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Credit (from
Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally spoken in the area around Rome, known as Latium. Through the power of the Roman Republic, it became ...

Latin
''credit'', "''(he/she/it)'' believes") is the trust which allows one
party A party is a gathering of people who have been invited by a host A host is a person responsible for guests at an event or for providing hospitality during it. Host may also refer to: Places *Host, Pennsylvania, a village in Berks Cou ...
to provide
money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a ...

money
or
resources A resource is a source or supply from which a benefit is produced and that has some utility. Resources can broadly be classified upon their availability — they are classified into renewable and non-renewable resources. They can also be classif ...

resources
to another party wherein the second party does not
reimburse Reimbursement is the act of compensating someone for an out-of-pocket expense by giving them an amount of money equal to what was spent. Companies, governments and nonprofit A nonprofit organization (NPO), also known as a non-business entity, n ...
the first party immediately (thereby generating a
debt Debt is an obligation that requires one party, the debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to ...

debt
), but promises either to repay or return those resources (or other materials of equal value) at a later date. In other words, credit is a method of making
reciprocity Reciprocity may refer to: Law and trade * Reciprocity (Canadian politics), free trade with the United States of America ** Reciprocal trade agreement, entered into in order to reduce (or eliminate) tariffs, quotas and other trade restrictions on ...
formal,
legally Law is a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to form a unified whole. A system, surrounded and influenced by its environment, is described by its boundari ...
enforceable, and extensible to a large group of unrelated people. The resources provided may be
financial Finance is a term for the management, creation, and study of money and investments. Pamela Drake and Frank Fabozzi (2009)What Is Finance?/ref> Specifically, it deals with the questions of how an individual, company or government acquires money ...

financial
(e.g. granting a
loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...
), or they may consist of goods or services (e.g. consumer credit). Credit encompasses any form of deferred payment. Credit is extended by a
creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

creditor
, also known as a
lender A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

lender
, to a
debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series ...
, also known as a
borrower A debtor or debitor is a legal entity, legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counter ...

borrower
.


Etymology

The term "credit" was first used in English in the 1520s. The term came "from Middle French crédit (15c.) "belief, trust," from Italian credito, from Latin creditum "a loan, thing entrusted to another," from past participle of credere "to trust, entrust, believe". The commercial meaning of "credit" "was the original one in English (creditor is
rom Rom, or ROM may refer to: Biomechanics and medicine * Risk of mortality The risk of mortality (ROM) provides a medical classification to estimate the likelihood of inhospital death for a patient. The ROM classes are minor, moderate, major, and ex ...

rom
mid-15c.)" The derivative expression "
credit union A credit union, a type of financial institution similar to a commercial bank, is a member-owned financial cooperative, controlled by its members and operated on a not-for-profit basis. Credit unions generally provide services to members simila ...
" was first used in 1881 in American English; the expression "
credit ratingA credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor Default (financ ...

credit rating
" was first used in 1958.


History

Credit cards became most prominent during the 1900s. Larger companies began creating chains with other companies and used a credit card as a way to make payments to any of these companies. The companies charged the cardholder a certain annual fee and chose their billing methods while each participating company was charged a percentage of total billings. This led to the creating of credit cards on behalf of banks around the world. Some other first bank-issued credit cards include Bank of America's Bank Americard in 1958 and American Express' American Express Card also in 1958. These worked similarly to the company-issued credit cards; however, they expanded purchasing power to almost any service and they allowed a consumer to accumulate revolving credit. Revolving credit was a means to pay off a balance at a later date while incurring a finance charge for the balance.


Discrimination

Until the Equal Credit Opportunity Act in 1974, women in America were given credit cards under stricter terms, or not at all. It could be hard for a woman to buy a house without a male co-signer. In the past, even when not explicitly barred from them, people of color were often unable to get credit to buy a house in white neighborhoods.


