chapter 3
CREDIT PRODUCTS AND SERVICES
Contents
1
Overdraft ................................................................................................................. 75
2
Term loans ............................................................................................................... 77
3
Bridging loans .......................................................................................................... 79
4
Hire purchase ........................................................................................................... 81
5
Leasing .................................................................................................................... 82
6
Invoice discounting/Factoring ..................................................................................... 84
7
Self-build finance ...................................................................................................... 85
8
House purchase loans ................................................................................................ 86
9
Equity/capital release loans ........................................................................................ 87
10 Personal loans .......................................................................................................... 87
11 Revolving credit ........................................................................................................ 87
12 Budget accounts ....................................................................................................... 88
73
CREDIT AND LENDING
13 Credit cards ............................................................................................................. 88
14 Alternative sources of finance ..................................................................................... 90
Key Words .................................................................................................................... 99
Review ....................................................................................................................... 100
74
3: CREDIT PRODUCTS AND SERVICES
Learning outcomes
On completion of this chapter you should be able to:

distinguish between a range of credit products and services and evaluate their suitability for
different types and profiles of customers based on an identified customer need

construct a profile of a (personal/business/corporate) customer and recommend a suitable
product that meets their needs

identify alternative sources of finance and explain the circumstances in which each can be used.
Introduction
Having considered the banker/customer relationship and learned about the principles of lending, we now
move on to study the credit products which banks offer to their customers.
A sound knowledge of the credit products and services available from your bank is essential to enable
you to match customer profiles to the appropriate credit product. Doing so leads to satisfied customers
who are likely to stay loyal, use other bank products, and recommend your bank to others. And so the
business grows.
Some of these products and services, like house purchase loans, personal loans, self-build finance and
credit cards, are available to personal customers, while others are used by businesses, although some
individuals may have an overdraft and need a bridging loan when moving house, for example. There are
many different variations of some of these products, but the basic elements are broadly similar.
Credit products and services used in the finance of foreign trade are not part of this study module. This
specialised area of finance is covered in the module for Applied Business and Corporate Banking which
you may study later in your Chartered Banker course.
Banks ‘borrow’ funds from depositors which are then advanced, or lent, to other customers. The margin
between the rate of interest paid by the banks and the rate charged to borrowers is profit margin for the
bank. You will appreciate therefore that lending is a very important part of any bank’s business. Thus a
great deal of marketing effort goes into designing, advertising and selling these lending products.
Q U I C K
Q U E S T I O N
What is an overdraft and what are its features?
Write your answer here before reading on.
1
Overdraft
An overdraft is a type of lending which offers a high degree of flexibility. For a bank, the overdraft is a
staple product by means of which the customer may overdraw their current account balance, that is,
draw out more from the account than the total amount of money standing in the account. The customer
is permitted to overdraw the account up to an agreed limit (the overdraft limit). When an account is
overdrawn, the customer is borrowing and owes the bank money. An overdraft is normally shown on the
customer’s bank statement by the abbreviation DR (meaning debtor) after the balance on the account.
Overdrafts are only available on current accounts, the accounts through which businesses and individuals
pass their income and expenditure.
75
CREDIT AND LENDING
Although overdrafts are repayable to the bank on demand, they are normally agreed subject to a regular
(often annual) review. There are not usually many terms and conditions attached to the facility because
overdrafts are repayable on demand.
Interest on an overdraft is only charged on the day-to-day balance outstanding on the account. Thus, if
the current account fluctuates from a credit balance (funds in the account) to a borrowing position (using
the overdraft), the customer only pays interest when the account is overdrawn and is charged only on
what the customer is actually borrowing.
The overdraft is a convenient and inexpensive way of borrowing to cover a business’s short term
requirements. It is only appropriate for short term temporary borrowing which is drawn down and then
repaid and drawn and repaid again during an income and expenditure cycle. Overdrafts are commonly
provided for seasonal-surges in business activity.
In relation to a business an overdraft provides finance to cover a business’s working capital needs (the
finance needed through the trading cycle) and help iron out the fluctuations in its cash flow as bills are
paid before funds are received from sales income. A large inflow of funds one week will reduce the
interest payable while the firm retains the ability to borrow again next week. For business customers the
overdraft is the cheapest and most convenient means of borrowing. The borrowings (drawings) can vary
in amount and be repaid and redrawn at will within the agreed terms up to the overdraft limit.
Customers can access the money easily and pay interest only on the outstanding daily balance.
An account with an overdraft facility should show wide fluctuations on the account which could swing
into credit at times. When the customer buys stock, you would expect that the balance of the account
would swing into overdraft and once the stock is sold and sales income received, the account should
swing back into credit. When an account remains in debit permanently, this is referred to as hard core
borrowing. This position can usually only be shifted by an injection of cash, significant sales or by its
transfer to a loan account with structured repayments designed to reduce the loan to nil over a period of
time.
The customer is allocated a limit up to which the account may become overdrawn. If the run of the
account shows that the account is not showing wide fluctuations and that the debt is becoming ‘hard
core’, then it may indicate that things are not going to plan. Perhaps the customer is not collecting cash
from debtors quickly enough, or the business may be making losses.
Overdrafts are convenient for personal customers who may need additional funds to tide them over until
their salary is received. When such a customer has an overdraft, it is expected that the account will
swing from credit to debit; for example, the account may show a debit balance prior to the monthly
salary being lodged to the account, when it will swing into credit again.
Several financial service providers now automatically offer overdraft facilities with some of their current
account products.
Q U I C K
Q U E S T I O N
How would you describe a term loan and what are its features?
Write your answer here before reading on.
76
3: CREDIT PRODUCTS AND SERVICES
2
Term loans
Term loans are usually granted over a period of years to assist business customers to buy assets such as
plant and equipment, and buildings. A term loan spreads the cost of the asset over its expected life. The
repayments can be tailored to suit the cash flow of the business, usually either monthly, quarterly, halfyearly or annually.
Banks may also agree to provide term loans to meet long term working capital needs, for example where
long term sales growth is creating permanently higher levels of debtors and/or stock. Term loans may
also be used for business restructuring where, for example it transpires that overdraft borrowing has
been used to purchase fixed assets, or finance business losses.
A term loan is a loan for a fixed amount, for an agreed period, and on specific terms and conditions.
Normally such loans are for terms of between three and seven years, although they can range up to
twenty years.
Longer periods obviously depend on the nature of the proposal, the strength of the business, the
robustness of its trading performance and its projections, and the security to be granted.
Term loans are used for longer term asset purchases as these are not suitable for financing under an
overdraft facility, which should be used for working capital purposes.
The terms and conditions under which term loans are granted include interest and other costs,
repayment, security and the covenants applicable.
The terms and conditions of the loan are set out in a loan agreement which includes:

the term over which the loan is to be repaid

the security to be granted

conditions/covenants to be complied with by the customer, such as the timely provision of
accounting information

events which would render the loan immediately due for repayment (known as ‘events of
default’), such as the customer failing to meet a repayment instalment on time or the loan being
used for a different purpose from that agreed.
Provided the customer complies with the conditions detailed in the loan agreement, the bank cannot
demand repayment. Given this and the duration of the loan, it is normal for security to be taken in
support of term loans. Remember that the longer a loan is outstanding, the greater is the risk of default.
Term loans are sometimes granted to individual customers in order to finance specific projects, or to
remove the hard core on an overdraft. As with a business, they are repaid from income over a period
and are always subject to specific terms and conditions.
2.1
Interest rates
Interest rates may be fixed or floating. Floating rates are more usual and fluctuate at a margin (agreed at
the outset) over bank base rate or the market-related LIBOR rate. LIBOR (London Inter Bank Offered Rate)
is the interest rate offered on loans to highly-rated (low risk) banks in the London interbank market (where
banks lend and borrow amongst themselves) for a specific period, such as three months. This LIBOR rate is
widely used as a reference rate for other loans which are arranged at a margin over LIBOR.
Loans can also be arranged with a fixed rate of interest and the regular repayments may cover both
capital and interest.
Interest is debited to the business’s operating current account on a quarterly basis. The interest paid will
be high at the start of the loan but will reduce as the loan is repaid.
77
CREDIT AND LENDING
2.2
Drawdown
Drawdown of the loan may be in tranches, or instalments, on certain conditions being met. For instance,
a loan to finance a building may be paid out in instalments when certain stages of construction are
reached.
2.3
Repayments
Repayments are often geared to meet the cash flow of the business, perhaps with a repayment ‘holiday’
for the first year until income starts to flow from the project or asset being financed. Alternatively,
repayment can be in one sum at the end (a ‘bullet’ repayment), or by a series of heavier repayments
towards the end of the loan (a ‘balloon’ repayment schedule).
Provided the customer keeps to the terms and conditions of the loan, the bank cannot demand its
repayment before the expiry date.
2.4
Security
Security arrangements are included in the loan agreement. Should the terms of the agreement be
breached, the loan usually becomes repayable on demand, giving the bank the power to seek repayment
and look to its security, although more usually the bank will renegotiate the terms of the loan.
2.5
Covenants
These are formal agreements made at the time of the loan. The bank agrees to the loan on the basis of
its assessment of risk and wants to ensure that the risk does not increase during the life of the loan. The
term loan agreement contains obligations such as provision of information to the bank and adherence by
the customer to financial covenants, such as, for example, interest cover maintenance, as well as gearing
and liquidity ratios. We will study interest cover and financial ratios in chapter 5 on Financial Statements
and How to Use Them.
Variations on the theme of term loans may include:

Fixed rate loans – where the rate is agreed at the outset and does not vary during the life of
the loan. The customer has certainty and is protected against interest rate rises. If rates fall,
however, the customer may be paying more than current market rates and be at a competitive
disadvantage. Usually, the loan may not be repaid early, except under payment of a penalty.

Capped rate loans – interest will not rise above an agreed level for the capped period; if base
rate falls, the customer can still benefit from the lower payments.

Discounted loans – lower repayments for say the first six months (similar concept to the capital
repayment holiday).

Commercial mortgages – to assist with the purchase or improvement of business premises.

