Lecture 9

INSTRUMENTS OF CREDIT“A promise to pay in future is called credit.”Prof. D.G.Locket:

When a person obtain loan on the security of his property and takes the responsibility for its payment in future is called “Credit.”Credit Instruments:

With the extension in business, the expansion in money system was essential. Because, the metallic money and currency notes were not enough to meet the business requirements. So,

1Operation of Banks & Financial Institutions

such instruments were issued to the deficiency of money, which were not moneybut had the characteristics of money because of their purchasing power. Thus, such instruments which are not actual money but serve as money and perform all its functions, are called as credit instruments. E.g: Cheque, Bills of exchange etc.

In other words, when businessman purchases goods from another person on credit then he gives his creditor a deed, which explains the transaction including the amount and the date of promised payment. This deed or instrument is called credit instrument. 2Operation of Banks & Financial Institutions

Features of Credit InstrumentsThere are following main features of credit instruments.1.In Writing:

Credit instrument are only acceptable in wriiten form.2.Unconditional:

Generally, credit instrument are used for the purpose of unconditional receipts and payments.

3.Substitute of Money:The credit instruments can be used in place


of money, because they perform the functions of money in business dealings.4.Necessary for Foreign Trade:

Imports & exports depends upon the availability of credit instruments. For example in the absence of commercial letter of credit, foreign trade is almost impossible.5.Proof of Debt:

All credit instruments can be presented as a token of legal proof of debt.


6. Reduces Risk and Loss:Carrying large amounts of cash is risky, but credit instruments have reduced this risk.

7. Saves Time and Labour:Credit instruments save time and labour in settlement of debts not only within the country but also outside the country.

8. Facilitates Trade:Credit instruments facilitates the trade, because people can buy and sell goods without paying cash at the spot. They can pay the amount


due after a certain period of time.9.Promoting Banking Activities:

Wide use of credit instrument makes the major contribution in promoting the banking business in the economy.


Kinds of Credit InstrumentThere are following two types of credit instruments.1.Negotiable Instruments:

These are such instruments whose rights can be transferred to any other person. The rights of these instruments are transferred only by endorsement. A person who takes the negotiable instrument in good faith becomes the true owner even if he has not received it from true owner. The Negotiable Instrument Act 1881, recognizes three instruments as negotiable are as under; 7Operation of Banks & Financial Institutions

i. Promissory Noteii. Bills of Exchangeiii. Cheque2. Non-Negotiable Instruments:

These are such instruments whose rights cannot be transferred to any other person, for example: Banker’s letters of credit, pay order etc.


1. Negotiable Instruments:Following are the important negotiable

instruments;I. Cheque:

A cheque may be defined as written order of a depositor upon a bank to pay to or to the order of a designated party or to bearer, a specified sum of money on demand.

Dr. Hart: A cheque is an unconditional order in writing, drawn on a specified bank, signed by 9Operation of Banks & Financial Institutions

drawer, directing the bank to pay him on demand a certain sum of money or to a certain person.In Other Words:

A cheque is a written order by which the customer requires his bank to repay the money which has been deposited with him or in other words, a cheque is a document which is used to withdraw money from the bank.


Parties of ChequeThere are following three main parties of the cheque.i.Drawer:

Drawer is one who draws a cheque and directs the bank for the payment of specified amount to specified person.ii.Drawee:

it is that particular branch of bank upon which the cheque is drawn for payment.


iii. Payee:The person who receives the specified amount written on cheque. It may be drawer or any body else.

Example:Suppose, Imran draws a cheque on Habib Bank,

UAF Branch FSD and gives to Ali. Here, Imran is drawer. Habib bank UAF Branch is drawee. Ali is payee.


Other Parties:i.Holder of the Cheque:

He is a person who holds the cheque and has the legal right to receive the amount of the cheque.ii.Endorser:

He is a person who signs on the back of the cheque to transfer it to any other person.iii.Endorsee:

He is a person in whose favour the cheque is transferred. 13Operation of Banks & Financial Institutions

Elements of ChequeThe information which is stated on the cheque are called elements or entries of the cheque. These are given below;Name of Bank:

Name of the bank and its branch is written on the cheque.Date:

It is necessary to write date on cheque. The cheque can be encashed within the six months of written date.


Nature of Account:The nature of account is printed on the

cheque to show whether the cheque is concerned to current or saving account.Account Number:

The account number of the depositor is written on the each and every cheque of cheque book.Cheque Number:

The serial number is always written on the cheque, which helps in the recognition and search


of the cheque.Payee:

The name of the person is written on the cheque that can receive the amount of cheque.Word ‘Bearer’:

The word ‘Bearer’ is also written on cheque which describes that the holder of the cheque is entitled to receive the amount of money written on this cheque.Amount in Words:

The required amount is written in words on 16Operation of Banks & Financial Institutions

on the cheque.Amount in Figures:

It is also necessary to state the amount of cheque in figure.Currency Type:

The type of currency in which the account is opened and maintained is also mentioned on the cheque.Signature of Account Holder:

For the withdrawal of money from the bank, the signature of account holder is mandatory on the cheque. 17Operation of Banks & Financial Institutions

Specimen of Cheque


Specimen of Cheque


Education

Lecture 9