CREDIT. – It is an exchange of wealth by which available wealth is surrendered at the present moment in exchange for a promise of future repayment of the value lent. An essential element of credit is therefore the trust that the debtor will at maturity fulfil the commitment to repayment assumed; often, however, credit is safeguarded not merely by trust in the borrower but also by real guarantees of various kinds: pledge on movable property or mortgage on immovable property.
A further characteristic of credit is the payment by the debtor of interest, which represents the price for the use of the capital obtained by loan. Throughout the entire Middle Ages, a strict extension of laws combating usury prevented interest from being charged on sums lent. At present, its lawfulness is admitted, as compensation for the renunciation of immediate availability of wealth and for the risk inherent in every loan, since it has been observed that interest is economically indispensable, inasmuch as it enables the practically unlimited demand for loans to be met by the limited supply of available capital.
The demand for credit may be made either for productive purposes, that is, to increase the capital invested in enterprises and thus to expand production (productive credit), or for consumption purposes, namely to obtain monetary means to expand or anticipate consumption (consumption credit).
The principal distinction among the various forms of credit is based on the length of the loan period. Thus, short-term credit is granted when a sum is lent for a period not exceeding, as a rule, one year, while loans extending over several years, often up to 15 or 20, constitute long-term credit.
The aggregate of transactions concerning short-term loans gives rise to the money market; to this market flow the liquid funds which their private owners or banks cannot invest permanently, either because they are dealing with capital of which they have only temporary availability, or simply because they wish to keep it in liquid form pending the moment when they will employ the funds for long-term investment. The level of remuneration due to those who grant short-term loans is regulated by the discount rate, which rises or falls according as the demand for such loans exceeds or falls short of the supply.
Transactions concerning long-term loans, on the other hand, form what is called the capital market, whose function is to distribute capital to those enterprises which need it for rather durable investments. The equilibrium between the supply of and demand for long-term credit is regulated by the trend of the interest rate. The term “interest,” which is used generically to denote the price of every type of loan, is applied specifically only to long-term loans.
From the practical as well as the scientific point of view, however, there is no clear and absolute separation between the money market and the capital market, since the two markets flow into one another and both influence each other, in the sense that variations in the discount rate and the interest rate end up being correlated.
If by credit we mean the complex of operations connected with it and originating from it, we can easily determine its functions. Here the distinction between short-term and long-term credit is useful. The bodies that engage in short-term credit activities, which essentially include deposit and discount banks or, more generally, commercial or ordinary credit institutions, after collecting liquid funds and savings existing in the form of metallic currency or banknotes, grant to depositors and to those to whom they have granted short-term credit the power to draw cheques; the typical operation by which these banks grant credit is represented by the discounting of bills of exchange. In this case, therefore, the function of credit consists in substituting for metallic currency, banknotes and the mass of bills of exchange that particular type of means of payment which are cheques. At present, in the economically more advanced countries, cheques account for the largest percentage of the money in circulation.
Banks that engage in long-term credit, which are specifically called credit institutions, collect newly formed savings and channel them towards investment in productive enterprises. In this situation, credit performs the function of enabling savings to be transformed into capital and distributed in the most efficient manner among the productive sectors where capital is most in demand.
A third function that can be attributed to credit is that connected with what is called the creation of credit (v. BANK). By this operation, the monetary means necessary to increase consumption or to make other investments beyond what would be permitted by the availability of savings are provided. The criterion on the basis of which credit is granted, with particular reference to long-term credit, consists in taking into account the remuneration that can be derived from it, that is, the interest, and the risks inherent in the repayment of the sums lent. In relation to this criterion, there would be productive activities which, independently of any consideration of risk, could not have access to credit because they are not in a position to pay sufficient interest. To meet the needs of enterprises belonging to these sectors of production, in many countries special credit institutions have been formed, often under the patronage and with the aid of the government, such as those for agricultural credit, land credit, shipping credit, building credit, etc., which in general grant loans at an interest rate below the market rate.
Often credit activity is carried on by bodies of such size and power that direct intervention by state organs becomes necessary for purposes of coordination and control. In Italy, for example—as is also the case elsewhere—mixed banks have been suppressed because of their dangerous nature, and the exercise of long-term credit has been entrusted to state bodies of the type of the IRI (Istituto per la Ricostruzione Industriale), the IMI (Istituto Mobiliare Italiano), etc. The exercise of long-term credit concentrated in the hands of the state has been deemed opportune in relation to the particular delicacy of the investment function. Indeed, research into cyclical economic fluctuations has shown how periods of expansion are marked and caused, among other factors, by an excess of investment over savings, while in phases of depression the opposite occurs, in that the mass of savings exceeds investment. It follows, therefore, that even independently of the regulations adopted in Italy, public bodies cannot leave to the discretion of individual institutions the exercise of a function that involves the entire course of national economic life. Control is also exercised to prevent larger monopolistic bodies from hindering and compromising the functioning of smaller banks and credit institutions.
As economic progress increases, so too does the importance of credit, and at the same time the tendency to subject it to more effective control in order to improve its use and avoid the possibility of its being employed for purposes not in harmony with the economic and social well-being of the community becomes consolidated.