Module 2: Principles and Nature of Credit

Chapter 2: Sources of Credit: Nature and Facilities

A. Main sources of Credit: Financial Institutions

B. Other Sources of Credit: Non-Financial Institutions

Introduction:

 Financial system is a network of various institutions which generates, circulates, and controls money
and credit. It entails an intermediation between the suppliers and users of credit or a mechanism that
facilitates the transfer of funds from savers with surplus or excess funds to spenders facing deficit or
shortage of funds. Its precise function is to allocate or match the supply of savings in the economy to the
demanders (users) of those savings in a safe and efficient manner.

Financial system which serves as the backbone of the economy revolves around granting of credit that
to succeed and be cyclical for maximum utilization of funds in the circulation for the benefit of all
concerned should be backed up by efficient collection system. It is for this reason credit is entrusted
most to facilitate being its main source by the financial institutions.

Main Sources of Credit

Financial institutions are intermediaries that channel the savings of individuals, businesses, and
governments into loans and investment. The major types of financial institutions in the Philippines are
the commercial banks, rural banks, thrift banks, specialized government banks, offshore banks,
insurance companies and non-bank financial institutions.

They are important channels for generating capital investments from savings. Dr. Magno L. Torreja, Jr.
(2003), described the foregoing in as follows

1. BANKING FINANCIAL INSTITUTIONS

A. COMMERCIAL BANKS

 Commercial banks lend money not only to business people, but also to people who need it for
personal reasons. Most of the time, when people take out personal loans, they have to give the
bank written guarantees from two or more responsible people that the contract will be kept.
These people who promise to payback the borrower's debt are called "so-makers.
 Legally, they can be held responsible for the loan's principal and interest if the person for whom
they acted as a guarantor doesn't pay the bank what he owes.
 As a standard banking practice, 6 to 12% of the total loan amount is taken out in advance to
cover the interest.
  Commercial banks are organized primarily to accept drafts and to issue
Letters of credit. Discount and negotiate promissory notes, drafts, bills of exchange and other
evidences of indebtedness; receive deposits; buy and sell foreign exchange; and lend money on
a secured or unsecured basis.

 Expanded commercial banks, otherwise known as universal banks, are

Banks that have exercise the powers of investment houses, invest in the
Equity of companies engaged in businesses not related to banking and
Own up to 100% of the equity of financial allied undertakings other than
Commercial banks authority, in addition to commercial banking powers,
To.

b. Thrift Banks
Thrift banks as defined under Section 3 of R.A. 7906, are savings and mortgage banks,
private development banks and stock savings and loan associations organized under existing
laws, and any banking corporation that may be organized for the following purposes:
i. Accumulating the savings of depositors and investing them, together with capital loans secured
by bonds, mortgages in real estate and insured improvements thereon, chattel mortgage, bonds
and other forms of security or in loans for personal or household finance, whether secured or
unsecured, or in financing for homebuilding and home development; in readily marketable and
debt securities; in commercial papers and accounts receivables, drafts, bills of exchange,
acceptances, or notes arising out of commercial transactions; and in such other investments and
loans which the Monetary Board may determine as necessary in the furtherance of national
economic objectives.

ii. Providing short term working capital, medium- and long-term financing, to businesses engaged
in agriculture, services, industry, and housing; and
iii. Providing diversified financial and allied services for its chosen market and
Constituencies especially or small and medium enterprises and individuals.

C. Rural Banks

 In the rural areas of the Philippines, rural banks are the main source of credit, especially for
farmers who need these services very much. Before RA 720, also called the Rural Banks Act, was
passed, this country didn't have any of these kinds of banks.
 The growth and development of these banks show how much people in rural areas need to be
able to borrow money. Having rural banks in towns and villages has definitely cut down on the
amount of usury that some money lenders charge, which hurts our poor people who can't get
credit from commercial or savings banks because they have certain requirements.
4. Offshore Banks

   Offshore Bank Unit (OBU) refers to a branch, subsidiary, or affiliate of a foreign banking
corporation which is duly authorized by the BSP to transact offshore banking business in the
Philippines.

 Offshore banking is the conduct of transactions in foreign currencies involving the receipt
of funds principally from external sources and, as allowed in the circular, from internal sources
and utilization of such funds. A foreign bank may operate an offshore bank unit.

