BCom 3^rd Year Credit Instruments & Credit Creation Study Material Notes in Hindi

BCom 3^rd Year Credit Instruments & Credit Creation Study Material Notes in Hindi: Definitions of Credit  Deference Between Money and Credit Instruments  Types of Credit Instruments  Specimen Bill of Exchange  Credit Creation BY Banks Process of Credit Creation by Banks Instruments  of Credit  Creation Banks Exercise Questions Long Answer Question Objective types Correct Options :

BCom 3rd Year Nature Importance Financial Money Study Material notes in Hindi

CREDIT, CREDIT INSTRUMENTS

AND CREDIT CREATION

Meaning of Credit: In the day-to-day communicative language, the credit taken for “faith’, but Economics rejects it. In the language of economists the world Credit just means the ‘Redemption Capacity’ or ‘Deferred Payment. The torm Credit’ has been derived from the Latin term ‘Credo’ which means Faith’. Thus when somebody wants to use a commodity or service at present and wants to pay for it in future or get a chance to do this is called Credit.

DEFINITIONS OF CREDIT

Different economists have defined Credit in different ways. These are the definitions of Credit by intellectuals:

1 According to Prof. Jevons, “Credit means Postponement of payment.”

2. According to Thomas, “Credit is Such a Confidence on the basis of which one person gives the other his valuable commodities and/or services, even if it is money and hopes that the other person would return/repay it in future.”

3. According to Prof. Gide, “Credit is an exchange which is complete after the expiry of a certain period of time after payment.”

4. According to Prof. Kinley, “By Credit, we mean the power which one person has to induce another to put economic goods at his disposal for a time on promise of future payment. Credit is thus an attribute on power of the borrower.”

5. According to Kent, “Credit may be defined as the right to receive payment on demand or at some future time on account of the immediate transfer of goods.”

The careful study of the above definitions clarifies that credit means a kind of economic faith in a person for the other.

Cole has given a definition which is a bit different from all other definitions. According to him. “Credit is such a purchasing power which doesn’t come from income, but it is formed by financial institutions by activating the passive income of depositors in the banks.”

Credit Instruments & Credit Creation

CREDIT INSTRUMENTS

Credit instruments mean those papers or documents which are not money but which act as money. Credit instruments as used in place of money, so these are also called credit money.

As stated above, despite being the medium of exchange there are differences between money and credit instruments. Their differences can be clarified in the following table.

DIFFERENCES BETWEEN MONEY AND CREDIT INSTRUMENTS

TYPES OF CREDIT INSTRUMENTS

Different types of credit instruments are as follows:

(1) Cheque : A cheque is an official paper instructing a bank to pay a specific amount from the person’s account to the person in whose name the cheque has been made. This is a popular credit instrument which a person deposits with a bank, instruct the bank to pay the specified amount to the bearer of the cheque or the person in whose name the cheque is written. Thus a cheque has three parties : (i) Drawer i.e. the person who writes the cheque, (ii) Drawee i.e. the bank that has to pay and (iii) Payee i.e. who will be paid.

KINDS OF CHEQUE

Different kinds of cheques are:

(i) Bearer Cheque : A bearer cheque is that the payment for which is given to the person who produces the cheque at the counter of the bank. It is not essential to know whether the person receiving the payment is proper or not. The bank is not responsible for an improper payment. However, it is not essential to get the signature of the payee of this Cheque, but the banks take the signature of the payee at the back of the cheque with respect of safety.

 (ii) er Cheque: An Order Cheque is that the payment for which can be obtained by that person only whose name is written as payee on the cheque or an endorsement has been made in the name of that person according to rules.

(iii) Crossed Cheque : When two oblique parallel lines are drawn at the top of the left side of a cheque it is called a Crossed cheque. It is the safiest Cheque. This cheque is not paid directly at the bank counter. Instead, the specified amount is first credited in the account of the person in whose name the cheque has been written and then he/she can withdraw it according to his/her own convenience.

