Credit and Collection: Sources of Credit (Notes)

SOURCES OF CREDIT

  • CREDIT AND COLLECTION (FMPM 2) – Overview of sources of credit and the principles governing credit operation.
  • LEARNING OBJECTIVES (from the slides):
    • List the different sources of credit.
    • Describe the principles governing credit operation.
    • Identify the different government financing institutions.

FINANCIAL INTERMEDIARIES

  • Financial intermediaries are entities whose role is to connect lenders and borrowers through credit instruments and markets, acting as middlemen.

  • Typical functions of credit institutions:

    • Pool the savings of lending customers.
    • Invest the funds carefully through credit analysis and investigation.
    • Diversify risk beyond what individual investors can achieve.
    • Transform short-term funds into long-term funds by staggering maturities.
    • Perform insurance and trust functions.

  • Important caveat: not all credit institutions perform all listed functions. For example, savings banks and commercial banks are often restricted by law from certain investments (e.g., buying industrial stock).

  • The following are among the most important sources of credit in the country:

    • Financing companies (Non-bank financing entities).
    • Investment houses (investment banks).
    • Commercial banking sector.
    • Savings and mortgage banking.
    • Rural banks.

FINANCIAL INSTITUTIONS (DEFINITIONS AND REGULATION)

Finance and credit institutions under the Financing Company Act

  • According to Republic Act No. 5980 (Financing Company Act): financing companies are corporations or partnerships (excluding those regulated by the Bangko Sentral ng Pilipinas, the Insurance Commissioner, and the Cooperatives Administration Office) organized to extend credit to consumers and industrial, commercial, or agricultural enterprises by:
    • discounting or factoring commercial papers or accounts receivable,
    • buying/selling contracts, leases, chattel mortgages, or other evidence of indebtedness,
    • leasing motor vehicles, heavy equipment, and industrial machinery, business/office machines and equipment, appliances, and other movable property.
  • Term: financing companies focus on consumer and business financing through various instruments, not banks per se.

What counts as "credit" (definition by financial institutions)

  • Credit includes:
    • any loan, mortgage, deed of trust, advance, or discount,
    • any conditional sales contract, any contract to sell (or sale) of property or service where part or all of the price is payable after the sale,
    • any rental-purchase contract,
    • any option, demand, lien, pledge, or other claim against or for the delivery of property or money, any purchase, or other acquisition.
  • Expressed as: ext{Credit} = ext{loans, mortgages, deeds, advances, discounts, contracts to sell, etc.}

Assignment of Credit and discounting rules

  • In assignments of credit or the buying of installment papers/accounts receivable by financing companies, the purchase discount (exclusive of interest and other charges) shall be limited to:
    • 14\% of the value of the credit assigned or the value of the installment papers, accounts receivable, or other evidence purchased, based on a period of 12\text{ months} or less,
    • and to 1\frac{1}{6}\% for each additional month or fraction beyond twelve months.
  • This means for a term of n months (n > 12), the discount rate is: 14\% + (n-12)\times\frac{7}{6}\%.

Factoring (accounts receivable) discount rates

  • For factoring accounts receivable or other pieces of evidence of indebtedness, the discounting rate shall not exceed:
    • 2\% of the value of the credit assigned or receivable purchased for every 30\ days, regardless of terms.

PHILIPPINE FINANCE COMPANIES

  • Rationale: In response to business and industry needs (and some individual needs), several corporations were organized to provide a wide range of corporate financing services, including:
    • machinery and equipment financing and leasing,
    • accounts receivable and inventory financing,
    • land development and real estate financing,
    • commercial, industrial, and agricultural loans,
    • motor vehicle financing,
    • sales and installment financing,
    • small and medium business financing,
    • import–export financing,
    • money market placements, and other related services.
  • Example: Philippine Finance Companies (PHILIPPINE FINANCE COMPANIES) – focus on financing and related services.

Capital and professional standards

  • Financing companies usually rely on stockholders’ funds plus cash generated from money market activities.
  • They are generally authorized to finance consumer durables under installment plans and to extend short-term credit to manufacturers and merchants for inventory financing.
  • Industry self-regulation: many groups have formed a code of ethics through associations (e.g., Philippine Association of Finance Companies).

INVESTMENT HOUSES (INVESTMENT BANKS)

  • Investment houses are typically non-bank financial intermediaries focused on capital mobilization for long-term projects.

  • They transfer capital from savers to those needing funds for long-term projects and activities, and they operate outside the traditional deposit-taking banking model.

  • They participate in underwriting, loans and equity investments, money market operations, and issue their own promissory notes.

