character Loan – no guarantors nor pledges are
the Philippines known as the “sari-sari” store. required. Such loans, usually consisting of small sums of
- This becomes evident when one takes into money, are based upon the character of the borrower.
account the number of such sari-sari stores in This kind of loan is being granted by the PNB.
every barangay of our communities. These stores
- In the case of loans granted by the bank for
cater to the everyday needs of the consumers,
commercial purposes, the borrower may be given
which explains their large numbers.
the amount of applied for and approved in terms
- Retail stores were run by Filipinos and aliens alike,
of cold cash (money available to spend).
although after May 15, 1954, in accordance with
the provisions of the Retail Trade Nationalization
5. Commercial Paper House
law, no alien is permitted to engage in retailing.
- The commercial paper house is a financial
institution that brings together the buyer and
3. Pawnshops
seller of short-term commercial paper that is the
- The present-day pawnshops owe their origin from
lending institution and the borrowing business
the Montes Pietatis which were established by
enterprise.
Franciscans (Friar Minor as they were invariably
- The commercial paper includes notes, banker’s
called then) in Italy.
acceptances, trade acceptances, and foreign
- The term mons referred to any form of capital
exchange bills.
accumulation and pietatis from the Latin “pietas”
- A commercial paper house also buys issues
meaning pious.
outright at a discount and resell the notes at a
- As such, montes pietatis consisted of charitable
slightly higher price to investors. Under such
funds from which loans came from, which were
instance, the commercial paper house assumes
exempted from interest, but secured by pledges.
the risk of loss that may result from sudden
Such loans were granted to the poor.
change in money rates in the market, or even, of
- According to Lien Sheng Yang, a Harvard professor
buying an issue that cannot be sold because
of Chines history, pawnshops are the “oldest
investors shy away from it.
credit institutions in China” whose origin could be
traced to as early as the middle of the six
dynasties when Buddhist monasteries practiced
6. Savings Banks members as stockholders, and using such
- Since savings banks accumulate the small savings accumulations, together with their capital in the
of depositors, such accumulated funds are in turn case of stock corporations, for loans and/ or
invested in bonds or in loans secured by bonds, investments in the securities of productive
real estate mortgages, and other forms of enterprises or in securities of the Government, or
security. any of its political subdivisions, instrumentalities
- In its broadest meaning, the term savings bank
or corporations.
include mortgage banks as well as savings and
Mortgage Loans – this are loans used to
loan associations. Savings and loan associations
purchase a home, land, or other types of real
are established on the principle of cooperation.
estate.
7. Rural Banks
- In the rural areas of the Philippines, rural banks 11. Finance Companies
provide the chief source of credit especially for - As an industry, it shares with government the
those engaged in agriculture who need these universal goal of achieving a strong and healthy
facilities badly. financial system.
- Such types of banks were unknown in this country - Given a conducive regulatory environment,
prior to the enactment of RA 720, known as the finance companies can effectively mobilize
Rural Banks Act. resources needed for productive investments.
- The growth and development of these banks - They have developed into a major source of funds
attest to the pressing need of the people in the for consumer, sales, and commercial financing.
rural areas for loanable funds.
- Undoubtedly, the existence of rural banks in the Finance companies may be divided into three
towns and communities has greatly minimized the categories:
existence of usurious practices of some money
lenders, which has victimized our poor people 1. The instalment sales finance companies –
who cannot avail themselves of the credit facilities discount consumer instalment notes arising
which may be offered by commercial and savings through the sale of merchandise.
bank because of certain requirements imposed by 2. The consumer finance companies – engaged
them. in lending cash directly to the customer
3. Commercial finance companies – which
8. Development Banks through various types of loans serve business
- Like those of rural banks, development banks from and industry
an important part of our banking system
extending the necessary fund for purposes of 12. Credit Unions
hastening development. They have been largely - Credit unions are corporate organizations which
responsible for the birth and development of
lend savings of members to some of the members
certain industries that are now quite common on
of the group.
the Philippine scene.
- However, in order that credit unions can be
successfully operated, they should consist of
9. Investment Banks
- It bridges the gap between those who have idle closely knit, cohesive, natural groups of employees
funds not knowing where to invest them and those with low labour turnover.
in dire need of such funds.
Advantages
- As source of credits, they help raise the needed
funds that are not easily procurable elsewhere for 1. Low cost of operation, ordinarily, the office
use because of the sizeable amounts involved and space for such purpose is donated by the
the length of time for their use. management
- The funds provided by investment banks are
2. Losses are very small in view of the fact that
important not only to entrepreneurs, but to
there exists an intimate relationship among all
government as well, which requires huge
the members of the credit union
expenditures to support the various economic
projects that are part of its program. 3. Rates charged for interest by credit unions are
very much lower than those charged on similar
Examples of Investment banks are: BPI, Rizal loans by commercial lenders.
Commercial Banking Corporation, PNB, BDO 4. Member-borrowers also become entitled to the
10. Savings and Loan Associations receipt of patronage dividends when the same
- It is described as “that corporation engaged in the is distributed by the credit union.
business of accumulating savings of their
13. Insurance Companies score. It will be based on credit reports created by
- The business of insurance companies is to enter credit bureaus.
into insurance contracts with those who wish to
Factors Evaluated During a Credit Appraisal Process
provide for such contingencies as death or fire.
- They receive premiums and pay out money on the A lender’s credit appraisal process will typically check
occurrence of the particular contingencies covered and evaluate the following important factors:
by the contracts.
 Income
- Insurance companies cannot, therefore be
regarded as financial institutions per se, like  Age
banks. They are, however, important participants  Repayment ability
in the money and capital markets because they
must accumulate insurance premiums to build up  Work experience
funds to meet policy claims, and they must  Present and former loans
meanwhile employ these funds in loans and
 Nature of employment
investments.
 Other monthly expenses
Other sources are:
 Future liabilities
GSIS – Government Service Insurance System
 Previous loan records
SSS – Social Security System
 Tax history
IGLF – Industrial Guarantee Loan Fund/
 Financing pattern
Agricultural Guarantee Loan Fund
 Assets owned
Pag-Ibig Fund – intended to boost housing
development in the country THE 5 C’s OF CREDIT
KKK (Kilusang Kabuhayan at Kaunlaran) – 1. Character. It is the most important consideration in
established as a priority program under EO 715 on the proper determination of the credit rating of an
August 6, 1981 is intended to involve the whole
individual. The character of an individual is the