Crossed Cheque are of two kinds :

(a) General Crossed Cheque : When two oblique parallel lines are drawn at the top left side and the space between the two lines is left blank or ‘Account payee’, ‘& Co’, ‘Not Negotiable’ is written but the name of the bank is not mentioned it is called General Crossed Cheque.

(b) Special Crossed Cheque : In this cheque the name of a bank is mentioned between two parallel lines. It means that this cheque can be cashed on the bank the name of which is mentioned there between these two lines.

(2) Bill of Exchange : According to the Section 5 of Indian Negotiable Instrument Act, 1881, “A Bill of exchange is an instrument in writing, containing an unconditional order, signed by the maker, directing to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument.” Thus, Bill of Exchange is a condition free instrument in which the writer instructs the drawee to pay a specific amount after a certain period. The right side of the Bill of Exchange retains the signature of the drawer and the name and address of the drawee is mentioned on the left side. There are three parties of a Bill of Exchange : (i) Drawer, (ii) Drawee and (iii) Payee.

Specimen of Bill of Exchange 

Credit Instruments & Credit Creation

 (3) Promissory Note: According to the Section 4 of Indian Negotiable Instrument Act, 1881, “A Promissory Note is an instrument in writing (not being a bank note or a currency note) containing an unconditional undertaking Signed by the marker to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument. In this way it is also a condition tree written document like a Bill of Exchange. The only difference is that the Bill of Exchange is written by the drawer/creditor and accepted by debtor/drawee which the promissory note is written as well as accepted/promised to pay by the debtor only. A promissory note has two parties (i) Maker/drawer/promisor and (ii) Drawee/payee/promisee.

Specimenof Promissory Note 

Difference among Cheque, Bill of Exchange and Promissory Note

  (4) Hundi: Hundi is such a condition-free document written in one of the vernacular languages in which one person instructs the other to pay a specific amount after the completion of a certain period or on demand. It can be written in different languages, so there is not any definite format. There are various kinds of Hundis. Some examples are as follows:

(i) Darshani Hundi: Darshani hundis are like sight bills. They are paid immediately on presentation, sight or demand.

(ii) Muddati Hundi : The muddati hundi is like a time bill. It becomes payable after a stipulated period from the date of the hundi.

(iii) Dhekhanhar Hundi : The payment of dhekhanhar hundi can be made to any person who presents the hundi.

(iv) Shahjog Hundi: Shahjog hundi is that hundi whose payment is made to a reputed person.

(v) Farmanjog Hundi : The payment of this hundi is made to a person whose name is mentioned in the Hundi.

(vi) Dhanijog Hundi : The payment of this hundi is made to the person mentioned in the hundi or to somebody else according to his instruction.

(5) Bank Draft : It is a bill of exchange drawn by a bank on another bank or by itself on its other branch. It is very nearly allied to a cheque but it can not be easily countermanded like a cheque and it cannot be made payable to bearer. In other words, it is a credit instrument in which the branch of a bank instructs the other branch to pay the specified amount to the person, organisation or institution mentioned in it. When somebody wishes to send money to other places, he deposits the amount with a branch of a bank and gets a bank draft issued in favour of paying party. Then he sends the draft to the concerned person or place by post. The draft is then carried to the concerned bank and encashed there.

(6) Letter of Credit : Letter of Credit refers to such a document through which a person, institution or bank requests the other person, institution or bank that the person specified in the document should be granted credit up to a certain limit or shares. A certain date is also mentioned in the letter of credit which is the period for which the credit is requested.

(7) Treasury Bills : Treasury bills are promissory notes issued by the Central Government for a fixed period for raising short term funds. It is issued at a discount. Site period is 3 to 6 months. The Payment is made just after the completion of the period.

 Credit Creation by Banks

We know that it is a primary function of the banks to accept deposits from public keep a certain part of this deposit with them and distribute the rest as loans and advances. If banks don’t distribute the money received as deposits in the form of loans, there will be no credit formation. So Prof. Sayers has said, “Banks are not merely purveyors of money, but also, in an important sense, manufacturers of money.”