  • They also develop industrial projects, conduct industry studies, and offer advisory services.

  • Through these activities, investment houses convert savings into productive capital, contributing to economic development.

  • Underwriting (special role):

    • Underwriting allows investment houses to guarantee distribution of government or corporate securities.
    • They can underwrite on a:
    • Best-effort basis: sell as much as publicly available; unsold shares may be returned to issuer; commission paid to the underwriter.
    • Firm basis: guaranteed purchase of all shares offered; if unsold, the underwriter must buy them.

  • Money market operations: investment houses act as dealers/brokers to buy short-term notes for clients or to facilitate intermediation between buyers and sellers, establishing purchase and offering prices to ensure competitive pricing for buyers and sellers.

  • Local history: development of local investment banking began in the 1960s with institutions such as the House of Investment, the Private Development Corporation of the Philippines (PDCP), Bancom Development Corporation (BDC), and CCP Securities Corporation (now Ayala Investment and Development Corporation, AIDC).

  • Regulation and governance:

    • Investment Houses are governed by Presidential Decree No. 129 (as amended by PD No. 590), known as the Investment Houses Law.
    • They are organized as stock corporations with a minimum paid-in capital of P20{,}000{,}000.
    • They coordinate their credit policies with the Monetary Board of the Bangko Sentral ng Pilipinas (BSP).
    • They may be subject to BSP or other non-bank financial intermediary regulations under RA 337 (General Banking Act), Section 2-B, as amended (including but not limited to rules on minimum fund acceptance, marketing/distribution methods, terms of placement/maturities, and uses of funds).
    • The Monetary Board can authorize quasi-banking functions with additional regulatory constraints (liquidity reserves, capital-to-risk-weighted assets, interest rate ceilings, etc.).

INVESTMENT HOUSES: PURPOSES AND FUNCTIONS

  • Emergence of investment houses introduced a new era of capital resource intermediation and sophistication in capital mobilization.
  • They function as money middlemen between individuals/institutions with money to invest and those needing funds for business expansion.
  • Core activities include:
    • Underwriting and distribution of government and corporate securities.
    • Direct investments in loans and equity.
    • Money market operations and advisory services to industrial projects.
    • Development studies and industry analyses to guide investments.
  • Through underwriting and market operations, they channel savings into productive investments, supporting corporate growth and economic development.

COMMERCIAL BANKING

  • Historical context:

    • Obras Pias (charitable religious endowments) in Spanish rule era served as early credit institutions, funded by charitable donors.
    • The first commercial bank in 1851 was the Banco Espanol-Filipino (evolving into Bank of the Philippine Islands).
    • Other early banks included Chartered Bank of India, Australia and China (1873) and Hongkong and Shanghai Banking Corporation (1875).
    • Post-war banking was revitalized with Rehabilitation Finance Corporation (RFC), which absorbed government-owned Agriculture and Industrial Bank and aided rehabilitation and expansion.

  • Definition and core capabilities of a commercial banking corporation (per General Banking Act concepts):

    • A commercial banking corporation accepts or creates demand deposits subject to withdrawal by check.
    • It has powers necessary to carry on commercial banking activities: discounting and negotiating negotiable instruments, issuing letters of credit, receiving deposits, buying/selling foreign exchange and bullion, and lending money on secured or unsecured terms.
    • It may lend against real estate with maturities typically not exceeding 15 years; home-building loans may extend up to 20 years.

  • Constraints on real estate lending:

    • Loans secured by real estate and first mortgages on real estate with long maturities generally have maximum terms and risk-based limits.
    • For real estate loans, total liabilities linked to such loans must not exceed 15\% of unimpaired capital and surplus, unless specific conditions apply.

  • Money creation and deposits:

    • Commercial banks hold customer checking accounts (demand deposits).
    • Demand deposits constitute money, enabling banks to create money by making claims against themselves in favor of borrowers/sellers of assets.

  • Distinction from non-bank lenders:

    • Savings banks largely rely on investment operations and deposits and do not inherently create money; they are intermediaries.
    • Commercial banks can create money via demand deposits tied to lending activity.

  • Liability constraints (typical framework):

    • Total liabilities to borrow money shall, under normal conditions, be limited relative to unimpaired capital and surplus (e.g., 15% limits, with additional secured liabilities constraints). The exact limits can be subject to Monetary Board prescriptions and non-risk asset classifications.