Professional practice loans – to assist qualified professionals (like dentists) to finance a private
practice.
You should ensure you are familiar with the range of facilities offered by your own organisation.
78
3: CREDIT PRODUCTS AND SERVICES
Q U I C K
Q U E S T I O N
Can you describe a bridging loan?
Write your answer here before reading on.
3
Bridging loans
Bridging finance is required when a major purchase precedes a major sale. The result of this timing
difference is that there will be a large deficit in funds for the purchaser to finance, but usually for a short
period of time. Bridging finance is most commonly encountered in house purchase and sale transactions.
Often the customer will have purchased their new home before receiving the sale proceeds from their
previous home; therefore they will need to finance both homes for the period between the purchase and
the receipt of the sale proceeds. Bridging finance allows the transactions to proceed smoothly.
Thus bridging finance is a short term loan which will be repaid from a specific source.
In England, and Wales, the security is by way of a letter of undertaking. The letter of undertaking is
issued by the solicitors, acting for the customer in the purchase or sale of the asset, and addressed to
the bank, stating that they will remit the free sales proceeds from the sale of the asset to the bank, once
these funds have been received.
In Scotland, the security that is taken for a bridging loan is an assignation in security which is in the form
of a letter from the customer, addressed to their solicitor, requesting that the free proceeds of the sale of
the previous house are sent to the bank which has provided the bridging loan. The ‘free proceeds’ refers
to the sale price of the property, less the outstanding mortgage and the legal fees.
This letter ends with the statement that ‘this order is irrevocable’ which means that the bank has the
comfort of knowing that the customer cannot alter this instruction at a later date. In addition to this, the
bank will normally send the letter to the solicitors, asking them to acknowledge receipt and to confirm
that they will comply with the terms of the mandate. Once these free proceeds have been received, the
bank will use them to repay the bridging loan and will allow the customer access to the remaining funds.
Here is a specimen of an assignation in security:
Date: 1 March 20XX
Dear Sir / Madam,
I/We hereby instruct and authorise you to remit to the Drumsheugh Bank, 147 Main
Street, Anytown, AA3 5YY when received by you the net proceeds of the sale of the property known as:
19 Lupine Crescent, Anytown AA8
and in respect that this mandate is granted in consideration of certain advances made or to be made to
me/us, whether separately or jointly with any other person or persons by the said Bank. I/We hereby
declare it to be irrevocable.
My/Our instructions to you to act for me/us in the above mentioned transaction may not be withdrawn
by me/us without the consent in writing of the said Bank.
79
CREDIT AND LENDING
Yours faithfully
Alan Customer
(First signature)
Alicia Customer
(Second signature)
Witness: Adam Wilson
Address: 1 Main Street
Anytown AA4 5GF
Occupation:
Admin Assistant
Witness: David Holmes
Address: 89 Main Street
Anytown AA 4 9KL
Occupation:
Teacher
Solicitor’s acknowledgement:
We, Messrs Constable and Currie, Solicitors, 78 Low Street, Anytown AA66 8KK acknowledge having this
day received the principal Assignation in Security of which the foregoing is a copy.
We confirm that no notice of any prior Mandate, Arrestment, Garnishee Order or other charge affecting
the proceeds has been received and that we are not aware of any reason why the Mandate should not
be implemented.
Signed James Constable
Date 1 March 20xx
Closed bridging occurs when the date of the sale of the asset that is to repay the bridging has been
confirmed. Therefore, in a house purchase scenario, it is when there is an agreed and binding settlement
date for the sale of the property. In this situation, the bank will know how much the house has been sold
for and when the funds are due to be paid. This type of finance is very acceptable business for the bank
because of the low risks involved.
Open-ended bridging happens when the sale of the asset that is to repay the bridging loan has not been
agreed, such as where the customer has bought their new property, but has not as yet sold the old one.
This represents a far higher risk for the bank because it does not know when it going to receive
repayment of the bridging loan.
Although bridging loans are usually encountered when dealing with house purchase, there may be other
situations where they occur, such as when the customer may wish to purchase a car, based on the sale
proceeds of shares. If they wish to pay for the car on 1 September, but the settlement date for the sale
of the shares is not until 14 September, then they may be looking for bridging finance to cover the
period 1 – 14 September. This bridging would normally be provided by way of an overdraft.
Business customers may need bridging finance for a number of reasons, such as:

when present premises are too small and new premises are purchased before the old ones have
been sold

when the customer is buying a new business prior to selling the present one.
Whatever the reasons for requiring bridging finance, the bank needs to know the length of time for
which the loan will be required. And bridging finance can be expensive for the customer, especially if it is
open- ended, as they may have to pay interest for an extended period.
As far as business is concerned, it is quite likely that bridging finance will be required on an open-ended
basis. In purely practical terms, if a business is moving premises then it will probably need to buy new
premises and then refurbish them before selling its own premises, which can all take time. The bank may
need to secure its position in case there is prolonged delay.
Bridging finance is an important element in bank lending. For the most part the lending is short term and
well secured and so presents little risk. Where it is open-ended, however, the risk is much greater. And
you must always offer the customer sound advice and only allow this finance where you feel that the
benefits accruing to both the bank and the customer outweigh the risks. In current market conditions
open-ended bridging loans are not easy to agree.
80
3: CREDIT PRODUCTS AND SERVICES
Q U E S T I O N
T I M E
1
Describe the two main types of bank lending products and explain the advantages and
disadvantages of each.
Write your answer here then check the answer at the end of the book
Q U I C K
Q U E S T I O N
Describe the features of a hire purchase contract?
Write your answer here before reading on.
4
Hire purchase
Hire purchase is an agreement to hire an asset with an option to purchase. The legal title passes to the
customer when the final payment has been made. The term of the agreement requires to be shorter
than the expected life of the asset. A business can claim capital allowances for tax purposes as if they
had undertaken an outright purchase of the asset.
The hire purchase finance company buys the equipment which it then owns, and lets the hirer use the
equipment in return for a series of regular payments. The equipment could be plant, machinery, vehicles,
etc. The hire purchase company has the security of ownership of the asset and can repossess it if the
terms of the agreement are broken. After all the payments have been made, the hirer becomes the
owner, either automatically or on payment of a modest fee.
The main advantages for the customer of a hire purchase agreement are:

small initial outlay

easy to arrange

certainty – the loan cannot be called in providing the terms are kept

availability when, for example, bank finance is not

fixed rate finance

tax relief – interest payments are tax deductible and the asset may also be subject to a writing
down allowance.
81
CREDIT AND LENDING
The disadvantages are that it is more expensive than a cash purchase and the fixed term means it may
be impossible or expensive to make early termination.
Q U E S T I O N
T I M E
2
Describe hire purchase as a form of financing and list its advantages and disadvantages.
Write your answer here then check the answer at the end of the book
Q U I C K
Q U E S T I O N
How would you explain what is meant by leasing?
Write your answer here before reading on.
5
Leasing
Leasing is similar to hire purchase in that an equipment owner (the lessor) gives the right to use the
equipment to the user (the lessee) over a period in return for rental payments. The essential difference
is that the lessee never becomes the owner. The purchase of machinery and equipment can tie up a lot
of business finances, but leasing effectively provides access to the asset without buying it up front.
The numerous types of leasing are fundamentally rental agreements providing the business (the lessee)
with the use of an asset owned by the finance company (the lessor) for a specified period of time subject
to agreed payments (rental payments). Almost any equipment in any price range can be leased.
A direct lease is where the business advises the leasing company of the asset which it wishes to
acquire and the lessor then buys it from the manufacturer (if new) or the previous owner (if used) in
order that it can be rented back.
Sale and leaseback (sometimes referred to as purchase leaseback) is where a business sells an
asset which it already owns to a finance company and then leases it back. (Sale and leaseback is quite
common with property – the property being sold to an investor who leases it back.)
In both cases, the asset requires to be returned to the lessor at the end of the agreed period. Many
leases have an end-of-lease option providing renewal of the lease at a minimal cost or sale to a third
party.
82
3: CREDIT PRODUCTS AND SERVICES
Leasing can be useful when other sources of finance are not available. There are also tax advantages;
for example, rental payments under an operating lease are tax deductible, as is interest under a finance
lease. The depreciation charge in the company’s accounts for a finance lease is tax allowable, dependent
on the method of depreciation used and its acceptability to HM Revenue & Customs.
There are two main types of leases:

Operating lease
This type commits the lessee to only a short term contract that can be terminated at short notice.
Usually the lessor pays for repairs, maintenance and insurance. An operating lease is used for
small items like photocopiers and short term projects like building firms hiring plant (although
many of Boeing’s aircraft go to leasing firms).

Finance lease
The leasing company expects to recover the full cost of equipment and interest over the period of
the lease. Usually the lessee has no right of cancellation or termination. Despite the absence of
legal ownership, the lessee bears the costs of maintenance etc, and suffers if the equipment is
underutilised or becomes obsolete. Finance leases offer less flexibility for the user but this is
reflected in the cheaper pricing.
The advantages of leasing are similar to those for hire purchase. An additional advantage for operating
leases is the transfer of the obsolescence risk to the finance provider. The lessee can hand back the
equipment and take a fresh lease of more modern items.
Finance leases have to be ‘capitalised’ under accounting rules to bring them on to the balance sheet. The
asset is shown and the lease obligation is stated as a liability. Over the years the asset is depreciated and
payments to the lessor reduce the liability. Depreciation and interest are both charged as expenses to
the profit and loss account.
Finance companies with plenty of profits can use their capital allowances under the tax system to reduce
their own tax paid on profits with finance leases, and so pass on these benefits to the lessee in the form
of lower rentals.
Leasing is a highly specialised area and a customer will need advice to assess whether to buy or lease,
especially on the complicated tax issues of finance leases. You may learn more about leasing from your
own organisation’s leasing department or subsidiary.
Q U E S T I O N
T I M E
3
Describe the features of leasing as a form of financing and explain the two main forms of
leasing.
Write your answer here then check the answer at the end of the book
83
CREDIT AND LENDING
Q U I C K
Q U E S T I O N
How would you describe a factoring agreement?
Write your answer here before reading on.
6
Invoice discounting/Factoring
Factoring is the raising of funds against the security of the company’s debts. Factoring companies – the
main ones are clearing bank subsidiaries – provide services to clients with outstanding debtors. The most
important element of these services is the immediate payment of cash to the client company. It can free
up funds that are locked up in sales invoices. Factors pay over cash on the understanding that the
proceeds of the invoice go to them when the customer settles the debt due.
The services are:

Provision of finance
The factor will advance up to 80% of the value of debts immediately. When invoices are paid, the
remaining 20%, less charges, is paid to the client. The factor thus provides cash immediately
against debtors and this cash is available to buy stock, pay suppliers and generally aid more
profitable trading and growth. It may also give the business the ability to negotiate supplier
discounts and thus improved profit margins.
The factor looks for clean debts in order to be reasonably sure of receiving payment for the
invoices. Factors will want to understand the business and be satisfied with the management. A
due diligence enquiry will be carried out on the books of the client to check their systems and the
quality of the debts; for example, how prompt payment has been in the past.

Sales ledger administration
The factor dispatches invoices and ensures that they are paid. Young, fast-growing businesses
sometimes want to outsource this work and use the factor’s sophisticated systems, although the
fees can be quite high for this service. It includes record keeping, checking creditworthiness,
sending invoices and chasing payment.

