Types of credit

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[A]According to Debtor

1. Commercial bank credit: This type of credit includes all types of credit instruments, which are issued by the banks e.g. Bonds, Debenture, Letter of credit, Time deposits, etc. Apart from that Central Bank credit which includes circulating notes and deposit liabilities are also included.

2. Consumer Credit: The credit obtained by consumers to fulfill their immediate personal needs fall under this category like car, house etc.

3. Government Credit: When the government takes the loan to fulfill the gap between expenditure and revenue, it is called government credit.

[B] According to Security

1. Fully Secured Loans: A fully secured loan refers that type of loans where a security is kept by the creditor for providing loans that in the event of nonpayment of the loan by the debtor. At the time of recovery, this security can be sold and the full loan can be recovered by selling off the security.

2. Partly secured Loans: If only part of the loan can recover by selling off the security in case of nonpayment of a loan by the debtor, such a loan is known as the partly secured loan.

3. Unsecured Loans: If nothing can be recovered or no security is kept against the loan, such a loan is known as the unsecured loan.

[C] According to Source

1. Financial Credit: The credit, which is provided by such institutions whose main business is to advance loans, comes under the category of financial credit. For example, Loans provided by commercial banks, finance corporations and insurance companies.

2. Personal Credit: Personal credit refers that type loan which is given personally for example, given to friends, relatives and dear ones.

3. Trade Credit: Trade credit is an important external source of working capital financing. It is a short term credit extended by suppliers of goods and services in the normal course of business, to a buyer in order to enhance sales.

[D] According to Time

1. Demand Loans: Loans, which are to be repaid by the debtor on demand, are known as demand loans.

2. Long Term Loans: Loans, which are taken for a period of 10 years and more, fall under this category. These loans are normally taken for purchasing valuable assets such as land, buildings car or costly machinery.

3. Medium Term Loans: Loans given for a period of 1-10 years fall under this category. Industrialists for purchasing machinery etc normally take these loans.

4. Short Term Loans: Loans, which are given for a period of One year, are short-term loans. For example, in agriculture loans are given for a period of one year.

[E]According to Use

1. Consumption Credit: Consumption credits are non-productive loans which have taken by individuals for consumption purposes.

2. Production Credit: Loans, which are taken by individuals, institutions and government for production purposes fall under this category like (Agricultural credit, Industrial credit, Trade credit).

Credit Creation by Commercial Banks

The creation of credit or deposits is one of the most important functions of commercial banks. Like other corporations, banks aim at earning profits. For this purpose, they accept cash in demand deposits and advance loans on credit to customers.

According to Benham – The term ‘credit creation’ implies a situation, when “A bank may receive interest simply by permitting customers to overdraw their accounts or by purchasing securities and paying for them with its own cheques, thus increasing the total bank deposits.”

Factors Affecting the Volume of Credit/

Limitations of Credit Creation

The following are the limitation on the power of commercial banks to create credit:

1. Amount of cash: The credit creation power of banks depends upon the amount of cash they possess. The larger the cash, the larger the amount of credit that can be created by banks.

2. Banking habits of the people: The banking habits of the people also govern the power of credit creation on the part of banks. If people are not in the habit of using, cheques, the grant of loans will lead to the withdrawal of cash from the credit creation stream of the banking system. This reduces the power of banks to create credit to the desired level.

3. Cash reserve ratio: All deposits cannot be used for credit creation. Banks must keep certain percentage of deposits in cash as reserve.

4. Leakages in credit-creation: If there are leakages in the credit creation stream of the banking system, credit expansion will not reach the required level, given the legal reserve ratio. It is possible that some persons who receive cheques do not deposit them in their bank accounts, but withdraw the money in cash for spending or for hoarding at home. The extent to which the amount of cash is withdrawn from the chain of credit expansion, limits the power of the banking system to create credit.

5. Monetary and fiscal policies: The financial and monetary authority of the country has the unlimited power to control the volume of credit in the economy according to the prevailing national and international circumstances.

6. Nature of business conditions in the economy: Credit creation will be large during a period of prosperity, while it will be smaller during a depression.

7. Proper securities: A bank creates credit in the process of acquiring sound and profitable assets, like bills, and government securities.

8. Situation of inflation: Inflation is a condition of high money supply in the economy, accompanied by high level of demand. During inflation, the government reduces the volume of credit mainly by reducing the rate of, interest.

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