5. Specialized Government Banks

   Specialized government banks are organized to serve a particular purpose. The existing
specialized banks are the Land Bank of the Philippines (LBP), Development Bank of the
Philippines (DBP), and Almanah Islamic Investment of the Philippines (AABB).

a. Land Bank of the Philippines

 The Land Bank of the Philippines is a government financial institution that strikes a balance in
fulfilling its social mandate of promoting countryside development while remaining financially
viable. This dual function makes LANDBANK unique. The profits derived from its commercial
banking operations are used to finance the Bank's developmental programs and initiatives.
 Over the years, LANDBANK has successfully managed this tough balancing act as evidenced by
the continued expansion of its loan portfolio in favour of its priority sectors: the small farmers
and fishers, a good part of which are agrarian reform beneficiaries; micro and SMEs; agri- and
aqua-projects of local government units and government-owned and controlled corporations;
communications, transportation, housing, education, health care, environment-related projects,
tourism, and utilities. LANDBANK is by far the largest formal credit institution in the rural areas.
It also ranks among the top five commercial banks in the country in terms of deposits, assets,
and loans.
b. Development Bank of the Philippines
 Like rural banks, development banks are an important part of our banking system because
they give out the money that is needed to help development happen faster. They have had a
lot to do with the start and growth of some industries that are now very common in the
Philippines.

Example: DBP in Makati.

Under its charter, DBP in Makati is classified as a development bank. It is primarily tasked
with providing banking services to cater to the needs of agricultural and industrial enterprises.
It may also perform all the other functions of a thrift bank. It focuses on four major areas of
financing infrastructure and logistics, social services, small and medium enterprises, and the
environment. It also offers deposit and investment products and services, trade products and
services, treasury products and services, and transfer and remittance services, among others.
 Development Bank of the Philippines is a state-owned development bank, was officially created
on June 14, 1958, headquartered in Makati City, Philippines? As December 2018, DBP have 137
branches. As the country’s pre-eminent development financial institution, DBP has taken upon
 itself the strategic task of influencing and accelerating sustainable economic growth, through
the provision of resources, for the continued well-being of the Filipino people.
 The DBP, under its new charter, is classified as a development bank and may perform all other
functions of a thrift bank. Its primary objective is to provide banking services principally to cater
to the medium and long-term needs of agricultural and industrial enterprises with emphasis on
small and medium-scale industries.
c. Almanah Islamic Investment of the Philippines
 
 Al-Amanah Islamic Investment Bank of the Philippines (AAIIBP) is a universal bank authorized to
perform and provide Islamic banking, financing and investment services pursuant to R.A. 6848,
otherwise known as the Charter of the Al-Amanah Islamic Bank of the Philippines of 1990. In
2008, AAIIBP became a subsidiary of Development Bank of the Philippines, owning 99.9% of its
capital stock, which introduced its current logo and tag name. “Amanah Islamic Bank”. 
 As an Islamic investment Bank, the Bank may also engaged in issuance or assist the government
in Islamic investment participation by issuance of investment participation certificates,
muquaradah or sukuk (Islamic bonds), debentures, collaterals and/or the renewal or refinancing
of the same, with the approval of the Monetary Board of the Central Bank of the Philippines, to
be used in its financing operations for projects that will promote the economic development
primarily of the Autonomous Region. 
 As a Universal Bank, the Bank also offers developmental and car loans to private and public
sector and other Islamic investment assistance. Today, AAIIBP has nine (9) operating banks in
the Cities of Cagayan de Oro, Cotabato, Davao, Iligan, General Santos, Marawi, Makati and
Zamboanga and one in Jolo, Sulu.

2. Non-Bank Financial Institutions

Non-bank financial institutions are either government or privately owned institutions. Among
the government non-bank financial institutions are the Government Service Insurance System
and Social Security System. The major private non-bank private financial institutions are the
investment houses, finance companies, securities dealers and brokers, lending investors,
pawnshops, venture capital and insurance companies.