citizenry and calls for the mobilization of the people
aggregate of distinctive mental and moral qualities
to direct their creative energies and resources
belonging to him. It denotes his good moral built up
toward productive participation in development.
by long years of honest dealing. The character of
Confidence is the cornerstone of every credit transaction the borrower indicates his willingness to discharge
– the prime mover of credit economy. his financial obligation, that is, to repay the loan as
BASIS OF CREDIT promised. However, it does not indicate his
probable ability to pay.
CREDIT APPRAISAL
2. Capacity. As a basis of credit, capacity signifies the
Credit appraisal refers to assessing a particular loan ability to pay when a debt is due. It need not be
application or proposal thoroughly to gauge the stated very strongly that no matter how desirous an
repayment ability of the loan applicant. A lender individual may be in discharging his financial
conducts a credit appraisal chiefly to make certain that obligations, however, if he suffers from lack of
the bank gets back the money that it lends to its ability to pay, that is, lack of adequate income, he
customers. will represent and remain a poor credit risk.
One’s capacity in business likewise is
Whether one applies individually or as a corporate circumscribed, among others, by factors relating to
entity, a lender always conducts a detailed and income, that is, the difference between sales and
systematic credit appraisal process. The credit appraisal cost of operation.
process before giving a loan to entities is
comprehensive as it appraises or evaluates 3. Capital. For credit purposes, credit represents the
management, market, technical, and financial elements. financial strength of the risk, that is, it consists of
the amount and quality of goods and property,
Credit Score – It refers to a particular score that is given
expressed in terms of money, which an individual or
to a borrower depending on his or her credit history.
firm possesses over and above, his financial
This score is provided by credit bureaus that will
obligations.
evaluate one’s full repayment behavior and give them a
From the standpoint of mercantile credit, it
may present the firm’s property like equipment,
 building and the like. A bank making loans to businessman, whether he be a seller of goods or
business concerns focuses its attention on the services on credit must have confidence:
financial statement filed by the borrowing concern.
- On the character of the buyer, that is, whether he
4. Collateral. Speaking of collaterals, creditors as a is trustworthy and, as such, represents a good
general rule would prefer loans or credits to be moral risk
backed up by collaterals as much as are necessary - On the capacity of the buyer to enter into a valid
for their self-protection. contract and conduct his business profitability
Thus, collateral must therefore be something of - On the adequacy of the capital possessed by the
value, which can be easily converted into cash, debtor to support the transaction for which credit
deposited as a pledge with a lender to secure the is required
repayment of a loan. If a borrower is unable to - On the fact that the collateral put up by the
discharge the loan obligation when due, the lender debtor is something of value and will not become
is free to sell the collateral and collect the debt from subject to wide and violent fluctuations in the
the proceeds of the sale. The collateral which may market
be required may vary with respect to kind of and - On the soundness of policies of the government of
amount sought to be obtained as a loan and the the country of importation in the case of foreign
term under which the loan is granted. trade
As a common banking practice, the amount of - On the stability of currency
the collateral must be 40% bigger than the amount
of the loan. Such a practice may be explained by the SOURCES OF CREDIT INFORMATION
desire of the bank to protect itself against undue
1. Financial Statements
fluctuations in the market value of the collateral
2. Applicant Information
that may take place during the period of the loan
3. Mercantile agencies
obligation.
4. Credit-rating agencies
Collaterals may partake of various forms, as real
5. CB Credit Information System
estate property, fishpond, or corporate securities
6. Other local sources
like stocks and bonds.
Collateral however cannot and should not be
If a borrower does not meet the minimum
made as substitute for character as a basis of credit.
requirements, then their loan application is generally
rejected, or the credit amount is lowered.
5. Conditions. Economic conditions exert profound
effect upon the grant of loans and credits. It may be How is Credit Appraisal done?
rightly mentioned that loans and credits may be
extended at certain times and may be denied at The process of credit appraisal consists of a set of
other times. steps. Once all steps are completed, the credit is
granted. The steps for credit appraisal are as follows:
6. Country. Since, as had been stated time and again,
1. Credit Processing
the sale of goods and services in any part of the
All applications and required information are
world on credit involves risk, it follows that every
gathered by the bank and processed. The
factor should be carefully considered and
application provided by the customer must
scrutinized insofar as they affect credit risk.
ensure detailing of the reason for credit, and all
information must be authenticated.
7. Currency. Not only is the stability of the country of
2. Approval of Credit
importation an important factor to reckon with in
Once the screening of individual application is
the consideration of credit risk in international
completed and vetted, the credit application is
trade transactions but, equally so is that which
approved by the concerned authorities within
pertains to that of currency. The risk of exchange
the financial institution. The application is
must also be taken into account.
rejected if the process results in poor credit
8. Confidence. After having indicated and discussed appraisal.
the various bases of credit, one is led to conclude 3. Documentation
that, in the ultimate analysis, credit is found on Post the approval of credit; all necessary
confidence – which by far is the principal C of documents are carefully documented in an
credit. For any credit transaction to take place, the orderly fashion. This ensures that the files are
 documented appropriately and are available at Parameters in Credit Appraisal Process
a moment’s notice.
4. Administration 1. Technical Feasibility. This is where the bank
The final step of the credit process is to ensure checks the living conditions and the standard of
that financial institutions are correctly living of the borrower, which is as essential factor
administering their credit portfolios, including that will help decide whether the individual is
writing out paper loan agreements, renewal creditworthy or not. The application is rejected if
letters sent out in a timely fashion, and ensuring the borrower has a poor credit score.
records are up to date. Most large organisations
have a dedicated administration department 2. Economic Viability. This is where factors such as
that keeps the administration in check. LTV and FIOR are taken into consideration, and
the borrower’s credit history is checked to ensure
Eligibility for Credit Appraisal
that the individual will be able to return the funds
For an individual to be eligible for appraisal, that were provided as credit.
there are specific criteria which they must meet:
3. Bankability. This step consists of steps like a credit
Instalment to Income Ratio
interview to determine the borrower’s
- This ratio is calculated to check how much of the
creditworthiness, and the individual’s profile is
borrower’s monthly income can be used to pay off
scanned, including information on valuable assets
loan instalments. Generally, this ratio lies
that can be used as collateral.
somewhere between 33-40%.

