Credit Instruments word is derived from a Latin word ‘Credo’ which means faith or trust hence one can say ‘I believe’. In affirming the primary of faith.
The faith has a basic implication in finance, in risk undertakings and even in associations of ordinary nature between individuals. For the bank therefore, credit refers to the faith the creditor (lender) places in a debtor (borrower) by extending him a loan.
The loan is often in form of money and when the loan is made, the lender extends credit of the borrower while at the same time accepting the credit of the borrower.
This credit or faith or trust is often equated to the character of the party in question in financial circles.
In fact, every credit undertaking of the banker usually requires the qualities of Capital, Character, Capacity and Collateral, but whereas capital (i.e. Knowledge and abilities), and capital can be substituted.
Hence the man who has no faith has no character and should be avoided completely. Character is the intrinsic obligation in a man that compels him to pay his debts when they are due.
A market economy could not function without extensive use of credit based almost exclusively upon the faith and trust of the participating buyers and sellers.
Charge amounts, credit cards, seller installment credit and trade credits differ from the banker’s direct lending since no funds are advanced when the credit is extended. The buyers’ credit is the basis for postponing payment.
Credit facilitates the transfer of capital or money, and thus increases the productivity of capital by placing it where it will be most effectively used. It also assist in economizing on the use of money proper or paper currency and coins and many other uses.
The ability to transfer debt is made possible by the use of credit instruments hence we can define credit as the transfer of property on promise of future payment and credit instruments written evidence of the existence and nature of the promise to pay in the future.
From the above discussion, we can describe bankers not just as dealers in debt or credit (since both are two aspect of the same coin) but as dealers in credit instruments.
Credit Instruments and Functions
As simply defined above, a credit instrument is as written evidence of the existence or extension of credit requiring payment in the future. By selling the instrument, the debt is transferred from one person to another, since a highly developed credit system is necessary for the widespread use of credit, banking activities largely takes the form of creating and managing credit or debt instruments.
Credit instruments take such forms as promissory notes, bonds, bills of exchange. A cheque is a specialized type of bill of exchange and a large part of commercial bank operations are concerned with the processing of cheques drawn upon them, most of their assets consist of different kinds of credit instruments, e.g. Treasury bills, Treasury certificates, certificates of deposits, ‘Bankers’ unit funds etc. These instruments have their different characteristics and markets, but generally a credit instrument will often indicate the following:-
- The identity of the debtor (i.e. the one borrowing the money and hence responsible for paying it back)
- The amount of the debt (the maturity value)
- The arrangement as to maturity (i.e. repayment terms or schedule) and
- The interest payments to be paid, what they are and when they are to be paid.