Thus it is clear that banks create credit through deposit. The money created by banks is called bank money.’ Now there is a need to highlight how banks create credit.

PROCESS OF CREDIT CREATION BY BANKS

Credit is created by banks in the following ways:

(1) By Issuing Paper Money : These days in almost every country, the Central Bank retains the authority of issuing paper notes. In India, too, the Reserve bank of India monopolises the process of issuing paper notes. Banks create credit by issuing bank notes also because, there is no need of maintaining a cent percent metallic reserve for issuing paper notes. After a certain metallic reserve, the remaining parts of paper notes are issued on the credit and bonds of the central bank. It is worth mentioning here that only the central bank can create credit in this way.

(2) By Primary and Derivative Deposits : Banks create credit by increasing deposits. Bank deposits are of two types :

(a) Primary Deposits : Primary deposits refer to that deposit which are made by the people directly in banks in the forms of cash. There is no role of banks in such deposit. It totally depends on the will of the customers. That is why Lord Keynes has called it Idle or Passive Deposits.

(b) Derivative Deposits : When somebody applies to the bank for loans and the bank accepts it the whole amount of loan is not issued as cash in one go, but the bank opens a loan account and deposits money in that. Then the borrower is authorised to withdraw it in installments through cheque according to his needs. This way every loan granted by banks creates deposits, but this deposit is not a cash deposit but a credit deposit. Thus loans create deposits. On the ohter hand loans given by the banks are on the basis of initial deposits. If banks don’t have initial deposits, they can’t give loans. Thus deposits create loans.

So, Prof. Keynes has said, “Loans are the Children of deposits and deposits are the children of loans.”

The Credit of Derivative Deposits created by banks can be, presented with the help of an example. Suppose a customer named Satyam deposits 1,000 with bank X. This will be called the initial deposit of bank X. Now suppose bank X keeps 20 percent of this deposit as liquid money and gives 800 as loans to another customer named Pragati. In this amount * 800 will be deposited in the account of the customer to whom the loan is being granted and she will have the right of withdrawing money using Cheque. This way this 1800 is the derivative deposit of the bank. Now if Pragati wants to pay some money to somebody, she would issue a cheque in his name. Suppose, Pragati gives a cheque for 800 to Aman. Aman deposits that cheque in bank Y. Bank Y also keeps 20 percent as liquid money and the remaining 80 percent i.e. 640 will be distributed as loans. Similarly 640 will the initial deposit of any other bank let it be bank Z. This way the sequence would keep going on. This system of credit creation can be clarified with the help of following table.

Table

LIMITATIONS OF CREDIT CREATION BY BANKS

Though banks posses the capacity of credit creation, but it is not unlimited. The limitations of credit creation by banks are as follows:

1 The total amount of cash in the country

Limitations                 2. Volume of primary deposits Limitations

of Credit                     3. Popularity of banking habits of Credit

Creation                     4. Cash Reserve Ratio Creation

By Banks                     5. Deposit with Central Bank by Banks

6.  Situation of Trade and Industry

7. Credit Policy of Central Bank

    8. Basis of Securities

(1) Total Amount of Cash in the Country: The Creation of Credit depends on the availability of cash money in the country. If the Central bank of the country issues paper notes in large amount, the commercial banks will have bigger volume of money and they will be able to create more credit. On the Contrary, if the Central Bank issues less amount of paper money, the credit creation power of banks will be less. Thus cash is the basis of creation of credit.

(2) Volume of Primary Deposits : Banks receive deposit in two ways: Primary deposits and derivative deposits. But the main basis of Credit Creation is the primary or actual deposit. If there will be more primary deposit, there will be more credit creation. On the Contrary, the less would be the primary deposit, the less would be the ability of credit creation.

(3) Popularity of Banking Habits : The credit Creation depends to a large extent on the popularity of banking habit among people. If people use cheque more and more in their transactions there would be more cash deposits with banks and they can create more credit. Opposite to it, if people use cash for most of transactions, there would be less cash deposits with banks and the credit creation ability would reduce.