Fixed Obligation to Income Ratio LENDING OPERATION

- This ratio is used to calculate the regularity of
payments by the customer to pay off past and Lending (also known as “financing”) occurs
existing debts. Depending on this percentage, the when someone allows another person to borrow
loan amount provided to the customer is decided. something. Money, property, or another asset is given
by the lender to the borrower, with the expectation
Loan to Cost Ratio that the borrower will either return the asset or repay
- This ratio is calculated to check the amount that the lender. In other words, the lender gives a loan,
the borrower can pay on the basis of the total which creates a debt that the borrower must settle.
amount of the loan requested. In other words, this
ratio calculates the maximum amount that can be How Lending works?
lent to the customer.
- Lending occurs whenever a lender gives
Benefits of Credit Appraisal something to a borrower on credit. It is a broad
term that encapsulates many different kinds of
The benefits of performing pre-sanction
transactions.
appraisal for financial institutions are as follows:
- Common lenders include financial institutions,
Risk Analysis such as banks and credit unions that build a
- It helps banks to calculate the amount of risk business model around lending money. The
involved in lending money to borrowers. The borrower pays a price for taking out the loan in
lower the risk, the more ready banks are to lend the form of interest. If the lender feels that there
money to individuals. is a higher risk of not being paid back by a
borrower, they will charge that borrower a higher
Confidence among Banks
interest rate. Hence, lower-risk borrowers pay
- Since the creditworthiness of an individual has
lower interest rates.
been determined, it provides a sense of security to
- Lenders have a different kind of risk from business
bankers that the instalments will be paid by the
owners/ shareholders. They also have different
borrower.
rights if the company goes bankrupt. A business
Helps Determine Loan Amount being liquidated must pay lenders back before the
- Depending on the creditworthiness of an owners receive any money.
individual, the amount that can be lent as loan is - Lending can be of two types: Personal lending and
decided, which can be repaid by the borrower and business lending
not put the banks at a financial loss.
Uses of Loans
 Loans to even out cash flow (working capital)
  Commercial and industrial loans for short-term the annuity regardless of how well the annuity’s
needs investments perform.
 Asset financing for equipment and machinery  All repayments are of equal amount
or vehicles throughout the loan period.
 Mortgages  If the reference rate rises, the loan period is
 Credit card financing extended; if the reference rate falls, the loan
 Vendor financing from suppliers period shortens. The repayment is always at
 Business start-up capital least equal to the amount of interest.
 Finance disaster recovery measures  If the interest rate level is very low at the
time you draw down the loan, a rise in the
As you shop around for either a personal or interest rate may extend the loan period
business loan, consider the following factors: unreasonably, hindering the amortisation of
1. The amount of money you want to borrow, which the loan. In such an event you should contact
will influence the type of lender that you need the bank and agree on a new repayment loan.
2. Any business assets you can pledge as collateral
for the loan which will help improve the terms of 4. Bullet Repayment. It is a lump sum payment
the loan made for the entirety of an outstanding loan
3. What you want to do with the loan which could amount, usually at maturity.
affect the type of loan you should seek
4. Whether you need a start-up loan to start a CODE OF ETHICS FOR THE EXCHANGE OF CREDIT
business or an expansion loan to help grow an INFORMATION
existing business
Credit Information System Act
5. How long will you need the money, which will
affect the type of loan and lender that best fits
Section 1. Declaration of Policy. – The State recognizes
your needs
the need to establish a comprehensive and centralized
credit information system for the collection and
METHODS OF PAYMENT dissemination of fair and accurate information relevant
to, or arising from, credit and credit-related activities of
1. Equal payments. This is a good option if you want
all entities participating in the financial system.
to know exactly when the loan period ends and if
your repayment ability allows a possible rise in the Section 6. Confidentiality of Credit Information. – The
interest rate level. Corporation, the submitting entities, the accessing
 The repayments (instalment + interest) are of entities, the outsource entities, the special accessing
equal size at the beginning of the loan period. entities and the duly authorized non-accessing entities
 The repayment only changes if the interest shall hold the credit information under strict
rate changes. confidentiality and shall use the same only for the
 Initially, the proportion of the instalment is declared purpose of establishing the creditworthiness of
small, but it increases during the loan period the borrower. Outsource entities, which may process
as the proportion of interest decreases. and consolidate basic credit data, are absolutely
prohibited from releasing such data received from the
2. Equal instalments. Equal instalment is a good Corporation other than to the Corporation.
choice if you want to make larger payments at the The accreditation of an accessing entity, a
beginning. special accessing entity and/or an outsource entity
 The instalment is always the same, but the which violates the confidentiality of, or which misuse,
repayment amount varies in accordance with the credit information accessed from the Corporation,
the interest: if the reference rate rises, the may be suspended or revoked. Any entity which violates
repayment increases; if the reference rate this Section may be barred access to the credit
decreases, the repayment decreases. information system and penalized pursuant to Section
 If the interest rate remains the same, the 11 of this act.
proportion of interest decreases as the loan
principal decreases. Code of ethics for the exchange of credit information
between banks
3. Fixed annuity loan. Fixed annuity loans are Article 1: There are two cardinal principles in the
annuities that pay a fixed amount for the life of exchange of credit information: confidentiality and
accuracy of inquiries and replies. This includes the
identity of inquirers and sources which cannot be
disclosed without their permission. 5. Conscientiousness
- He must be devoted and dedicated to his job.
Article 2: Each inquiry should specifically indicate its - The credit man must serve as a catalyst of the
purpose and the amount involved. members of the credit team and with the other
Article 3: Responses should be prompt and disclose unit of the company.
sufficient material facts commensurate with the
purpose and amount of the inquiry. 6. Consistency
- He must be consistent in making credit decisions.
Article 4: It is not permissible when soliciting an account - He must have a consistent performance which is
to make an inquiry to a competitor without frankly consistent with the company’s goals and
disclosing that the subject of the inquiry is a prospect. objectives.
Reply is at the discretion of the bank of account. - He must unnecessarily deviate, nor completely
Article 5: A request for information based on existing or veer away from policies and guidelines to
intended litigation shall be clearly identified as such. accommodate friendships and other personal
considerations.
Article 6: All credit correspondence, including form
letters, should bear the manual signature of a 7. Certitude and Celerity
responsible party. - He must not only act with certainty and accuracy
but also with swiftness and speed.
Article 7: The sharing of credit information on a mutual
customer should not be more frequently than annually,
8. Contact
unless a significant change in the relationship requires
- He must have good public relations both within
an earlier revision.
and outside the business organization.
CARDINAL C’S OF CREDIT PERSONNEL
9. Cost-consciousness
1. Competence and Capability - He must focus on minimizing cost and
- He must be aware of institutional viewpoints and maximization of profit.
correspondingly acts in behalf of the institution as
10. Character
a whole.
- He must have character, honesty, integrity, and
- He should know and understand the goals,
reliability.
objectives, and policies of the company; of the
other department in the business organization; of
11. Confidence
his own department which is credit.
- Credit is said to be based primarily on trust and
confidence.
2. Communication
- He must have the ability to effectively convey his
12. Computer Literate
ideas, and this includes not only the preparation
- He must have some basic knowledge of computers
of reports and correspondence but also the
and the in and out of information technology.
delegation of duties and the corresponding
authority to subordinate.
13. Congeniality
- He must be cool, calm, and deliberate, but
3. Constructiveness
certainly must be firm and uncompromising.
- He must be positive and constructive in his
approach to both credit and collection
14. Considerateness
management.
- He must realize that he is dealing with human
- In the dispensation of credit , he must find a way
beings and therefore must have regard for other’s
by which credit can be granted and in the process
feelings.
free himself of the negative image concerned with
finding a way by which credit should be denied. 15. Common sense
- In credit and collection and in any field of
4. Creativity
endeavour for that matter, it is a must.
- He must keep pace with the changing times and
changing conditions.
- He must constantly pursue creative answers to
new questions.
Chapter III. SERVICING LOANS THE LOANS AND DISCOUNTS DEPARTMENT