Bank-issued credit

Bank-issued credit makes up the largest proportion of credit in existence. The traditional view of banks as intermediaries between savers and borrowers is incorrect. Modern banking is about credit creation. Credit is made up of two parts, the credit (
money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a ...

money
) and its corresponding
debt Debt is an obligation that requires one party, the debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to ...

debt
, which requires repayment with
interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...

interest
. The majority (97% as of December 2013) of the money in the UK economy is created as credit. When a bank issues credit (i.e. makes a loan), it writes a negative entry in to the liabilities column of its balance sheet, and an equivalent positive figure on the assets column; the asset being the loan repayment income stream (plus interest) from a credit-worthy individual. When the debt is fully repaid, the credit and debt are canceled, and the money disappears from the economy. Meanwhile, the debtor receives a positive cash balance (which is used to purchase something like a house), but also an equivalent negative liability to be repaid to the bank over the duration. Most of the credit created goes into the purchase of land and property, creating inflation in those markets, which is a major driver of the
economic cycle The business cycle, also known as the economic cycle or trade cycle, are the fluctuations of gross domestic product Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced in a s ...

economic cycle
. When a
bank A bank is a financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), stat ...

bank
creates credit, it effectively owes the money to itself. If a bank issues too much bad credit (those debtors who are unable to pay it back), the bank will become
insolvent In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to comp ...
; having more liabilities than assets. That the bank never had the money to lend in the first place is immaterial - the
banking license A banking license is a legal prerequisite for a financial institution Financial institutions, otherwise known as banking institutions, are corporations that provide services as intermediaries of financial markets. Broadly speaking, there are ...
affords banks to create credit - what matters is that a bank's total assets are greater than its total liabilities and that it is holding sufficient liquid assets - such as cash - to meet its obligations to its debtors. If it fails to do this it risks
bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' par ...

bankruptcy
or banking license withdrawal. There are two main forms of private credit created by banks; unsecured (non-collateralized) credit such as consumer
credit card #REDIRECT Credit card #REDIRECT Credit card A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's promise to the card issuer to pay them for ...

credit card
s and small unsecured loans, and secured (collateralized) credit, typically secured against the item being purchased with the money (house, boat, car, etc.). To reduce their exposure to the risk of not getting their money back (credit
default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It ...
), banks will tend to issue large credit sums to those deemed credit-worthy, and also to require
collateral Collateral may refer to: Business and finance * Collateral (finance) In loan agreement, lending agreements, collateral is a Borrower, borrower's pledge (law), pledge of specific property to a lender, to Secured loan, secure repayment of a loan. ...
; something of equivalent value to the loan, which will be passed to the bank if the debtor fails to meet the repayment terms of the loan. In this instance, the bank uses the sale of the collateral to reduce its liabilities. Examples of secured credit include consumer mortgages used to buy houses, boats, etc., and PCP (personal contract plan) credit agreements for automobile purchases. Movements of
financial capital Financial capital (also simply known as capital or equity in finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contra ...
are normally dependent on either credit or
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the differe ...

equity
transfers. The global credit market is three times the size of global equity. Credit is in turn dependent on the reputation or
creditworthiness A credit risk is risk of default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they ope ...
of the entity which takes responsibility for the funds. Credit is also traded in
financial market A financial market is a market (economics), market in which people trade financial Security (finance), securities and derivative (finance), derivatives at low transaction costs. Some of the securities include stocks and Bond (finance), bonds, ra ...
s. The purest form is the
credit default swap A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default Default may refer to: Law * Default (law), the failure to do something required by law ** Defaul ...
market, which is essentially a traded market in credit insurance. A credit default swap represents the price at which two parties exchange this
risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to ...

risk
the protection ''seller'' takes the risk of default of the credit in return for a payment, commonly denoted in
basis point A basis point (often abbreviated as bp, often pronounced as "bip" or "beep") is (a difference of) one hundredth of a percent or equivalently one percent of one percent or one ten thousandth. A very rarely used term, permyriad, means parts per te ...
s (one basis point is 1/100 of a
percent In mathematics Mathematics (from Greek: ) includes the study of such topics as numbers ( and ), formulas and related structures (), shapes and spaces in which they are contained (), and quantities and their changes ( and ). There is no ...

percent
) of the notional amount to be referenced, while the protection ''buyer'' pays this premium and in the case of default of the underlying (a loan,
bond Bond or bonds may refer to: Common meanings * Bond (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of ...
or other receivable), delivers this receivable to the protection seller and receives from the seller the paramount (that is, is made whole).