(4) Cash Reserve Ratio : According to banking regulations, every bank has to keep a certain part of their deposits as Cash reserve. Only the remaining sum can be advanced as loans. Thus if the Cash Reserve Ratio is less then there would be more credit ccreation and in the condition of a higher Cash Reserve Ratic there would be less Credit Creation.

(5) Danasit with Central Bank: Every commercial Bank has to keep a deposits with Central Bank. What part of the deposit should be Intral bank is decided by the Central Bank. This rate is changed the Central bank increases this rate, the credit creation from time to time. When the Central bank increases this rate, the ability of commercial banks decreases because there is less cash because there is less cash availability.

 (6) Situation of Trade and Industry : The development of Trade and Industry in the country also affects the credit creation in the country. The demand of loans by trade and industrial world decreases during economic depression. This lowers down the credit creation ability of banks.

(7) Credit Policy of Central Bank : The Credit policy is determined by the Central Bank of the Country. There is change in it from time to time. The increase or decrease in the credit creation by banks depends to a large extent on the credit policy of the Central Bank. I

(8) Basis of Securities: Loans are given by banks on the basis of Collaterals. The better the collateral, the more will be the credit creation. On the other hand, in the situation of ordinary collateral, there would be less credit creation.

This way, it can be concluded that the banks don’t have the infinite ability of credit creation. But, even within the limits of credit creation banks help in the economic development.

EXERCISE QUESTIONS

 Long Answer Type Questions

1 What do you mean by credit ? Explain the process of credit creation by banks.

2. What is credit creation instrument? Explain the different types of credit instruments.

3. Describe the differences among cheques, bills of exchange and promissory note.

4. “Loans are the children of deposits and deposits are the children of loans.” Explain this statement.

5. How Commercial banks create credit ? State the limitation of credit creation.

Credit Instruments & Credit Creation

Short Answer Type Questions

Write short notes on the following:

1 Crossing of Cueque

2. Bank Draft

3. Bearer Cheque

4. Hundi

5. Treasury Bill,

6. Derivative Deposits

III. Objective Type Questions

Choose the correct option

1 Which Credit instrument contains a condition-fee instruction ?

(a) Cheque

(b) Bill of Exchange

(c) Promissory note

(d) Hundi

2. On drawing two oblique lines on the left top of a cheque, it is called…

(a) Bearer’s Cheque

(b) Order Cheque

(c) Crossed Cheque

(d) None of these

3. Loans are the children of deposits and deposits are the children of loans’. The statement is given by…

(a) Prof. Keynes

(b) Prof. Sayers

(c) Prof. Jevons

(d) Prof. Kinley

4. Which of these credit instruments is written in Native Language ?

(a) Bill of Exchange

(b) Promissory note

(c) Cheque

(d) Hundi

5.Which of the credit instruments is written by the drawee ?

(a) Bill of Exchange

(b) Promissory Note

(c) Hundi

(d) Bank Draft

6. Which of these is a kind of Cheque ?

(a) Bearer’s Cheque

(b) Order Cheque

(c) Crossed Cheque

(d) All of these

7. In which section of Indian Negotiable Instrument Act the Bill of Exchange has been defined ?

(a) Section 3

(b) Section 4

(c) Section 5

(d) None of these

(Ans. : 1. (b), 2. (c), 3. (a), 4. (d), 5. (b), 6. (d), 7. (c).]

State whether the following statements are True or False :

1 Prof. Keynes has said, “Loans are the children of deposits and deposits are the children of loans.”

2. Credit instuments are based on mutual trust.

3. There are three parties of a promissory note.

4. A bill of exchange is not crossed.

5. Crossed cheque is safest cheque.

6. Cheque is a request document.

7. Hundi is a condition free document.

8. Promissory note has 3 days of grace period for payment.

9. The creation of credit depends on the availability of cash money in the country.

10. Treasury bills are issued for raising long-term funds.

[Ans.: 1. True, 2. True, 3. False, 4. True, 5. True, 6. False, 7. True, 8. True, 9. True. 10. False.)