Servicers are paid a proportion of the loans’ Loans and discounts are amounts extended to
outstanding balances. Depending on the size of the persons needing capital or for some other purposes.
loan, whether it is secured by commercial or residential The difference lies in the fact that loans are advances on
real estate and the degree of service needed, the which interest is collected at maturity while discounts
charge rate might range from one to forty-four basis are advances on which interest is deducted in advance.
points.
 The loan and discount department or the Credit
What is Servicing Loans? department has a specialized task such as
processing of loan applications, credit
It refers to the administrative aspects of a loan
investigation, preparation of the credit
from the time the proceeds are dispersed to the
investigation report, loan release, follow-up and
borrower until the loan is paid off.
collection of loans, and other credit activities.
Loan servicing includes sending monthly  This department has been singled out as one of
payment statements, collecting monthly payments, the banks’ training grounds for it is here that bank
maintaining records of payments and balances, personnel get well-rounded inkling on important
remitting funds to the note holder, and following up any bank functions. It is in this department that loan
delinquencies. investigators and loan officers get in constant
touch with customers of practically all walks of
How Loan Servicing Works? life, as evidenced by the types of loans granted.

TYPES OF LOANS SERVICED BY BANKS

Bank loans come in many shape and sizes and
deciding what type of loan you need is a little
overwhelming. Banks lend money to individuals and
businesses to purchase homes, businesses and cars, and
to pay for college. Loan types include fixed rate, variable
rate, instalment, secured, unsecured and convertible.
Each type of loan has unique repayment terms, and
understanding those terms can make choosing the right
loan easier.

Fixed Rate Loans

Fixed rate loans are among the most consumer loans.
Loan servicing is the process that a company, Fixed rate loans keep the same interest rate throughout
known as the loan servicer goes through to collect the life of the loan. The interest rate on fixed-rate loans
payments, interest, and escrow (if needed) from may be slightly higher in most cases than a variable rate
borrowers of loans. It can be carried out by the bank or loan.
financial institution that issued the loans, a non-bank
entity specializing in loan servicing, or a third-party Variable Rate Loans
vendor for the lending institution. Variable rate loans have interest rates that fluctuate
depending on the market rate or “prime rate”. With a
Loan Servicers vs. Lenders
variable interest rate, the amount you pay on your
LOAN SERVICER LENDER home loan, car loan or student loan can vary each
Manages the daily aspects Approves, funds, and month. Variable interest rates are usually lower than
of the loan disburse loans fixed rates, which make them attractive to first-time
homebuyers or those wishing to refinance a loan.
Either the lender or a Can service the loan, but
third-party company the usually hires a third-party Instalment Loans
lender hires An instalment loan is one that is repaid in equal
Sends monthly billing Receives monthly amounts over a certain period of time. Repayment
statements and collects payments from the periods for instalment loans can range from six months
payments servicer to 30 years. Instalment loans have very specific
repayment terms, including a starting date, an ending
date, and the amount of interest you will pay over the  Promote or provide financial counselling as needed
life of the loan.  Report to committee meetings
 Implement internal controls recommended by the
Secured Loans
board of directors and/or supervisory committee
A secured loan is one backed up by collateral, such as a
house or a car. The most common secured loans are Internal Controls
home mortgages, home equity loans, auto loans, boat  Committee members should sign the minutes of
loans, and business loans. each meeting to provide a comparison with the
Unsecured Loans signatures appearing on approved applications; it
also identifies the original minutes
Unsecured loans require no collateral. These loans are  Your credit committee secretary should draw a
usually offered to individuals with very good credit double line after the last entry on each side of the
scores. The interest rates for unsecured loans are minutes form and a diagonal “X” on the unused
typically very high and usually correspond to a person’s portion of the last page as a precaution against any
credit score; the higher the credit rating, the better the unauthorized insertions
interest rate. Examples of unsecured loans include bank  Any unusual transactions such as extension
credit cards or other personal lines of credit. agreements and requests for release of collateral
Convertible Rate Loans should be carefully documented
 No one in your credit union or on your committee
Convertible rate loans can be changed from one type of
should be able to disburse funds in advance of loan
loan to another throughout the life of the loan.
approval
Convertible rate loans are usually home mortgages that
 Credit committee members and loan officers who
begin as a variable rate and then change to a fixed rate
approve loans should not be able to disburse the
after a period of time. Small business owners often use
funds or collect the payments
convertible loans for start-up costs and then convert the
 The board of directors, being ultimately responsible
business loan to a fixed-rate secured loan.
for the credit union’s safety and soundness, should
THE CREDIT COMMITTEE review the credit committee’s actions, as well as the
loan portfolio, delinquency report and charge-offs,
A credit committee is the lending or management at least monthly
committee of a bank or other lending institution. It  Credit committee members should test the
generally consists of upper-level officers with authenticity of loan applications by periodically
management authority. The loan committee analyses contacting loan applicants and borrowers at
and subsequently approves or rejects any loan that the random to discuss member satisfaction with service
initial loan officer does not have the authority to and indirectly confirm identities and application
approve, typically those of large sizes or higher risk. The
LOAN APPROVAL AND DISBURSEMENT PROCESS
committee ensures that the loan meets the institution’s
standard lending policy. If it does, the committee can
Not all banks are created equal, but many of
agree to fund and disburse the loan with a binding
them focus on the same areas throughout the loan
commitment.
review process. In the process of granting of loans, the
General Duties and Responsibilities most fundamental characteristics most prospective
lenders will concentrate on include:
 Approve or disapprove all member requests for
1. Credit History
credit
2. Cash flow history and projections for the business
 Rule on each application solely on the basis of a
3. Collateral available to secure the loan
member’s creditworthiness
4. Character
 Grant sound loans protecting the overall financial
5. Myriad pieces of loan documentation that
stability of the credit union
includes business and personal financial
 Regularly review loan policies
statements
 Recommend changes in policy, procedures, and
underwriting guidelines to the board of directors Procedures for Loan Application and Processing
 Regularly analyse loan portfolio
1. Application. The applicant approaches the officer
 Ensure compliance with state and federal laws and
concerned and signifies his intention to borrow.
regulations
An application form is given containing questions
 Serve as a court of appeals for members who
which the prospective borrower should answer
dispute their loan decision
 truthfully as this will be used to gauge his department to service these particular activities of
character, capacity, and capital. The applicant the bank.
shall submit the duly accomplished from and the
LOAN MONITORING
necessary documents like ITR’s, sketches,
photographs, and other supporting papers. Loan monitoring do just what the name says –
monitoring credit. They track the credit history shown
2. Interview. Upon submission, the bank officer will on credit report, and then alert the borrower of changes
interview the applicant. If properties are used to via email, text or call.
secure the loan, the site will be inspected to The exact activity reported by a credit
determine its worth. monitoring service varies by provider, but it may include
the following:
3. Credit Investigation. After the interview and  Hard inquiries on your credit report, such as
ocular inspection of the properties, the officer someone applying for credit in your name
known as the credit investigator then performs an  New accounts opened in your name
investigation to ascertain the credit risk. In this
 Balances and payments
step, the information gathered are analysed and
filed for further updates.  New address or name changes to the credit file
 Public records such as bankruptcies
4. Deliberation of Credit Report. A formalized report  Personal information such as your social
known as the Credit Investigation Report is then security number, email address, and passwords
forwarded to the loan officer or committee who
Limitations of Loan Monitoring
will finally deliberate on the report.
 Stop someone from applying for credit and
opening new accounts in your name
5. Recommendation to the Board. After a thorough
 Keeping information safe from data breaches
deliberation of the report, the loan officer or
committee then sends its recommendation to the  Prevent credit card from being skimmed
board of directors.  Notify you if someone withdraws money from
your bank account
6. Approval. If everything is in order, the board or  Stop phishing email
the president, as the case may be, will approve  Report fraud
the loan as evaluated. The same amount applied  Fix credit report errors
for or a slashed amount may be the final verdict. If  Freeze credit
something else must have to be done, the loan
officer will appraise the applicant before sending
the papers for approval. If the bank finds itself in a
position where its interest is jeopardized, then the
board or the president will tactfully disapprove
the loan.