Types

There are many types of credit, including but not limited to bank credit,
commerce Commerce is the exchange of goods and services, especially on a large scale. Etymology The English-language word ''commerce'' has been derived from the Latin word ''commercium'', from ''com'' ("together") and ''merx'' ("merchandise"). History ...

commerce
, consumer credit,
investment credit A tax credit is a tax incentive A tax incentive is an aspect of a country's tax code designed to incentive, incentivize or encourage a particular economic activity by reducing tax payments for a company in the said country. Tax incentives can ha ...
, international credit, public credit


Trade credit

In commercial
trade Trade involves the transfer of goods from one person or entity to another, often in exchange for money. Economists refer to a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of r ...

trade
, the term "
trade credit Trade credit is the loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to ...
" refers to the approval of delayed payment for purchased goods. Credit is sometimes not granted to a buyer who has financial instability or difficulty. Companies frequently offer trade credit to their customers as part of terms of a purchase agreement. Organizations that offer credit to their customers frequently employ a credit manager.


Consumer credit

Consumer credit can be defined as "money, goods or services provided to an individual in the absence of immediate payment". Common forms of consumer credit include
credit card #REDIRECT Credit card #REDIRECT Credit card A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's promise to the card issuer to pay them for ...

credit card
s, store cards, motor vehicle finance, personal loans (
installment loanAn installment loan is a type of agreement or contract A contract is a legally binding document between at least two parties that defines and governs the rights and duties of the parties to an agreement. A contract is legally enforceable becaus ...
s), consumer lines of credit,
payday loan A payday loan (also called a payday advance, salary loan, payroll loan, small dollar loan, short term, or cash advance loan) is a short-term unsecured loan In finance Finance is the study of financial institutions, financial markets and ...

payday loan
s, retail loans (retail installment loans) and
mortgages A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a ...
. This is a broad definition of consumer credit and corresponds with the Bank of England's definition of "Lending to individuals". Given the size and nature of the mortgage market, many observers classify mortgage lending as a separate category of personal borrowing, and consequently, residential mortgages are excluded from some definitions of consumer credit, such as the one adopted by the U.S. Federal Reserve. The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has to pay. It includes
interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...

interest
, arrangement fees and any other charges. Some costs are mandatory, required by the lender as an integral part of the credit agreement. Other costs, such as those for
credit insuranceCredit insurance refers to several kinds of insurance relating to financial Credit (finance), credit: *Trade credit insurance, purchased by businesses to insure payment of credit ''extended by'' the business *Payment protection insurance, purchased ...
, may be optional; the borrower chooses whether or not they are included as part of the agreement. Interest and other charges are presented in a variety of different ways, but under many legislative regimes lenders are required to quote all mandatory charges in the form of an
annual percentage rate 279px, Parts of total cost and effective APR for a 12-month, 5% monthly interest, $100 loan paid off in equally sized monthly payments. The term annual percentage rate of charge (APR), corresponding sometimes to a nominal APR and sometimes to an e ...
(APR). The goal of the APR calculation is to promote "truth in lending", to give potential borrowers a clear measure of the true cost of borrowing and to allow a comparison to be made between competing products. The APR is derived from the pattern of advances and repayments made during the agreement. Optional charges are usually not included in the APR calculation. Interest rates on loans to consumers, whether mortgages or credit cards are most commonly determined with reference to a
credit score A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness A credit risk is risk of default (finance), default on a debt that may arise from a borrower failing to make requi ...
. Calculated by private credit rating agencies or centralized credit bureaus based on factors such as prior defaults, payment history, and available credit, individuals with higher credit scores have access to lower APRs than those with lower scores.


Statistics


See also


References

* Logemann, Jan, ed. (2012). ''The Development of Consumer Credit in Global Perspective: Business, Regulation, and Culture''. New York: Palgrave Macmillan. .


External links

{{Authority control Debt