Credit lines: meaning and types. In-depth analysis of credit lines in current accounts, simple credit lines and example.
Credit lines: meaning and types
General considerations. From a legal perspective, the opening of a bank credit line is ” the contract by which the bank undertakes to keep a sum of money available to the other party for a given period of time or for an indefinite period “, as stated in art. 1842 of the Civil Code, the first of a series of four articles which deal with the fundamental aspects of the credit line contract, which can therefore be defined as:
- typical , as regulated by the civil code;
- consensual , as it is perfected at the moment of acceptance by the bank, even if the customer does not immediately make use of the credit facility;
- bilateral , as it involves obligations for both parties;
- by adhesion , since the contract signed by the borrower is drawn up by the credit institution on the basis of the credit resolution and the customer can only decide to accept or reject it in its entirety.
We can make different classifications of credit lines, namely:
- based on the maturity , the credit facility can have a fixed maturity or an indefinite maturity;
- Depending on the guarantees , the credit line can be blank (i.e. unguaranteed) or covered by guarantees.
In the case of a blank credit line, the bank usually asks the customer to sign a blank promissory note (i.e. without the amount to be paid being reported) on which a stamp duty sufficient to cover the entire amount of the loan , including fees and interest, is paid and charged to the customer .
This promissory note, which is called a mobilization note , is essentially intended to guarantee the bank with regard to the fulfillment of the obligation, in fact if the customer does not repay the loan the bank fills out the promissory note with the amount due and has in hand an executive title to present to the judicial authority to request forced fulfillment.
If guarantees are presented, it should be remembered that they can be real (pledge or mortgage, respectively on movable and immovable property) or personal (guarantee and endorsement by third parties).
- depending on the beneficiary , the credit line can be in favour of the applicant (and this is the most common case) or in favour of third parties (this is the case, for example, of the request for a credit line in favour of the exporter in the case of payment with a documentary credit line, widely used in international trade);
- Depending on the method of use, the credit line can be for cash (when a sum of money is made available) or for signature (when the bank does not make money available but acts as a guarantor for the creditors of the borrower).
Opening a current account credit
A current account credit line exists when the bank allows the customer to withdraw sums of money from his current account in a greater amount than those present in it .
This is what is commonly called an overdraft . Currently this is the most widely used credit facility and therefore it is to this type of financing that the majority of the resources collected by the bank are directed.
There can be ordinary credit lines , when the borrower’s account is constantly negative, or credit lines for cash elasticity , when the borrower’s account has alternating positive and negative balances.
The use of this type of credit opening has advantages for both the customer and the bank. The main advantages for the customer are:
- the possibility of having a flexible form of credit, which can be used to a greater or lesser extent depending on the need, obviously within the limits of the credit granted by the bank;
- the cost of financing is proportionate to the portion used by the account holder, so if the account holder has obtained the opening of credit but does not overdraft the account (absurdly) he does not pay interest on debit, or in any case if he is overdrafted he pays interest on debit only on the amount of the overdraft and its duration.
This aspect differentiates current account credit lines from simple fixed-term lines and is a great advantage, because in those with a fixed term the customer pays interest on the entire loan requested and for its entire duration, even if in practice the part actually used is smaller.
The main advantages for the bank are:
- the possibility of periodically reviewing the conditions applied to the financing, for example in correspondence with significant variations in the rates present on the market;
- the possibility of obtaining important information on the performance of the entrusted customer’s current account, which in itself constitutes an important tool for the bank to control the customer’s behaviour and his/her ability to repay the debt incurred.
The simple credit opening
Simple lines of credit, on the other hand, are lines of credit that consist of the payment by the bank of a certain amount and the reimbursement of the same by the customer upon maturity , with the addition of interest and various expenses .
Unlike what happens in the opening of credit in c/c, in these cases the payments eventually made by the customer during the duration of the financing do not entail variations in the amount of the cost to be sustained for the indebtedness, in fact this is determined at the moment of granting the financing on the total of the financing and for the entire duration of the same, without taking into consideration the fact that the customer uses completely the financing obtained.
This type of financing is mainly used by companies with seasonal activities, which need financing to finance the production cycle and are then able to repay the financing itself when the products are sold.
An important example of a simple credit facility directed to businesses is the bill of exchange subsidy , also called direct promissory note discount , which we will now look at in detail.
Example of a simple credit facility: the bill of exchange subsidy
This is a promissory note that the customer requesting the loan issues in favor of the bank where the loan is requested as a guarantee of its fulfillment.
Upon presentation of the promissory note, the bank credits the customer with the face value of the promissory note, minus the discount, commissions, and reimbursement of stamp duty. Upon maturity, the customer reimburses the face value of the promissory note.
The cost of financing is therefore given by the difference between the net proceeds credited to the customer at the time of payment and the amount that the customer repays to the bank at maturity.
Since it is a non-commercial bill of exchange, the risk for the bank is higher since the fulfillment by the customer depends exclusively on his solvency.
For this reason, the cost of financing is generally higher than the cost that the customer would bear if he discounted a commercial bill of exchange and, in addition, signature guarantees from third parties are often required.