7. Release of Proceeds. In the event of approval, the

cheque is prepared and then given to the
customer. That is, if he wishes to get the proceeds
in cash. If the proceeds are to be transferred to a
current account, proper entries are made to
signify the transfer of funds placed at the disposal
of the borrower-turned-depositor.

8. Follow-up and Collection. A systematic procedure

for follow-up and collection is adopted; for it is
only when loans are collected that the bank could
boast realized success. Moreover, the matter of
extension or renewals should the debtors find
themselves incapable to meet the scheduled
payments form part of loan processing. Cursory
evaluation may also be necessary to allow
extensions or renewals. Perhaps, adjustments on
the loan may also occur during the life of the loan.
In any case, it is the task of the Loan and discount
Chapter IV. CREDIT INSTRUMENTS Bonds are promises to pay the principal as well as
the interest to the holder at a certain specified time
Credit plays a significant role in modern business indicated on the face of the instrument.
and that part is represented by credit instruments. They represent as indebtedness on the part of the
These are written, printed or typed financial documents issuing corporation. In the issue, the corporation is
that serve either as promises to pay or as orders to pay. called the bond issuer or the debtor; the bondholder is
They provide the means by which funds are transferred the creditor. The corporation has the obligation to
from one party to another. honour its commitment to the bondholder redeeming
the bond issued when it measures, to pay the principal
What is a Credit Instrument? as well as interest earned.