  • Line of credit (credit facilities):

    • A line of credit is an open-ended advance commitment by the bank to lend up to a specified maximum.
    • Banks require ongoing information about the borrower's operations and financial condition to keep the line open.
    • Example: A line of credit of P300{,}000 for a shoes manufacturer could allow borrowing up to P300{,}000, but actual draws may be lower (e.g., P100{,}000) depending on need; the bank expects utilization to sustain the line.
    • Typical terms: loans under the line are usually repaid within one year; borrowers should stay free of debt for at least 30 days to keep the line in good standing.

  • Loan agreements (non-line-of-credit arrangements):

    • Revolving credit: borrow, repay, borrow again within a defined period (e.g., 2–5 years) up to an approved maximum.
    • Term loans: for acquisition of facilities (machinery, equipment, furnishings, etc.) used for working capital; typical maturities 2–10 years; amortized via installments.
    • Stand-by commitments: provide a guarantee of term loans under specified terms when needed.

  • Summary of practical distinctions:

    • Line of credit provides flexibility for continuous but limited credit usage.
    • Revolving credit offers frequent borrowing and repayment within a fixed limit and period.
    • Term loans fund specific asset purchases or working capital with fixed maturities.

SAVINGS AND MORTGAGE BANKING

  • Definition: a savings and mortgage bank is a corporation designed to accumulate the savings of depositors and invest them along with capital in bonds or loans secured by bonds, real estate mortgages, or other securities, or in long-term personal financing programs (home building and development).
  • Loans and investments (typical categories):
    • (a) Loans secured by savings deposit obligations, mortgage and chattel mortgage bonds, or other savings obligations of Philippine banks.
    • (b) Medium-term loans (up to 3 years) for cattle, carabao, and other animal rearing; secured by a lien on animals; may require real estate or other securities; livestock-loan collateral rules:
    • Livestock loan may be secured by lien on real estate worth 70% of the loan or more, in which case additional real estate lien is not required.
    • The loan cannot exceed 50% of the commercial value of the livestock at the time of the loan, with up to 50% additional loans allowed if stock value increases.
    • (c) Equipment loans up to 5 years for fertilizers, instruments, machinery, and other moveable equipment used to produce/handle agricultural/industrial products; asset-based lien on equipment; may require a real estate mortgage for 70% of appraised value if a mortgage is used instead of a lien on equipment.
    • (d) Mortgage loans up to 10 years for the conservation, enlargement, or improvement of productive properties, or for the acquisition of machinery; secured by a first mortgage.
    • (e) Real estate mortgage loans up to 20 years for rural/urban property development, refinancing, and related purposes; secured by a first mortgage.
    • (f) High-grade bonds and other debt instruments, and loans secured by such obligations; allowed up to 10\% of total assets.
    • (g) Drafts, bills of exchange, acceptances, or notes arising from current transactions endorsed/accepted by a solvent Philippine bank; total investments in this class not to exceed 10\% of the bank’s net worth.
  • Equity investments and related governance:
    • Equity investments in single enterprises generally must remain a minority holding; investments in other banks require Monetary Board approval and must be deducted from net worth for net worth-to-risk assets ratio calculations.
    • Equity investments in non-related activities are not permitted.
  • Existing banks and special allowances:
    • Savings and mortgage banks operating before the act that engage in jewelry/precious stones lending may continue to do so (Monte de Piedad is a primary beneficiary).
    • This existing right to lend against jewelry is considered an acquired right.

RURAL BANKS

  • Definition and origin:
    • Rural banks are sometimes referred to as agricultural banks; the term reflects their focus on rural areas.
  • Legal framework:
    • Rural Banks are governed by the Rural Bank Act (Republic Act No. 720).
  • Purpose and significance:
    • Intended to meet credit needs of borrowers in rural areas by providing easier access to financial services at reasonable terms.
  • Significance and objectives:
    • Accessibility: Bring banking services closer to rural populations who previously relied on money lenders or travelled to urban centers.
    • Financial relief: Reduce exposure to usurious lending and informal lenders.
    • Support productive activities: Promote cooperatives and cottage/small-scale industries.
  • Objectives (reiterated):
    • Provide credit to rural borrowers who need convenient, accessible loans.
    • Combat usurious lending practices.
    • Support productive activities and cooperative development in rural communities.
  • Financial assistance and loan coverage (rural banks):
    • Promote balanced growth in rural areas by channeling loanable funds to small businesses and essential rural enterprises within regulatory limits.
    • Loan coverage categories include small farmers, farm families cultivating up to 50 hectares, cooperatives, and small rural merchants.
  • Security and eligibility for loans:
    • Lands without Torrens title: loans may be granted where the owner has peaceful, continuous possession for over 5 years.
    • Lands under sales contracts: includes lands under administration of the Bureau of Lands/Land Authority where the purchaser has paid at least 5 years of installments.
    • Homesteads and free patent lands: loans allowed pending title issuance but approved by relevant government authorities.
  • Technical assistance and development role:
    • Rural banks provide technical assistance to small business enterprises and farm operators on credit utilization for production/marketing.
    • Coordination with supervisory/government agencies to improve program effectiveness.
  • Role in economic development:
    • Accelerate economic development by providing adequate and timely credit to government programs (e.g., agrarian reform, food production, cooperative movement, cottage/small-scale industries).
    • Uses an integrated approach to address multiple economic needs.
  • Impact on the banking system:
    • The establishment of rural banks is a milestone, making banking services more accessible and better understood in rural communities.