a. Investment Houses – is defined as any enterprise that engages or purports to engage, whether
regularly or on an isolated basis, in the underwriting of securities of another person or
enterprises, including securities of the government and its instrumentalities.
b. Financing Companies – are corporations which are primarily organized for the purpose of
extending credit facilities to consumers and to industrial, commercial or agricultural enterprise,
by direct lending or by discounting or factoring commercial papers or accounts receivable, or by
buying and selling contracts, leases, chattel mortgages, or other evidences of indebtedness or by
financial leasing of movable as well as immovable property.
c. Security Dealer and Broker Security dealer is any person other than a salesman who engages
either for all or part of his time in the business of selling securities issued by another person or
purchasing or otherwise acquiring such securities from another for the purpose of reselling
them. While, security broker is any person engaged in the business of effecting transactions in
securities for the account of another but does not include a bank.
 d. Lending Investors – are persons who make a practice of lending money for themselves or others
at an interest and mainly for personal consumption.
Their borrowers include individuals who are employed or engaged in business. Most lending
investors lend without collateral but charge high interest compared to the regular loans.
 "Loan sharks" are people who lend money for a high interest rate. Once they have a
borrower, they rarely let him go. These lenders don't care about getting their money
back; they just want to keep the borrower in debt. Most of them won't take anything
but the full amount, and the interest rates they charge are quite high. People who can't
or don't know how to borrow from reputable sources are likely to use them.
 TWO MAIN TYPES OF LAON SHARKS IN THE PHILIPPINES
o 5-6 LOANS - This is a kind of loan where you borrow five pesos and pay six. If you
do the calculation, you are paying 20% on your loan. Some banks do charge this
level of interest but within many years. A loan shark, however, charges this
interest per month
o SANGLA ATM- The word "sangla" means pawn. In a loan shark scheme like this,
the borrower must surrender his ATM card to the lender, along with this
password or PIN code. The borrower will not be able to get his ATM card back
unless the payment has been mode.
 
e. Pawnshop – is referred to a person or entity engaged in the business of lending money on
personal property delivered as security for loans and shall be synonymous, and may be used
interchangeably, with pawnbroker or pawn brokerage.
 referred to a person or entity engaged in the business of lending money on personal
property delivered as security for loans and shall be synonymous, and may be used
interchangeably, with pawnbroker or pawn brokerage. Pawnshops give out loans with
interest rates that are a lot higher than what banks usually charge for personal loans.
The risk of not paying back the loan is much higher, and many people who want loans
from pawnshops can't get them from banks. Most pawn shops charge between 5% and
25% interest on loans.
f. Venture Capital – as a corporation is organized to assist small and medium scale enterprises
primarily in the form of equity financing.
 

g. Insurance Companies – generate chiefly their income from premiums collected from policy holders
and income from investments and loans. Their expenses include outlays for maturing policies and
operating costs. With regular cashflows from insurance premiums, the risks of insurance companies are
statistically determinable (called “actuarial” targets). Insurance companies usually make prudent
investments and always maintain a strong capital position. Their investment portfolio is mainly in
government securities and in companies of unassailable financial standing.

Other Sources of Credit

There are other sources of credit other than the financial institutions. These sources
may vary from one another based on kinds granted, amounts involved, and volume transacted.
These may include the private money lenders and commercial establishments (e.g. retail stores,
grocery and department stores, and supermarkets).
1. Private Money Lenders
One of the biggest frustrations every businessman encountered despite all efforts spent to
obtain sales is when the being worked deal failed out of lack or insufficient funds of the target
client. Finding a deal is great, but if you do not have earnest money to tie up a deal or funds to
purchase it, then all that time and effort is for nothing. Therefore, if you work on raising capital
from private money lenders while locking up deals, you will have a greater chance for
investment success.

What Is a Private Money Lender? A private money lender is a non-institutional (non-bank)

individual or company that loans money, generally secured by a note and deed of trust, for the
purpose of funding a real estate transaction. Private money lenders are generally considered
more relationship-based than hard money lenders. Ankit Duggal (2012) cited three circles of
people you can reach out to fund your deals, to wit:
a. The Primary Circle: Family and friends.
This circle is made up of family, friends, and acquaintances (neighbors and coworkers) – any
individual you personally know. Ordinarily, people find their first funding or tend to tap first this
circle to avail what they need or want. This circle usually responds positively as a form of
personal accommodation termed in Pilipino as “pakikisama” or to replicate a debt of gratitude
or what is known as “utang na loob”. As such, they most of the time do not charge interest.
However, default for borrowed money might lead to their disagreement or sour relationship.

b. The Secondary Circle: Friends and colleagues of friends.

 The secondary circle of investors is the friends and colleagues of your primary circle. The bigger
your primary circle, the bigger your secondary. This is appropriately, the second-best source of
credit and a bigger capital pool as there are more people in this group than in your primary
circle. They will generally be receptive to your credit proposal, given that your primary circle’s
mutual contact gave the nod of their approval. But not all the time since this group is less
positively inclined to say yes. Hence, you need to prove your worth with a very convincing
business plan presentation and meeting them face-to-face.

c. The Third-Party Circle: Investors you do not know (yet).

 This circle consists of people who are most removed from your network. This is the biggest
capital pool that you can access, but it takes the longest to convert them into capital partners
since they do not know you personally or professionally. This group might include accredited
investors, strangers, and people found through networking and advertising.