- A credit instrument is a promissory note or other

Kinds of Bonds
written evidence of a debt.
- It is any agreement, oral or written,  Government bond. It is a debt security issued by a
acknowledging an obligation to pay a sum or sums government to support government spending and
of money to a bearer or order on demand, or at obligations.
any future time or times.  Municipal bond. Municipal bonds (munis) are
- This document gives evidence to a credit debt securities issued by state and local
obligation resulting from the past transaction governments. These can be thought of as loans
which sets forth the responsibility of the debtor to that investors make to local governments, and are
his creditor. used to fund public works such as parks, libraries,
bridges and roads, and other infrastructure.
Characteristics of Credit Instruments  Corporate bond. A corporate bond is a type of
debt security that is issued by a firm and sold to
1. Payable to bearer. When the instrument does not investors. The company gets the capital it needs
specify the Payee’s name. and in return the investor is paid a pre-
2. Payable order. When the instrument specifies the established number of interest payments at
payee’s name. either a fixed or variable interest rate.
3. Payable on demand. Instruments with the current  Savings bond. Savings bonds are a type of debt
dates, like open check. security issued by the U.S. government. Unlike
4. Payable at a future time. An instrument with a typical bonds that pay interest regularly, a savings
future time. bond is a zero-coupon bond, meaning it pays
interest only when it is redeemed by the owner.
Functions of Credit Instruments The bond is also non-transferable, so it can’t be
1. Written documents make claims enforceable. sold to someone else, which distinguishes it from
The credit instrument enables the creditor to more typical bonds.
hold the host instrument to collect from his  Treasury bond. Treasury bonds are debt securities
debtor. The debtor on the other hand is issued by the government. Essentially, you're
protected of his rights with respect to the loaning money to the government by purchasing a
amount of the obligation, interest, and bond at a predetermined interest rate. In turn, the
maturity date. government will pay you a fixed interest rate for a
2. Credit instruments facilitate exchange set duration of time.
transactions.
3. Credit instruments minimise disputes among Advantages of Bonds
the contracting parties. Such instruments define a. It represents a safe form of investment, that the
the extent of the obligations and claims of company must honour its obligation of paying
debtors and creditors. its indebtedness to the bondholder upon
maturity regardless of whether it is losing or
Credit instrument can be classified as investment making profits.
credit instruments and commercial credit instruments. b. It can be used as collateral to support loans
sought by the bondholder from financial
INVESTMENT CREDIT INSTRUMENTS institutions.
c. Transfer to another holder is easily done by
Investment credit instruments are those which earn mere endorsement and delivery of the
income in the form of dividends or interest. These instrument.
include stocks and bonds.
 Stocks are permanent invested capital of a January 3, 2023
corporation contributed by the owners (stockholders)
I promise to pay RAQUEL
which are evidenced by certificates. FERNANDEZ, sum of fifty thousand Pesos
It represents the stockholder’s right to a certain (Php 50,000), on April 4, 2023.
portion of the assets of a corporation upon liquidation
and certain shares of the profits after prior claims have Sgd. SELENA GOMEZ
been paid.
Stocks are transferable to third parties in such way Two-name note. Another party is presented
that the holder, may in normal times, obtain immediate known as the co-maker. The co-maker serve as the
cash through the sale of the said stock. guarantor and thereby assumes a joint liability
with the maker.
Kinds of Stocks
January 3, 2023
Common stocks are with voting right. One share is I promise to pay RAQUEL
equivalent to one vote. The common stockholder FERNANDEZ, sum of fifty thousand Pesos
receives portion of the corporate income which remains (Php 50,000), on April 4, 2023.
after all other claimants have been satisfied.
Sgd. SELENA GOMEZ
Preferred stocks are given preference to assets,
Sgd. HAILEY BIEBER
dividends declarations of payments. They have right to (Co-maker)
a fixed dividend higher than common shares, and
secondary to the interest on all classes of bonds and
ORDERS TO PAY
notes.
3. Cheques
COMMERCIAL CREDIT INSTRUMENTS - A cheque is the most common instrument of
credit and almost works like money.
Commercial credit instruments are substitutes for - It is a financial document that directs a bank to
money on a business transaction. These are promissory transfer money from one account to another.
note, checks, bill of exchange, bank draft and bank - There are three parties involved in the processing
deposits. of a cheque: the drawer, who issues the cheque
and holds the bank account; the drawee, which is
PROMISE TO PAY the financial institution; and the payee, who is the
1. Open Book Account - gives the implied verbal person whose name appears on the cheque and
promise of the debtor when he buys consumable will receive the funds.
goods on credit. The creditor enters this ledger to - No bank ordinarily refuses to pay money for a
show the existence of the credit transaction. cheque, provided it is correctly filled in, and there
is enough money in the drawer’s account with the
2. Promissory Note bank.
- The simplest form of a credit instrument is the
promissory note. A promissory note (or pro-note Kinds of Cheques
for short) is a written promise from a buyer or a  Bearer Cheque. Any one, who happens to have
borrower to pay a certain sum of money to the the cheque, can get it cashed. In this case, the
creditor or his order. bank need not worry as to who presents it at the
- The payee is the party to whom payment is due or counter. If a bearer cheque is lost, the finder can
promise to pay is given. The maker is the issuer of cash it unless the bank is notified in time to stop
the note, party making the promise to pay. the payment. The drawer runs the risk of losing
- A note can be single-named or two-named his money, and not the bank.
instrument.
- It is composed of: it is a promise to pay, definite  Order Cheque. The word “bearer” after the
sum of money, and settlement date. payee’s name is crossed out, as in the cheque
form below, and the word “order” written
Single-name note. The maker makes a sole instead. It is a safer form of payment, because
promise to pay. 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 lose your check during the trip, the original
payment as it cannot be cashed at the bank issuer can cancel it and provide a replacement to
counter. A crossed check is any check that is pick up at a local bank or travel agency abroad.
crossed with two parallel lines, either across the It uses a Dual Signature System which
whole check or through the top left-hand corner prevents anyone other than the purchaser from
of the check. This double-line notation signifies using them.
that the check may only be deposited directly
into a bank account. Therefore, such checks  Self Cheque. A self-cheque is drawn when the
cannot be immediately cashed by a bank or by drawer wishes to draw money from the bank in
any other credit institution. cash for his use. This cheque can only be
encashed in the account holder’s or the
 Open Cheque. An uncrossed or open cheque is a drawer’s bank.
type of cheque that is payable to the person A self cheque must be used carefully
presenting it to the drawee. because if it is lost, another person may easily
The drawee of an open cheque can transfer get it encashed by visiting the drawer’s bank.
the cheque to another person by writing their
name on the cheque, making them the next  Stale Cheque. Stale cheques are those that have
drawee. passed their life as a valid form of payment. This
The word “open” should not be crossed out life only lasts up to 6-months from the date of
on open cheques, and the drawer must sign both issue.
the front and back of the cheque. If these When a cheque goes stale, your financial
institution will no longer honour it. This means if
requirements are not met, the bank may refuse
you want to get the funds owed to you, you will
to pay the cheque.
need to contact the cheque writer to get a
replacement cheque.
 Post-dated Cheque. A post dated check is a
check on which the issuer has stated a date
 Banker’s Cheque. A banker’s cheque is a
later than the current date. It is used when
cheque issued by the bank on behalf of the
the issuer wants to delay payment to the
account holder in order to make payment of a
recipient, while the recipient may accept it
specified sum, by order, to another person
simply because the check represents a firm
within the same city.
date on which it will be able to deposit the
It is valid only for three months from the
check.
date of issue, but if needed, can be re-validated
This situation represents a risk to the check
upon filling certain legal obligations.
recipient, since the passage of time may result
in there being no cash left in the issuer's bank  Blank Cheque. It means an unlimited offer
account to be used to pay the amount listed because the signature is put, whereas the space
on the check when it is eventually presented for the amount is left blank to be filled in by the
to the bank for payment. drawee.
A post dated check is also used when the
recipient requires the issuer to hand over a Advantages of Cheques
set of post dated checks to cover a series of  It is more secure and convenient to carry a
future payments, which the recipient agrees cheque than cash.
to cash on the specified dates.  It is a negotiable document that may be
endorsed in favor of a third party.
 Traveller’s Cheque. A traveller’s cheque is a  Payment through cheques serve as official
once-popular but now largely outmoded receipt for business transactions.
medium of exchange utilized as an alternative  If misplaced, it can be quickly tracked.
to hard currency and intended to aid tourists.
Disadvantages of Cheques
The product is typically used by people on
 Since cheques are not considered legal tender,
vacation in foreign countries. It offers a safe way
payments made with them may occasionally be
to travel overseas without the risks associated
rejected.
with losing cash. The issuing party, usually a
 Cheques cannot be used by someone without a
bank, provides security against lost or stolen
bank account.
checks.
 You must visit the bank to deposit a cheque into
Each traveller’s check has a unique serial
your bank account, which is time-consuming.
number for insurance against theft or loss. If you
 4. Bills of Exchange one person to another in such manner as to constitute
- A bill of exchange is a written order binding one the transferee the holder thereof.
party to pay a fixed sum of money to another  If payable to bearer, it is negotiated by delivery;
party on demand or at some point in the future. If an instrument is payable to bearer, it is
- A bill of exchange transaction can involve up to negotiated by mere delivery, but it may, if
three parties. The drawee is the party that pays desired be endorsed.
the sum specified by the bill of exchange. The  If payable to order, it is negotiated by the
payee is the one who receives that sum. The endorsement of the holder and completed by
drawer is the party that obliges the drawee to pay delivery.
the payee. The drawer and the payee are the
same entity unless the drawer transfers the bill of Negotiability – It is the quality possessed by a credit
exchange to a third-party payee. instrument of value that permits legal title to it, to be
- The bill is drawn by the drawer (creditor) and sent transferred to one person to another by mere delivery
to the drawee (debtor) for acceptance. The bill is or endorsement.
accepted when the drawee puts his signature on
the bill. The requisites are:
1. It must be in writing.
- The difference between a promissory note and a
2. It must be signed by the maker or drawer.
bill of exchange is that a promissory note is drawn 3. It must contain an unconditional promise or
by a debtor and accepted by his bank, whereas a order to pay a sum certain in money.
bill of exchange is drawn by a creditor and is 4. It must be payable on demand or at a fixed
accepted by the debtor. determinable time.
5. It must be payable to order or bearer.
Types of Bills of Exchange 6. Where the instrument is addressed to a
drawee, he must be named therein or indicated
Bank Draft. If a bill of exchange is issued by a with reasonable certainty.
bank. The issuing bank guarantees payment on 7. If however, the name of the payee is misspelled
the transaction. or is erroneously written, the endorser may
endorse it in the same manner as it was written
Trade Draft. If bills of exchange are issued by but must include below the endorsement his
individuals. real name

