What Is Bank Credit?

Bank credit is the total amount of credit available to a business or individual from a banking institution. It consists of the total amount of combined funds that financial institutions provide to an individual or business. A business or individual's bank credit depends on the borrower's ability to repay the loan and the total amount of credit available in the banking institution.

Understanding Bank Credit

Bank credit is an agreement between banks and borrowers where banks make a loan to a borrower based on their assessment of the borrower's creditworthiness. The bank is essentially trusting a borrower to repay funds plus interest for either a loan, credit card or line of credit at a later date. Bank credit also refers to money that banks lend or have already lent to customers.

Bank credit for individuals has grown considerably during the past half-century as consumers have become used to having multiple credit cards for various needs.

However, businesses also use bank credit. Many businesses need funding to pay startup costs, to pay for goods and services or supplement cash flow. As a result, startups or small businesses use bank credit as short-term financing.

[Important: Bank Credit is the aggregate amount of credit available to a person or company from a bank.]

How Bank Credit Works

Bank credit is the total borrowing capacity banks provide to borrowers. The credit allows borrowers to buy goods or services. Bank Credit requires a fixed minimum monthly payment for a certified period.

For example, the most common form of bank credit is a credit card provided by a bank. Borrowers start with a zero balance, a specified credit limit and an agreed upon Annual Percentage Rate (APR). The borrower is allowed to use the card to make purchases. They must pay either the balance or an agreed upon monthly minimum to use the card and may continue borrowing until the credit limit is reached.

Bank Credit Approval

Bank credit approval is determined by a borrower’s credit rating and income or other considerations, including collateral, assets or how much debt they already have.

There are several ways to ensure approval, including cutting the total debt-to-income ratio. An acceptable debt-to-income ratio is 36%, but 28% is ideal. Borrowers are generally encouraged to keep card balances at 20% or less of the credit limit and pay off all late accounts. Banks typically offer credit to borrowers with bad credit histories with terms that are good for the banks and not so good for the borrower.

Special Considerations

Bank credit comes at a cost, with the terms varying by bank, type of credit and the borrower's credit rating and the reason for borrowing money in the first place.

There are two types of bank credit: secured and unsecured. Each one has its own fees, interest rates, terms and conditions, and regulations. Fees include the amount borrowed plus interest and other charges. Some fees are required, such as interest rates, while some are optional, such as credit insurance; some are based on specific events, such as late payment fees.

Key Takeaways

  • Bank credit is the total amount of funds a person or business can borrow from a financial institution.
  • Credit approval is determined by a borrower's credit rating, income, collateral, assets, and pre-existing debt.
  • There are two types of bank credit, secured and unsecured. Each one has its own fees, interest rates, terms, and conditions.