Credit

CREDIT AS A TERM refers to the granting of goods, services, or money in return for a promise of future payment. The future payment includes an interest or charge for the use of credit or money. Interest is usually determined as a percentage of the principal and computed annually, which makes the future payments greater than an immediate payment would have been. Credit and its opposite, debt, are operations that involve lending. Taking credit is an equivalent to going into debt.

In commercial trade, credit is used as the approval for delayed payments for goods purchased. Credit enables producers to close the gap between production and sales of goods and services, and it allows consumers to purchase goods and services at the present time and pay for those services from their future income. Companies regularly offer credit to their customers as part of the terms of a purchase agreement.

Credit extension and debt creation can be traced back to ancient times. The volume and complexity of credit transactions have grown substantially with the emergence of capitalism. Credit transaction emerges whenever capital is used and savings are required. Any movement of financial capital is dependent on credit, which in turn is founded upon the lender's confidence in the borrower and borrower's reputation or credit risk. The credit risk or default risk generally refers to the probability that the borrower will default on future payments. Data as to credit risk are supplied by agencies organized for that purpose. The chief agency in the United States is Dun and Bradstreet, formed by a merger (1933) of R.G. Dun & Company (1841) and the Bradstreet Company (1849). Often the borrower is required to provide collateral, that is, a financial instrument, as security for payment of a loan.

The most commonly used instruments of credit are the acceptance, bill of exchange, letter of credit, and promissory note. The instruments are often negotiable and traded in money markets. The purest form is the credit default swap. This is a specific type of counter-party agreement which allows the transfer of third-party credit risk from one party to the other. One party in the swap is a lender and faces credit risk from a third party, and the counterparty in the credit default swap agrees to insure this risk in exchange for regular periodic payments. If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. In turn, the insurer pays the insured the remaining interest on the debt, as well as the principal.

There is a distinction between business credit and consumer credit. The principal function of business credit is the transfer of capital from those who own it to those who intend to use it. The main objective of business credit is an enlargement of capital. Consumer credit, on the other hand, allows the purchase of retail commodities without the use of cash or with the use of relatively little cash.

The principal economic function of consumer credit is to move consumers’ consumption of goods and services forward in time. The main types of consumer credit are noninstallment credit and installment credit. Noninstallment credit is to be repaid in a lump sum. Installment credit, which is a prevalent form, represents all consumer credit that is scheduled to be repaid in two or more installments. It is estimated that some 90 percent of all wholesalers’ and manufacturers’ sales, and more than 30 percent of all retail sales, are made on a credit basis.

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