Sight Draft. If the funds are to be paid Endorsement - is the signing usually at the back of a
immediately or on-demand. In international negotiable instrument in order to guarantee or
trade, a sight draft allows an exporter to hold title establish transfer of legal title over property right.
to the exported goods until the importer takes
delivery and immediately pays for them. 1. Blank endorsement is the signing of the
instrument without specifying the evidence.
Time Draft. If the funds are to be paid at a set
2. Special endorsement is one where the
date in the future. A time draft gives the importer
endorser specifies the person to whom or to
a short amount of time to pay the exporter for
whose order the instrument is to be payable.
the goods after receiving them.
3. Restrictive endorsement is one where the
transfer of the possession of an instrument is
Other Credit Instruments include Money Market
for a certain purpose such as:
Instruments such as:
a. To prohibit further negotiation of
1. Commercial paper
the instrument
2. Certificates of Deposits
b. To constitute the endorsee to be the
3. Treasure Bills
agent of the endorser
4. Banker’s Acceptances
c. To vest the title in the endorsee in
5. Letters of Credit
trust for or to the use of some other
6. Interbank Loans
persons
7. Repurchase Agreements
4. Qualified endorsement is one that limits or
8. Bank deposits
qualifies the liability of the endorser, and is
HOW CREDIT INSTRUMENTS ARE NEGOTIATED affected by writing the words "without
recourse" or "at the risk of the endorser".
The Negotiable Instrument Law states that an 5. Unconditional endorsement is one where the
instrument is negotiated when it is transferred from payment of the instrument depends on the
 happening of condition specified on the
instrument.

Presentment – is the act of offering at the proper

time and place a note, a bill of exchange or the like
for acceptance, payment or discharge of liability on
any credit instrument.

Dishonour – refers to the non-payment or non-

acceptance of the credit instrument by the party on
whom it is drawn.

Protest – is the file in writing if upon presentment, a

credit instrument is dishonoured.

Acceptance-Supra Protest – refers to an agreement

to pay a protested note, draft or any other credit
instrument by a person other than the debtor.

Accommodation Phase – refers to a promissory note

that has been endorsed by one or more persons in
order that one who originally made that note may
obtain credit at a financial institution, usually a bank.
Chapter V. BILLING AND COLLECTION
4. First Collection Phone Call
CREDIT AND COLLECTION POLICY 7-10 days after Follow the overdue notices with a
second overdue phone call to find out if there is a
A collection policy is the set of procedures a notice is sent reason for non-payment. For
company uses to ensure payment of accounts out/ 27 + days example, the customer may be
receivables. after the invoice dissatisfied with your product or
The purpose of having a collections policy in place is due date service, or may be experiencing
cash flow problems. Be
simple – to protect accounts receivable. Efficiently
courteous, but also get a
collecting payment on current accounts receivable and commitment to pay. Be prepared
past-due accounts while maintaining positive customer to handle excuses.
relationships is the main goal of the collections
department. 5. First collection letter
The Collection process begins when an account first Immediately Keep the tone of this letter
becomes past due. The process needs to continue until after the first consistent with the first phone
payment is collected, turned over to a third-party collection phone call – courteous, but direct.
collections agency, or written off as bad debt. call/ 28+ days Confirm in writing what was said
The policy should include account prioritization and after the invoice in the call, and remind the debtor
due date of his or her promise to pay
clearly defined timeframes for contacting customers
and escalating issues, collections strategies to be used,
6. Second collection phone call
and tone and behavior to be exhibited throughout
10 days after the The account is now 30-40 days
interactions with customers and internal departments.
first collection past due. Be polite yet firm, and
Collection Strategies – Policy and Procedures letter has been ask for full immediate payment.
sent/ 38+ days Work to resolve payment
after the invoice problems. If the debtor cannot
A. Contact Customers
due date pay immediately, get him or her
1. Customer Satisfaction Phone Call to commit to a payment date.

