Bank Loans and Bank Credit

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How The Bank Work

 

line of creditBanks offer various types of loans to business customers.  One of the more common is a Revolving Line of Credit.  A Revolving Line of Credit represents an amount of money that a business can borrow against to cover short-term expenses.  In fact, the amount can be borrowed, repaid and then borrowed again by the borrower. A Line of Credit is generally offered by banks to business borrowers for one year at a time.  The borrower can borrow any amount up to the maximum amount at any time with no advanced notice to the bank required.

A Term Loan is a bank loan to a company which includes a fixed maturity date.  A Term Loan often includes amortization of the principal amount.  Banks make Equipment Loans.  These enable companies to purchase capital equipment.  Typically, these loans are amortized.  The term of the loan relates closely to the useful life of the asset being purchased.

A Short-term loan is an amount extended to a borrower with a maturity date of less than one year.  These loans can have maturities of as little as 30 days.  Short-term loans can be unsecured, but banks are generally secured creditors.  The obligation of the borrower to repay a short-term loan on a specified date may be evidenced by a Promissory Note created by the bank lender and signed by the borrower.

The main difference between bank credit and other forms of money lending is that no cash changes hand when a bank loan is made. Rather, a paper amount is set up in the borrower’s account. This is called check-account credit and is backed by a specified cash reserve required by the Federal Reserve Board.  This paper transaction is in effect money, although no physical currency is printed. It acts as a multiplier to the amount of physical currency in circulation, since only a percentage of actual currency is required as reserve against checking-account currency. The ability of banks to create money is an important aspect of the economic and financial climate in the United States.

Bank credit differs from business trade credit in a number of ways, but primarily in terms of the type of resource which changes hands in a transaction. A bank furnishes money, while a business trade creditor [a supplier] furnishes goods or services on open account terms. After the transaction is completed, however, both are creditors to the extent that the customer [the debtor] owes money to each.  As a general rule, business credit terms are shorter than the periods of repayment offered by banks. Payment for goods or services usually comes due in 30, 60 or 90 days, depending on the industry. Bank loans, on the other hand, are generally longer term.

Edited by Michael C. Dennis

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