Meaning of bank credit
When short-term finance is provided by the Commercial banks to business firms, it is known as bank credit. It is granted in the following ways:
(a) Loans and Advances:
When a certain amount of money is advanced by a bank usually against security of assets, repayable after a specified period, it is known as bank loan. The borrower has to pay interest on the whole amount of loan irrespective of the amount of loan actually drawn.
(b) Cash Credit:
Under this arrangement, the borrower can draw, repay and again draw the amount within the sanctioned limit. This limit is known as cash credit limit. This facility is granted against some security like goods in stock or promissory notes etc. Interest is charged only on the amount actually withdrawn and not on the amount of entire limit.
(c) Bank Overdraft:
When a bank allows its customers to withdraw money in excess of the balance in his current deposit account up to a specified limit, it is known as overdraft facility. Credit worthiness of the borrower is the deciding factor in this case. Interest is charged only on the overdrawn money.
Distinction between Cash Credit and Bank Overdraft
| Cash Credit | Bank Overdraft |
| The firm may or may not have an account with the bank. | Overdraft is granted to an account holder. |
| The amount of credit is placed in a separate account of the borrower. | Overdraft limit is generally granted to an existing account of the customer. |
| The amount of credit in case of cash credit depends upon the value of securities offered. | Overdraft limit is decided on the average balance in the customer’s account. |
| For cash credit, security of tangible assets is an essential requirement. | Overdraft is granted without the security of any assets but on creditworthiness of customer. |
(d) Discounting of Bill:
When a bill of exchange is presented before the bank for encashment, bank credits the amount to customer’s account after deducting some discount (the amount of discount is charged on the basis of the interest on the amount of the bill from the date of discounting to the date of maturity of the bill.)On maturity of the bill, the payment is received by the bank from the drawee.
Types of security required for obtaining bank credit
Securities offered against bank credit may be of two types:
(1) Personal security
(2) Security of assets
Personal security means the creditworthiness of the borrower i.e. financial soundness and past dealings with the bank.
When the banks ask for security of assets, the following are generally accepted as security for extending short-term finance.
(a) Moveable Goods like Stock of raw materials and finished goods.
(b) Shares quoted on a recognized stock exchange.
(c) Documents of Title to Goods: Bill of Lading, Railway Receipts (RR), Goods Receipt (GR), Warehouse warrant.
(d) Fixed Deposit Receipts: Banks normally grant loan up to 90% of the value of such receipts.
(e) Life Insurance Policies: Banks extend credit on the basis of life insurance policy up to the amount of surrender value of such receipts.
(f) Jewellery or Precious Metals.
(g) Other Securities: Banks also accept National Savings Certificate (NSC) etc.