ADDITIONAL CONTEXT: POLICY, ETHICS, AND PRACTICAL IMPLICATIONS

  • Ethical and professional implications:
    • Regulation and supervision are essential to maintain trust, protect depositors, and ensure prudent lending.
    • Philippine associations (e.g., Philippine Association of Finance Companies) promote ethical codes of conduct within the finance industry.
  • Real-world relevance:
    • Financial intermediaries and credit sources play a pivotal role in funding households, manufacturing, agriculture, and infrastructure projects.
    • Regulation shapes how much credit can be extended and under what terms, influencing economic growth and financial stability.
  • References to government policy instruments:
    • Investment Houses Law (Presidential Decrees No. 129 and 590).
    • General Banking Act (RA No. 337) as amended.
    • Rural Bank Act (RA No. 720).
    • Monetary Board regulations via the Bangko Sentral ng Pilipinas.

SUMMARY OF KEY NUMBERS AND FORMULAE

  • Discounting via assignment of credit (12 months or less): 14\% of credit value.
  • Discounting via assignment of credit (beyond 12 months): 14\% + (n-12)\times\frac{7}{6}\% where n is the number of months.
  • Factoring discount rate: 2\% per 30\text{ days} (every 30 days).
  • Capital requirements for Investment Houses: minimum paid-in capital = P20{,}000{,}000.
  • Liabilities limits for commercial banks (typical, subject to regulations): up to 15\% of unimpaired capital and surplus; additional liabilities up to another 15\% with collateral backed by assets (e.g., shipping documents, warehouse receipts) and other criteria (as determined by the Monetary Board).
  • Real estate and related lending limits: maturities and terms vary; generally, real estate loans may have long maturities, with risk controls.
  • Asset mix and investment caps for Savings and Mortgage Banks:
    • High-grade bonds and similar instruments: ≤ 10\% of total assets.
    • Collateral Trust Bonds/Notes: governed by specific limits (e.g., bonds/notes not exceeding 15% of bank net worth for certain collateral structures).
  • Equity investments: generally minority holdings for single enterprises; investments in other banks require approval and must be deducted from net worth for risk-weighted asset calculations.

CONNECTIONS TO PREVIOUS AND FUTURE TOPICS

  • Foundations of financial intermediation: how intermediaries gather savings, assess credit, and allocate funds to productive uses.
  • The regulatory environment links to risk management, consumer protection, and financial stability.
  • The role of rural banks demonstrates how financial inclusion supports national development goals and agricultural productivity.
  • The evolution from traditional banking to investment banking and modern non-bank finance illustrates diversification of financing channels for the economy.

PRACTICAL APPLICATIONS AND SAMPLE QUESTIONS

  • Identify which credit source is best suited for a given scenario (e.g., small rural farmer vs. large corporate expansion).
  • Explain the difference between a line of credit and a revolving credit facility, including typical terms and when each is preferred.
  • Describe how a savings and mortgage bank funds its lending and the kinds of assets it is allowed to hold.
  • Discuss the regulatory constraints on commercial banks’ liability exposures and how collateral can affect lending limits.
  • Analyze the social and economic rationale for rural banks and how they can impact rural development and agriculture.

REFERENCES AND CLOSING

  • Credit and Collection (FMPM 2) – Flores, MARIVIC F., DBA (2023).

  • Slide deck excerpts include: RA 5980 (Financing Company Act), RA 337 (General Banking Act), PD No. 129 (Investment Houses Law), PD No. 590 (amendment to Investment Houses Law), Rural Bank Act (RA 720), and BSP regulatory guidelines.

  • Motivation quote: "Motivation gets you going, but discipline keeps you growing." — John C. Maxwell

ACKNOWLEDGEMENTS

  • Thank you for studying these notes. If you want, I can tailor a condensed cheat-sheet for quick review or expand any section with worked examples.