TOPIC 3: SOURCES OF CREDIT Flashcards
refer to the various avenues through which individuals, businesses, and governments can obtain funds or resources, typically with the obligation to repay the borrowed amount along with any applicable interest.
Sources of credit
These include regulated financial institutions such as banks, credit unions, and specialized financial entities that provide structured credit products like loans and credit cards.
Formal Sources
These encompass non-institutional options such as peer-to-peer lending, microfinance institutions, trade credit, and loans from family or friends, which may offer more accessible but riskier borrowing options.
Informal Sources
Sources of credit provide individuals and businesses with the funds necessary for various purposes, such as purchasing homes, financing education, or expanding business operations. For example, a small business may secure a loan from a bank to invest in new equipment or inventory, enabling growth and increased revenue.
Access to Capital
Credit sources stimulate economic activity by enabling consumers to spend and businesses to invest. When banks lend money for home purchases, it supports the housing market and related industries, contributing to overall economic development
Economic Growth
Access to credit allows borrowers to manage cash flow effectively. For instance, businesses can use lines of credit to cover short-term expenses while waiting for customer payments, ensuring smooth operations without cash shortages.
Financial Flexibility
Credit enables consumers to make significant purchases without needing the full amount upfront. For example, credit cards allow individuals to buy goods and services immediately and pay for them over time, making it easier to manage personal finances.
Consumer Empowerment
Student loans are a crucial source of credit for many individuals seeking higher education. This investment in education can lead to better job opportunities and higher earning potential in the future.
Investment in Education and Skills
Access to credit is vital for start-ups and entrepreneurs who need funding to develop new products or services. Microfinance institutions, for example, provide small loans to aspiring business owners in underserved communities, fostering innovation and economic empowerment.
Support for Innovation and Entrepreneurship
Credit can help individuals and businesses manage unexpected expenses or financial emergencies. For instance, a personal loan can provide quick cash for medical emergencies or urgent repairs, helping to avoid financial distress.
Risk Management
FORMAL SOURCES OF CREDIT
FINANCIAL INTERMEDIARIES
FINANCIAL INSTITUTIONS
INVESTMENT HOUSES
COMMERCIAL BANKING
SAVINGS AND MORTGAGE BANKING
RURAL BANKS
These are entities that act as middlemen between savers and borrowers, helping facilitate the flow of funds.
FINANCIAL INTERMEDIARIES
Pool of money from investors and lend or invest in various financial instruments.
Mutual Funds
Invest the contributions from employees and employers in a variety of assets, providing loans or credit facilities in some cases.
Pension Funds
Offer loans through policyholder funds or act as intermediaries by investing premium in credit markets.
Insurance Companies
Broad institutions that provide various financial services
FINANCIAL INSTITUTIONS
Offer personal and business loans, mortgages , and credit cards.
Commercial banks
Provide similar services as banks but are member-owned and may offer lower interest rates.
Credit Unions
Specialize in lending for specific purposes, often at a higher interest rates.
Finance Companies
These firms primarily focus on securities but also offer credit and financing, especially in the form of corporate loans or underwriting
INVESTMENT HOUSES
Provide loans for large corporations, mergers and acquisitions, and other specialized financing.
Investment banks
Can offer margin loans to customers for stock investments, allowing borrowing against the value of securities.
Brokerage Firms
These banks are the primary source of credit for businesses and individuals, offering various products
COMMERCIAL BANKING
For operational needs, expansion, and investment in new projects.
Business Loans
Including credit cards, mortgages, auto loans, and personal lines of credit.
Personal Loans
Large loans offered to businesses for working capital or large investments.
Corporate Loans
These banks focus primarily on savings and providing loans for home purchases and real estate
SAVINGS AND MORTAGE BANKING
Primarily accept deposits and provide mortgage loans.
Savings Banks
Specialize in offering mortgages and home equity loans, usually funding through selling mortgage-backed securities.
Mortgage Banks
Specialized banks that provide financial services in rural areas
RURAL BANKS
Loans for farmers and agribusinesses, including crop financing, equipment loans, and land improvement loans
Agricultural Loans
Small loans to rural entrepreneurs and low-income individuals.
Microfinance
Promotes local development through small and medium-sized loans.
Community Lending
CHARACTERISTICS OF FORMAL SOURCES OF CREDIT
- Regulated and Monitored
- Standardized Terms
- Creditworthiness Assessment
- Legal Recourse
- Credit History Impact
These institutions are subject to government regulations, which ensure fairness, transparency, and protection for borrowers.
Regulated and Monitored
The loan agreements, interest rates, repayment schedules, and penalties are clearly outlined in formal contracts.
Standardized Terms
Borrowers are often required to demonstrate their ability to repay the loan through credit checks, income proof, and collateral.
Creditworthiness Assessment
In case of disputes, borrowers and lenders have access to legal mechanisms for resolution.
Legal Recourse
Borrowing from formal sources contributes to an individual’s credit score, affecting future access to loans and financial products.
Credit History Impact
provides stability and protections, but it may not always be accessible or flexible for those in urgent need or with poor financial standing.
Formal credit
INFORMAL SOURCES OF CREDIT
Family and Friends
Moneylenders
Pawnshops
Microfinance (Informal)
Shark Loans (Loan Sharks)
one of the most common informal credit sources. This type of lending is often based on trust, and the terms (such as interest rates or repayment schedules) are usually flexible or nonexistent.
Family and Friends
In many communities, there are individuals who lend money at interest. These may operate privately and can have high-interest rates. They are often accessible to borrowers who might not qualify for loans from formal institutions.
Moneylenders
semi-formal, they operate under more flexible rules than banks. A borrower can get a loan by pawning an asset, usually without a formal credit check. If the loan is not repaid, the pawned item is forfeited.
Pawnshops
Although these institutions are becoming more formalized, these arrangements still exist, particularly in rural areas where community-based lending practices are common.
Microfinance (Informal)
These are lenders who offer quick and easy loans but at extremely high-interest rates and with very strict repayment terms. They often operate outside the law and may use intimidation to collect debts.
Shark Loans (Loan Sharks)
often more accessible, but they carry higher risks and costs due to their unregulated nature.
Informal sources of credit
