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Classification of credit

The major sources of credit can be classified into institutional or formal and non-institutional sources.

Non-Institutional

The non-institutional or informal sources are those which do not have any uniformity in their lending procedure, their interest rate or their collateral requirement. Loan from such sources are usually made directly to the borrower by the lender and are prevalent in areas where individuals are quite familiar with and share confidence in one another. In other words, the lender knows the borrower and reasonably vouch-safe for his (borrower’s) integrity. The relative ease of obtaining the loans devoid of administrative delays, non-insistence by the lender on security or collateral from the borrower and flexibility built into repayment programmes has made the non-institutional sources very popular among the peasant farmers. Non-institutional sources however have such limitations as smallness of loan, high interest rates etc. Notable examples under this source include

  1. Merry go rounds

These are funds to which a group of individuals sharing common characteristic make a contribution of a fixed amount of money, handed to one person. Each member is able to make use of the money in turn, making allowance for a member in dire need of a loan or advance. These are granted without interest payment.

  1. Money Lenders

These people usually make their money outside the rural community but later settle down in villages giving loans to farmers at exorbitant interest rates. Some farmers who pledge their lands, crops and buildings have lost them due to their inability to pay the high interest rates charged on the principal when due.

  1. Friends and Relatives

This is part of cultural heritage whereby the prosperous help their less fortunate relatives and friends with loans. In some cases, the loan is not collected back.

Institutional Sources

The institutional sources are those recognized institutions which follow standardized procedures of lending. They lend at regulated interest but normally require some collateral. The loans from this source are always large compared with those obtained from non-institutional sources. Under this sources include

  1. Cooperatives

Formal cooperatives can be regarded as a transition or an interphase between formal and informal credit sources. Cooperatives especially savings and credit cooperatives (SACCOS) also play an important role in saving.

  1. Commercial Banks

These are institutions set up by the government or group of private individuals with the aim of accepting savings and deposit from members of the public as well as granting them credit whenever they are in need. Those farmers who keep their money in such banks may be able to get loan from the bank. But due to the inability of most farmers to offer suitable collateral security coupled with the risky and uncertainty nature of agricultural business, commercial banks often prefer to lend to borrowers engaged in non – agricultural ventures which are less prone to risk and uncertainty.

  1. Specialised Banks

These are institutions specially set up to meet the need of a particular sector of the economy. For instance, the Agricultural Finance Corporation (AFC) was specifically established to cater for the agricultural sector of the economy.

 

Classification of credit

Credit can be classified on the basis of time, purpose, security, lenders and borrowers.

Classification on the basis of time

This classifies credit into three major areas as short, medium and long-term.

  1. Short-term Loans

The short- term loans are generally advanced to meeting annual recurring purchases like seeds, feeds, fertilizers, hired labour, expenses on herbicides, pesticides and machinery service charges. It is therefore termed “seasonal loans or production loans or crop loans” and it is usually expected that the loans (principal) and the interest would be repaid through the income received through the enterprise in which it is invested. Time limit to repay such a loan is usually one year or at most 18 months.

  1. Medium-term Loans

Are advanced for comparatively longer span assets like machines, wells, threshers, sheds for livestock, shelter, farm structures, irrigation structures etc. The returns accrued from the use of such assets are usually spread over more than one production season. Repayment period spans between 15 months and 5 years.

  1. Long-term Loans

These are related to long life assets like land, farm buildings construction of permanent drainages or irrigation system etc which require large sum of money as initial investment. Benefits generated through such assets are spread over the entire life span of the asset. Repayment period ranges from 5 years to 20 years.

Classification according to Purpose of the Loan

Credit could be classified based on the purpose of the loan such as crop loan, poultry/dairy/piggery loan, machinery and equipment loan, forestry loan, fishery loans etc. This type of loan signifies relationship between time of usage and the rate of returns (profitability).Sometimes loans could be classified as “production loan” or “consumption loan”

Classification according to Security offered

Loans can be classified as secured and unsecured loans. Securities are usually advanced against tangible assets like land, livestock or any capital asset, as either medium or long term loans. Note that credit worthiness may sometimes count much more than the security offered, which if doubtful, may result in wilful default. Secured loans can be further classified on the basis of the type of security offered as:

(i) Mortgage loans: Where legal mortgage of tangible and intangible properties like land, land improvement and other infrastructures are offered.

(ii) Hypothecated loans: Where legal ownership of assets e.g. machinery and equipment, financed remains with the lender though physically possessed by the borrowers.

Classification according to the Lenders

Classified as Institutional and non-institutional credit.

Classification according to Borrowers

Credit can be classified on the basis of the borrower as producers, business concerns etc. Such classification has equity considerations.

Credit instruments

Promissory Note

A promissory note is the primary legal document in most loan contract. It is the written promise of the borrower to repay the loan. When advancing loan funds, the lender receives in exchange a note signed by the borrower promising to pay the lender a certain stated principal with interest on a certain date as specified in the note. The dominant position of the note in all credit transactions should be clearly understood. There may be tendency to overlook this small form that has much less printed matter that many other legal document, but such an oversight may prove costly, since the borrower’s signature at the bottom of a note is a direct obligation holding the borrower liable for payment of the loan according to the stated terms. In case of default and failure of the proceeds from sale of the collateral to cover the amount due, the borrower usually is till liable for the unpaid balance, and the lender may have other non exempt property of the borrower sold to satisfy the deficiency. If the lender requires an additional signature on the note a common condition where the borrower is a young farmer with little capital the co signer should study the provisions of the note as carefully as if acting as the borrower, since in effect the co signer is liable for the payment if the borrower defaults. Notes may be unsecured or they may be secured by real property, personal property or both.

Mortgages

This is ranked second to the promissory note. It is not only an additional note but a complement. A mortgage is a list of certain property set aside to guarantee the payment of a loan which is set in a promissory note. Mortgages are identical to promissory note in their chief provisions. They are also sometime called indentures. The mortgage in addition to identifying the property to back up the promissory note contains provisions which establish a priority of claims among lenders according to the filling or according the mortgage in a court of law. Sometimes a bond and not a promissory note accompanies the mortgage but the general effect is the same. The transaction will be publicized so that other lenders and other members of the public will know about it.

There are several types of mortgages

  1. Real Estate Mortgage: Real estate in law is land and laded property. The important feature of real-estate mortgage is the unchanging character of the security.
  2. Chattel Mortgage: These are mortgage on movable property such as animals.

Purchase on Contract

This is sometime simply referred to as hire purchase contract. This involves the transfer of the property to the buyer or the purchaser while with the title of the property remains with the seller until the last instalment is paid. Hence purchase on contract is sometimes referred to as conditional sales contract.

References

Finlay, S. (2009). Consumer Credit Fundamentals (2nd ed.). Palgrave Macmillan

Logemann, Jan, ed. (2012). The Development of Consumer Credit in Global Perspective: Business, Regulation, and Culture. New York: Palgrave Macmillan. ISBN 978-0-230-34105-0

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