1-3 days after Dissatisfied customers are 7. Second collection letter

delivery, but more likely to pay late. These 10 days after Now is the time to communicate
before past due friendly calls let you inquire payment is the seriousness of the
about your performance to expected from delinquency. This letter should
ensure you met your previous demand immediate payment, and
customers’ needs. End these collection phone discuss the short-term
calls by mentioning that a bill call/ 50+ days consequences of failure to pay.
will be arriving shortly, and after the invoice Send this letter – and any
reinforce its due date. due date correspondence that follows – via
certified mail or overnight mail to
2. First Overdue Notice give you a record that it was
received.
1-10 days past This is a friendly reminder that
due the due date has passed. You
8. Third collection phone call
are assuming that the client
has forgotten, neglected, or 15 days after While remaining polite and calm,
lost the bill and will pay with a second collection stress the seriousness of the
gentle prodding. One common letter is sent situation. Use this phone call to
method is to send a duplicate out/65+ days explain that this is the last
invoice with “past due” after the invoice opportunity for the customer to
stamped on it. due date pay before you turn the matter
over to a collection agency and
3. Second Overdue Notice possibly take further legal action.
Be sure to communicate the
10-15 days after Another mild nudge reminds benefits of resolving the issue –
first overdue the customer that the account maintaining good relations or
notice was sent/ needs attention. This can be a good credit. As with the previous
20+ days after short form letter with a phone call, get the debtor to
the invoice due duplicate invoice attached. promise to pay by a certain date.
date Keep it friendly and non-
threatening. 9. Final collection letter
 other hand, a company with tighter profit margins
7 days after The tone is now stern and would likely be more risk averse and may set forth in
third collection demanding. Use this letter to their collections policy the transfer of past-due accounts
phone call/ 72+ confirm what was agreed upon
to a collections agency at a designated number of days
days after the in the last call and demand
invoice due payment. State that if payment past due.
date is not received by the agreed-
upon date, you will turn the D. When to Write Off Bad Debt
account over to a collection If it has been determined by the collections team, in
agency. congruence with the collections policy, that the debt
has become worthless (because it can’t be collected),
10. Turn over to collection agency then it can be written off. Writing it off means adjusting
your books by removing it from the accounts receivable
If payment has The account is now 90+ days in balance so that it is not represented in the total amount
not been arrears and may require of your current accounts.
received by 10- professional assistance.
15 days after Receiving a letter from a GENERAL STEPS TO EFFECTIVE COLLECTION
the final collection agency often
collection letter motivates a debtor to pay, but 1) Notify your customers
is sent/90+ days these services can be costly – 2) Confirm
after the invoice agencies typically take from a 3) Remind your customers
due date quarter to a half of what they 4) Inquire
collect. Instead of immediately 5) Increase the pressure
turning the account over to a 6) Escalate the account
collection agency, you might
want to enlist your attorney to WHY IS IT IMPORTANT TO HAVE A CREDIT AND
make a quick phone call to the
COLLECTION POLICY IN PLACE
debtor – this can often
motivate payment. Along with cash and inventory, accounts receivables
is one of the most important short-term assets a
B. How to Handle Disputes company has. The more predictability and effectively
A comprehensive collections policy should include you can convert your Accounts receivable the healthier
guidelines on how disputes and deductions should be your cash flow will be.
handled. Before initial contact with a customer, the
By having a formalized plan that your employees
collections professional should ensure that any internal
follow and by documenting all steps and
issues are cleared up. These might include unapplied
communications along the way, your team will be much
checks, unused credits, or any special terms offered by
more consistent, effective, and efficient in collecting
the sales representative but not applied to the account.
outstanding A/R.
If a dispute arises during interactions with the
customer, handle it quickly to avoid slowing down the A well written and comprehensive credit and Collection
receivables process. For example, if you wait a week to policy will:
send the customer a corrected bill, you’ve just put off
getting paid by a week.  Ensure continuity in the department in the
event that key personnel leave the credit
C. When to Send Accounts to Collections Agencies department
When all internal means of collecting on a past-due  Help assure all customers are treated fairly
account have been exhausted, some companies choose  Ensure consistent credit decisions are being
to turn the delinquent account over to a third-party made
collections agency. A collections agency is a company  Be used as a training tool for new sales
used to recover funds that are past due or from associates and the credit and collections team
accounts that are in default. This step in a collections  Be used to ensure consistency of procedure and
process usually occurs when the account is 60 or more execution between the credit department,
days past due. sales, and management

There are several factors that influence a company’s WHAT TO INCLUDE IN A CREDIT AND
decision to turn past-due accounts over to a collections COLLECTIONS POLICY
agency. One factor is the company’s risk tolerance for
bad debt. If positive cash flow would not be greatly A credit and collections policy should help a company
impacted by a certain level of bad debt, a company may answer the following questions:
choose not to outsource collections efforts. On the 1) What is the purpose of the policy?
 2) What are the goals of the credit department?
3) How will these goals be measured?
4) Who is responsible for what?
5) What is the credit evaluation process?
6) What is the collections process?

ESSENTIAL PARTS OF A CREDIT AND COLLECTION

POLICY

A. Mission Statement
A well-crafted mission statement will define
the purpose of the credit department and
provide a general, long-term focus for the
department as a whole. Be sure this statement
aligns with the corporate, mission, is specific to
your industry, and has input from upper
management as well as the sales and finance
department.

B. Departmental Goals
What is the objective of the credit
department? What is the long-term goal and
what are the short-term goals that will help you
work toward it? Be sure these goals are
measurable.

C. Roles and Responsibilities

In this section, you will describe the different
roles of the department, who reports to whom,
and who is responsible for what.

D. Procedures
This is the real meat of your credit policy.
Here, you will define the rules that apply to all
customers to guide your sales and credit
department. Some of the procedures you will
want to define and explain include:
 Evaluation of the creditworthiness of
new customers and reevaluation of
current customers
 Terms and Conditions of sale
 Invoicing
 Collection procedures
 Disputes and deductions
 Credit holds
 Payment plans
 Write-offs
 Third party collections
 Law suits

E. Measurement of Results
It is important to measure the effectiveness
of the credit department regularly; at least once
every quarter. The metrics you are measuring
should align with the departmental goals.