Credit and Credit Creation of Bank

Credit is the confidence or trust that allows one person or institution to obtain money, goods, or services now with the promise to pay at a future date. In banking, credit generally refers to loans and advances provided by banks.

Definitions of Credit by Economists

1. Thomas H. Greco Jr. (commonly cited)

   • "Credit is the ability to obtain goods or services before payment, based on the trust that payment will be made in the future."

2. Hartley Withers

   • "Credit is nothing but the right to receive payment or the promise of future payment."

3. John Maynard Keynes (idea related to banking credit)

   • Credit represents purchasing power created through the banking system, enabling borrowers to spend before earning sufficient cash.

• Credit in finance is the act of borrowing money or getting access to goods & services with a promise to pay you back in the future. It plays an essential role in economic activity by facilitating transactions & and allowing people & companies to make investment decisions that they may not otherwise be able to make.
•  When you get a loan from a lender, they lend you money. You agree to pay back the loan amount plus interest within a certain period.
• Credit can be in the form of a credit card, a loan, a mortgage, or a trade credit. It is the financial instrument that helps people and businesses manage cash flow, reduce financial volatility, and invest in new opportunities.

How Credit Functions?

Credit Functions through a systematic process in which a lender provides money or goods to a borrower based on trust and an agreement that the amount will be repaid in the future with interest. It plays a vital role in the economy by facilitating trade, investment, production, and consumption.

1. Application for Credit

• The borrower approaches a bank or financial institution for a loan or credit facility.
• The borrower states the purpose of the loan, the amount required, and the repayment period.
• Necessary documents such as identity proof, income proof, and business details are submitted.

2. Assessment of Credit worthiness

• The bank evaluates the borrower's financial position and repayment capacity.
• It examines factors such as income, employment, business performance, credit history, and existing debts.

3. Sanction of Credit

• If the bank is satisfied with the borrower's eligibility, it approves (sanctions) the loan.
• The terms and conditions, including the loan amount, interest rate, repayment schedule, and security (IF REQUIRED), are communicated to the borrower.

4. Disbursment of Funds

• After completing all legal and documentation formalities, the bank release the approved amount.
• The funds may be credited directly to the borrower's account or paid to the seller or service provide, depending on the purpose of the loan.

5. Utilisation of credit

• The borrower uses the funds for the intended purpose, such as purschasing goods, investing in a business, paying educational expenses, buying a house, or meeting working capital needs.

6. Repayment of credit

• The borrower repays the loan in instalments (EMIs) or as agreed in the loan contract.
• Repayment includes both the principal amount and the interest charged by the bank.
• Timely repayment improves the borrower's credit reputation and future borrowing ability.

7. Recycling of funds

• The repaid amount returns to the bank.
• The bank can lend these funds to other borrowers, enabling continuous credit creation and supporting economic growth.

Variety of Credit Cards