In most countries, financial institutions operate in a heavily regulated environment. As critical parts of countries’ economies, those economies depend on them to grow the money supply. Regulatory structures differ for each country. Typically, these involve prudential regulation as well as consumer protection and market stability. Some countries have one consolidated agency that regulates all financial institutions. Other countries have separate agencies for different types of institutions. These include banks, insurance companies and brokers.
Financial institutions serve various purposes in our everyday lives. Depository institutions (banks, savings and loans, and credit unions) transform liquid liabilities (checking accounts, savings accounts, and certificates of deposit that can be cashed in prior to maturity) into relatively illiquid assets, such as home mortgages, car loans, loans to finance business inventories and accounts receivable, and credit card balances.
Depository institutions also operate the payments system where bank balances are shifted between parties through checks, wire transfers, and credit and debit card transactions.
Insurance companies fall into two broad categories–life and health insurers, whose policies provide financial protection against death, disability, and medical bills; and property and casualty insurers, whose policies protect policyholders against losses arising from fire, natural disasters, accidents, fraud, and other calamities.
Stockbrokers and related investment banking firms are central players in the capital markets where businesses raise capital and where individuals and institutional investors buy and sell shares of stock in business enterprises.
So What Is Bank Credit?
Bank credit is the total amount of money a person or business can borrow from a bank or other financial institution. A borrower’s bank credit depends on their ability to repay any loans and the total amount of credit available to lend by the banking institution. Types of bank credit include car loans, personal loans, and mortgages.
Understanding Bank Credit
Banks and financial institutions make money from the funds they lend out to their clients. These funds come from the money clients deposit in their checking and savings accounts or invest in certain investment vehicles such as certificates of deposit (CDs). In return for using their services, banks pay clients a small amount of interest on their deposits. As noted, this money is then lent out to others and is known as bank credit.
Bank credit consists of the total amount of combined funds that financial institutions advance to individuals or businesses. It is an agreement between banks and borrowers where banks make loans to borrowers. By extending credit, a bank essentially trusts borrowers to repay the principal balance as well as interest at a later date. Whether someone is approved for credit and how much they receive is based on the assessment of their creditworthiness.
Approval is determined by a borrower’s credit rating and income or other considerations. This includes collateral, assets, or how much debt they already have. Banks typically offer credit to borrowers who have adverse credit histories with terms that benefit the banks themselves—higher interest rates, lower credit lines, and more restrictive terms.
Consumers have become used to relying on debt for various needs and, as a result, bank credit continues to grow. Many consumers finance large purchases such as homes and automobiles, as well as credit that can be used to make items needed for daily consumption. Businesses also use bank credit in order to fund their day-to-day operations. As a result, startups or small businesses use bank credit as short-term financing.
Types of Bank Credit
Bank credit comes in two different forms—secured and unsecured.
Secured credit or debt is backed by a form of collateral, either in the form of cash or another tangible asset. In the case of a home loan, the property itself acts as collateral. Banks may also require certain borrowers to deposit a cash security in order to get a secured credit card. Secured credit reduces the amount of risk a bank takes in case the borrower defaults on the loan. Banks can seize the collateral, sell it, and use the proceeds to pay off part or all of the loan. Because it is secured with collateral, this kind of credit tends to have a lower interest rate and more reasonable terms and conditions.
Banks normally charge lower interest rates on secured credit because there’s a higher risk of default on unsecured credit vehicles.
Unsecured credit, on the other hand, is not backed by collateral. These kinds of credit vehicles are riskier than secured debt because the chance of default is higher. As such, banks generally charge higher interest rates to lenders for unsecured credit.
Examples of Bank Credit
The most common form of bank credit is a credit card. A credit card approval comes with a specific credit limit and annual percentage rate (APR) based on the borrower’s credit history.
The borrower is allowed to use the card to make purchases. They must pay either the balance in full or the monthly minimum in order to continue borrowing until the credit limit is reached.
Banks also offer mortgage and auto loans to borrowers. These are secured forms of credit that use the asset—the home or the vehicle—as collateral. Borrowers are required to make fixed payments at regular intervals, usually monthly, bi-weekly, or monthly, using a fixed or variable interest rate.
One example of business credit is a business line of credit (LOC). These credit facilities are revolving loans granted to a company. They may be either secured or unsecured and give corporations access to short-term capital. Credit limits are normally higher than those granted to individual consumers because of the needs of businesses, their creditworthiness, and their ability to repay. Business LOCs are normally subject to annual reviews.
As you can see, bank credit affects our lives in a variety of ways both personally and professionally. Managing that credit and performance is vital to both consumers and businesses.
- Bank credit consists of the funds that a person or business can borrow from a financial institution.
- A borrower’s credit rating, income, collateral, assets, and pre-existing debt determine approval.
- There are three types of credit accounts – revolving, installment and open.
- Bank credit may be secured or unsecured.
- Specific examples of bank credit used in everyday life include credit cards, mortgages, car loans, and business lines of credit.
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