Credit management
The factor provides insurance against bad debts.
Most factoring arrangements are on the basis of non-recourse with the factor accepting the risk of nonpayment by the client’s customer. This service costs the client more and, to ensure payment, the factor
will want control over the credit assessment and credit approval processes as well as other aspects of
managing the sales ledger.
Confidential factoring means that the client’s customer is unaware of the factoring arrangements. In this
case, the client collects the debts and pays the funds to the factor.
While the term factoring accurately describes the above process, the description invoice discounting is
now more often preferred, and covers both factoring and invoice discounting.
84
3: CREDIT PRODUCTS AND SERVICES
Invoice discounting is where a company pledges selected invoices to a finance house and guarantees
that they will be paid. The finance house remits up to 90% of the total invoice value to the company,
which then collects the debts and pays the finance house. This is with recourse finance and is
confidential. The business needs to be well established and profitable and have professional and efficient
administration.
Certain companies extend this service to exporters, with advances paid in sterling or currency
(depending on the invoicing procedure), assisting in the management of risk in exchange rate
fluctuations.
Q U E S T I O N
T I M E
4
Explain factoring/invoice discounting and describe the services offered by factors.
Write your answer here then check the answer at the end of the book
7
Self-build finance
In this section we are going to look at the situation where a bank will lend to a customer who is building
their own home. This is an undertaking which requires the involvement of a number of external parties
such as builders, solicitors, architects, bankers, etc. We will also look at the procedures that should be
followed during the life of the loan. Due to their very nature, there is no one ‘standard’ self-build project,
therefore, while we look at the principles behind self builds, each one does have to be assessed on its
individual merits. As a result, the principles of lending that you studied earlier should be carefully
considered when assessing a self-build application.
A self-build loan is an advance that will finance the building, converting or renovating of a property as
the customer’s principal residence. It is important to be aware that the self-build facility is not a
mortgage-backed loan in the traditional sense of the word – rather it is structured as an overdraft that is
secured over the plot of land on which the house is being built. The facility is normally granted for a
maximum of 12 months, with the loan being reviewed after this.
Because self-build facilities require a mortgage to be granted in support of the borrowing, this kind of
facility falls under the auspices of mortgage regulations. Transactions of this type are known as
‘Regulated Mortgage Contracts‘. We shall come back to regulated mortgages later in the course.
By the nature of the project, the funding for this type of borrowing must be flexible.
Either of these potential options could be used:

funding of the project in arrears on confirmation of stage completion – this is the most common
funding arrangement.

funding of the project in advance may be considered depending upon the individual proposition,
such as low LTV (loan to value).
The expenditure involved in building the house is then drawn down against this overdraft. In most
instances, repayment of the overdraft will come from the drawdown of a mortgage once the house has
been completed. It is better to set up the facility on a separate account for ease of monitoring.
85
CREDIT AND LENDING
The bank will expect the valuer to confirm that there are no restrictions affecting the site, that outline
planning consent is held and that there are no anticipated problems with any potential development,
such as access, supply of services, etc. This information concerning access restrictions and supply of
services can also be confirmed by the customer’s solicitors.
Normally two valuations are required when dealing with a self-build:


at the start of the project, a current and projected end valuation
at the end of the project, a revaluation prior to the loan (mortgage) drawdown.
The normal stages of a self-build project are:






completion of the foundations/underbuildings
delivery of kit – if the house is to be of a kit structure
erection of kit/wall plate level
building made wind and watertight
formation of rooms to plasterboard/roof tiled stage
final stage.
It is normal practice to allow the customer to draw down on the self-build loan at the end of each of
these stages, formal certification being generally required from:




8
a qualified architect
an NHBC solo inspector/acceptable structural warranty inspector
a structural engineer
some other suitably qualified professional such as a quantity surveyor.
House purchase loans
House purchase loans (normally referred to by customers as mortgages) are a big part of retail banking
business. In the past they were mainly the domain of building societies.
The amount available to borrowers will often be a stipulated multiple of the customer’s salary or a
multiple of joint borrowers’ combined salaries (the earnings multiplier). The basic lending criteria are
based on the borrower’s ability to meet the repayments.
Mortgage lending is often a separate area of study in itself for bankers in retail banking. In chapter 6 we
cover the lending policies and procedures for mortgages in detail. Credit scoring is common in assessing
the borrower and their ability to meet the mortgage repayments. Again, we study credit scoring in
chapter 6.
Q U I C K
Q U E S T I O N
What is an equity release loan?
Write your answer here before reading on.
86
3: CREDIT PRODUCTS AND SERVICES
9
Equity/capital release loans
Often the value of a customer’s house will exceed the amount of the outstanding house purchase loan.
The excess is often called the equity or reversion in the property. Some banks are willing to lend
customers a certain percentage of this equity provided the bank is granted security over the property. In
present market conditions at the time of writing these types of loan will not be in plentiful supply.
As the bank holds security, the loans are normally granted at a rate linked to the banks mortgage rate
and thus are a cheaper form of borrowing than personal loans. In addition, equity/capital release loans
can be granted for longer periods than personal loans.
The purposes of such loans can be varied and are broadly similar to the purposes for personal loans.
10
Personal loans
Personal loans are normally granted for the purpose of consumer purchases such as cars, holidays,
consumer durables (televisions, fridge-freezers, etc) and for home improvements such as a new fitted
kitchen, double glazing, the building of a conservatory, etc. Personal loans are not restricted to these
purposes and may be granted for any purpose that is acceptable to the bank.
Interest is charged on personal loans at a flat rate which means that it is calculated on the total amount
of the loan for the full term and applied to the amount of the loan at the commencement of the
repayment term. This total amount is then divided by the number of monthly instalments to determine
the amount of the repayment instalments.
Personal loans are not usually secured and the repayment period will vary from a few months to several years.
When a personal loan application is received, it is usually credit scored to determine whether or not the
bank is willing to grant the facility. Once a customer’s application has been processed and shows an
acceptable credit score, a pre-contract illustration is provided prior to the customer and banker signing
the loan agreement. A formal letter setting out the terms and conditions of the loan is normally given to
the customer containing details of the interest structure, total payable and the amount of the rebate
should the loan be repaid early.
Personal loans fall within the ‘regulated agreement’ criteria as set out in the Consumer Credit Acts.
The loan is created by a transfer of funds into the customer’s operative account and a corresponding
debit is made to a separate loan account. The agreed repayments are credited to the loan account until
it is cleared off.
Some personal loans carry automatic life cover and there is also an option for the customer to purchase
accident, sickness and unemployment insurance. These ensure protection for the customer and the bank,
although have recently attracted negative publicity. The mis-selling of Payment Protection Insurance
(PPI) for such loans to customers has cost banks billions in repayments, as a result banks are now much
more cautious about selling such cover and are careful to ensure any such cover is actually required.
11
Revolving credit
A revolving credit account allows a customer to draw up to a set limit which is related to a monthly fixed
payment into the account. A multiplier is related to this monthly payment; for example, if the customer
pays in £200 per month, the limit of borrowing may be set at £6,000 (30 x £200).
The application form is similar to that for a personal loan and the response data is credit scored. A credit
limit is agreed but the bank does not normally look for security.
A separate account is maintained and it is usual to arrange for the monthly payment to be transferred
from an operative account to the revolving credit account by standing order.
87
CREDIT AND LENDING
Interest is charged on a daily basis and normally applied monthly. Should the account move into credit,
interest on the credit balance may be paid by the bank.
Provided monthly payments are maintained and interest is paid, the customer can sustain the borrowing
at or near the limit, subject to periodic review by the bank.
Insurance may be offered to pay off the debt in the event of the death of the customer or to meet
repayments if the borrower has a prolonged illness or is made redundant.
Revolving credit accounts are intended primarily for the professional type of customer with good income;
being designed to allow the customer to change a car, purchase electrical goods, etc without the need to
keep contacting the bank to enter into new personal loan agreements for each purchase.
The rapid growth in the use of credit cards over the last few decades has seen this type of lending
dramatically reduced, however many banks do still make such services available if requested.
Q U I C K
Q U E S T I O N
Describe how a budget account operates.
Write your answer here before reading on.
12
Budget accounts
A budget account enables customers to spread the cost of their regular bills and expenses over a year.
The customer adds up all the bills and expenses that are due over the course of the year and agrees the
total amount with the bank. The total is divided by twelve and this sum is paid in to the budget account
by the customer each month from their operating account into which their salary is paid. The customer
may be issued with a separate cheque book with which to pay the bills, or they can arrange for their
monthly and other direct debits/standing orders to be debited to the budget account as the fall due
without worrying whether or not there are funds in the account. This type of account smoothes out the
cash flow and makes budgeting easier.
As with revolving credit facilities, the almost infinite flexibility of the credit card has replaced a large
amount of lending that used to be provided by means of budget accounts.
13
Credit cards
Credit cards are very much a part of everyday life. These plastic cards can be used by the cardholder to
purchase goods and services which are paid for at a later date. They are a widely used method of
making payments and for obtaining credit facilities.
Credit cards are a method of money transmission where the customer has the option of settling only part
of the monthly bill, thereby borrowing the amount of the unpaid balance. If the customer pays off the
outstanding balance in full prior to the repayment date, no interest is charged and therefore this is a very
88
3: CREDIT PRODUCTS AND SERVICES
cost-effective method of short term borrowing. By careful timing of their purchases and then repaying
the bill in full, the customer may obtain up to 56 days interest-free credit.
There are currently two dominant groups who operate international networks – Visa and MasterCard. All
the main banks, building societies and other organisations offer their own versions of either or both of
these cards. You should familiarise yourself with the type(s) of card(s) that are offered by your own
organisation.
The essential features of a credit card are:
13.1

the purchase of goods and services on credit subject to an agreed overall limit

the issue of regular statements by the credit card company

the option for the customer of either paying all of the sums due to the credit card company or
electing to pay off only a portion of the sums due (minimum amount or 3 - 5%, whichever is the
greater) and paying interest on the remainder.
Application procedure
A credit card account operates independently of a customer’s other accounts with the bank, and the
relationship between the bank and the cardholder differs from the traditional banker/customer relationship.
It is not necessary for a person to maintain an account with the bank before they can be issued with a
credit card. It is initiated by a separate agreement between the bank and its customer regulating the
issue of the credit card and the debtor/creditor relationship that exists between the parties. In addition,
due to the element of credit involved, the bank will have to be satisfied that the customer can be
considered creditworthy for the amount of their limit. The customer completes an application form as the
basis of the agreement between them and the bank. The application form also provides the bank with a
great deal of information about the customer, such as employer, salary, house owner or tenant, marital
status, number of children, etc.
Normally the creditworthiness of the applicant is screened by application scoring. The process determines
the statistical probability that the credit will be repaid.
13.2
Use of the credit card
Provided that the issuer is satisfied with the creditworthiness of the customer, a card and personal
identification number (PIN) will be issued and the customer will be granted a credit limit. The customer
can then use the card to make purchases up to the amount of the limit on the account. The cardholder
presents the card to the retailer and the transaction is completed by the card being swiped through the
retailer’s terminal and the customer inputting their PIN number on a keypad.
A credit card can also be used for postal, internet and telephone transactions; the card number being
quoted over the phone together with the security code number quoted on the back of the card. This
information is input on to a computer or noted on an order form sent in the post.
Cash can be withdrawn via ATMs using the credit card by the cardholder inputting their PIN. This
withdrawal will be treated by the credit card company as a cash advance and so interest will accrue from
the date of the transaction.
Joint credit cards are not offered, but the customer has the option of applying for other persons to be
issued with cards on the account. For example, a husband and wife may both have credit cards and the
same account will be debited regardless of whose card is used, but only one person will be liable for
repayment of the debt.
Every month, the cardholder receives a statement showing:



their limit
the transactions that have been made with the card(s)
any payments that have been received
89
CREDIT AND LENDING




any interest that has been debited to the account
the current balance
the amount of available credit remaining
an estimate of the interest which will appear on the next statement based on the current balance.
On receipt of a statement, a cardholder has the option of:

repaying the whole balance by the due date shown on the statement, or

repaying a minimum amount or 3 - 5% (whichever is the greater) of the balance by the due date
(provided that the balance is more than £5, otherwise the whole amount due must be repaid).
Should the cardholder elect not to clear the balance due, interest will be charged monthly from the
statement date on any outstanding balance not repaid.
13.3
Company credit cards
Companies can make use of credit card facilities to help them control business expenses and manage
cash flow. This also provides staff who incur regular expenses with a simple and convenient payment
method, in the UK or abroad.
An overall limit is agreed between the company and the bank and designated members of company staff
are given a credit card with set limits within the overall agreed limit.
Each card issued normally bears the name of the company and of the cardholder.
Statements are usually produced in respect of each cardholder with an additional summary statement
showing the total amount due for payment from all cardholders.
Settlement of the sum due is normally effected by direct debit from the company’s bank account.
Q U I C K
Q U E S T I O N
List other sources of finance available to a business besides those studied above.
Write your answer here before reading on.
14
Alternative sources of finance
In many cases customers will present you with proposals for which the bank is to provide only part of the
total funding package. For example, a hotel may receive a low-interest loan from the brewer whose
products it sells. In another case there may be a grant available from a local or government body. Mostly
the customer should take advantage of these offers.
There is a very wide range of alternative sources of finance and these are continually changing. This
section provides a broad understanding of the type of facilities which are available and where up-to-date
information can be sourced. The more common sources, such as the Enterprise Finance Guarantee
Scheme (EFG) and franchising, will be covered in more detail, while leasing and factoring were covered
earlier.
90
3: CREDIT PRODUCTS AND SERVICES
You may well be able to point your customer in the right direction towards alternative sources of finance.
It will then be up to the customer to take ownership of any such approach and seek advice from their
advisers, such as accountants and lawyers. In any case, the principles of lending remain fundamental
and will be applied in one form or other by any outside lender.
14.1
Grants
Q U I C K
Q U E S T I O N
Explain what is meant by a grant.
Write your answer here before reading on.
We start with grant assistance and should say at the outset that generally a grant is equivalent to cash.
Unlike a loan, it does not have to be repaid, provided the conditions applied to the grant are satisfied.
The criteria often require the creation of jobs.
14.2
What does the business need to finance?
In considering this question you should be aware that support by way of grant is not just available to
new businesses, but also to established businesses wanting to expand. As with any lending request, the
customer needs to clearly determine the purpose for which they require financial support.
In studying the principles of lending we identified the basic reasons why businesses borrow. Let’s look at
some specific examples, remembering that your customer’s needs may span more than one category,
such as:












funding the start-up of a new business
setting up or running a rural business
employing additional staff or developing existing people
investing in plant, machinery or property
developing new products and markets
finding new customers and markets
taking new products or services to the market/ marketing
funding growth
energy efficiency and the environment/conservation
exporting or funding overseas partners
investing in community development
specific support for women in business
The reason for this expansive set of examples (and there are obviously many more) is to illustrate that at
an early stage some key indicators can materialise, which may highlight that external support could be
available.
The government Business Link website, [www.businesslink.gov.uk] provides wide-ranging
information on grants and support schemes. These schemes are usually made available for specific
activities and initiatives and are not necessarily dependent on the nature of your business. There is also
www.bis.gov.uk
91
CREDIT AND LENDING
Equally, some grants and support schemes are only available to businesses operating within specific
sectors, such as:



Agriculture and Fishing
Recreation, Culture and Tourism
Manufacturing and Engineering
Qualification can also be as a result of a combination of criteria such as a proposal to support women in
business in a particular sector.
The Business Link website contains a Grants and Support Scheme directory illustrating a selection of
government programmes to fit with your customer’s criteria. Ultimately there will always be a
discretionary element and matching the criteria will not always mean that your customer will be eligible
for the programmes identified.
In Scotland, the website also has links to Scottish Enterprise [www.scottish-enterprise.com] and
Highlands and Islands Enterprise [www.hie.co.uk]. The job of Scottish Enterprise is to identify and
exploit opportunities for economic growth by supporting Scottish companies to compete, build globally
competitive sectors, attract new investment and create a world-class business environment. HIE is the
Scottish government’s economic and community development agency for the Scottish Highlands. Business
Gateway [www.bgateway.com] is part of Scottish Enterprise, providing a point of contact for core
services or guidance to start-ups and small businesses. The website provides details of local offices.
14.3
What type of grant or loan support is available?
The main scheme is:
Regional Selective Assistance (RSA)
RSA is a discretionary scheme available in those parts of Great Britain designated as Assisted Areas. RSA
takes the form of discretionary grants to encourage firms to locate or expand in these areas. Projects
must either create new employment or safeguard jobs.
In England RSA is available for projects involving capital expenditure of at least £500,000. In Northern
Ireland similar funding towards the stimulation of new enterprises and expansion of existing companies
is available from the Industrial Development Board or LEDU.
In Scotland, RSA encourages businesses to undertake development that will directly result in the creation
or safeguarding of jobs in Scotland. Both indigenous and foreign companies can apply. The amount
offered is dependant on the size of the business, location of the project and an assessment of how much
is needed for the project to go ahead. There are three tiers of assisted areas in Scotland reflecting
different maximum levels of grant assistance. You should see the websites for Scottish Enterprise and
Highlands and Islands Enterprise for more details.
DTI Grants for Innovation, Research and Development
The Government is actively encouraging businesses to undertake innovation, research and development
projects. These grants cover research and development into new technologies, innovative products and
processes. Again, they are part of the EU Framework Programmes. [www. businesslink.gov.uk] or
[www.bis.gov.uk]
European Investment Fund (EIF)
The EIF is the European Investment Bank’s specialist provider of small and medium sized enterprises
(SMEs) risk finance across Europe. They do not provide finance to SMEs directly but their clients include
a wide range of financial institutions, banks and venture capital funds involved in SME funding.
This fund provides guarantees to banks and leasing companies to help provide finance to small and
medium sized companies. This can be arranged through financial institutions with loans at highly
competitive rates – fixed or variable – over terms from five years upwards.
92
3: CREDIT PRODUCTS AND SERVICES
Its other main function is the provision of venture capital which takes the form of equity investments in
venture capital funds supporting SMEs, particularly those at an early stage and technology orientated.
[www.eif.org]
European Structural Funds
These structural funds are the European Union’s main instrument for supporting social and economic
growth and restructuring across the Union and account for over a third of the EU’s budget.
The European Regional Development Fund (ERDF) is set up to stimulate economic development in the
least prosperous regions of the EU.
Structural funds available in the UK:




The
The
The
The
European Regional Development Fund (ERDF)
European Social Fund (ESF)
guidance section of the European Agricultural Guidance and Guarantee Fund (EAGGF)
Financial Instrument for Fisheries Guidance (FIFG)
All of these funds contribute to the economic development of disadvantaged regions of the UK.
[www.bis.gov.uk]
Further information is available on the following websites:
www.eurofundingnw.org.uk
www.scotland.gov.uk
The information above is only a brief outline of the type of grant or loan support that could be available
to your customer, but you should always refer to the relevant websites to ensure the information you
employ is up to date and to keep informed of additions or alternatives.
Enterprise Finance Guarantee Scheme (EFG)
Many small to medium sized enterprises (SMEs) have viable business plans that need funding, for which
a loan would be appropriate. However, some of them may be unable to obtain a conventional loan
because they do not have assets to offer as security. The EFG helps to overcome this by providing
lenders with a government guarantee against default in certain circumstances. It is a targeted measure
intended to facilitate additional commercial lending to viable SMEs unable to obtain a normal commercial
loan due to having no or insufficient security. EFG facilitates lending that would not otherwise be
available by providing lenders with a partial guarantee.
The scheme is a joint venture between the Department for Business, Innovation and Skills (BIS) and the
lender. All commercial decisions affecting borrowers are taken by the lenders; the BIS cannot intervene.
In return for Government support, a premium is payable by the borrower to the BIS.
The following loan facilities may be used under EFG (repayable over terms between three months and
ten years, except where indicated):





new term loans (unsecured or partially secure)
refinancing existing loans
conversion of an existing overdraft into a term loan
invoice finance guarantee (available for terms up to three years)
overdraft guarantee (available for terms up to two years).
The precise nature and terms of any facility made available by individual lenders will vary in accordance
with that lender’s standard commercial lending criteria.
A premium of two percent per annum is payable to the Department for Business, Innovation and Skills
(BIS) in addition to the lender’s capital and interest repayments and arrangement fee.
EFG is intended to support lending to viable businesses that can ultimately repay the full loan. The
government guarantee is a guarantee to the lender. Neither the guarantee nor the premium provides
insurance for the borrower in event of default.
93
CREDIT AND LENDING
Eligibility:
Loans can be made (at the discretion of the lender):




to small and medium-sized businesses in the UK with an annual turnover of up to £25m
to businesses seeking loan facilities of between £1,000 and £1million
for terms between three months and ten years
or an eligible loan purpose.
Loans for most business purposes are eligible.
Other main features and criteria of the scheme are:

a guarantee to the lender covering 75% of the loan amounton.

available to businesses in most sectors and for most business purposes, although there are some
restrictions., such as financial services, betting, education, medical, postal, professional sports,
ticket agencies, transport and tied pubs.
[www.businesslink.gov.uk]
14.4
Other sources of finance
So far we have considered the type of grants and loans that could be available for your customers. However,
getting the right finance or financial balance is essential to the future of any business. There are many
different types of finance available, each designed to meet different needs. It is important that your customers
try to secure the financial package that best reflects the needs of their business. We shall now look at some of
the other options that should be considered when compiling this package of financial support.
14.5
Franchising
Mention franchising to anyone and they probably think of fast food restaurants such as McDonald’s,
Burger King or Kentucky Fried Chicken. Franchising, however, has developed and grown substantially
since the 1970s into a respected and recognised force in the business community reaching into a wide
range of sectors. Research has shown that of all businesses starting today, only 20% will still be trading
in five years. In the case of franchised businesses, the statistics are reversed, with 80% still trading at
the end of this period. When you consider that there are over 700 franchise systems operating in the UK,
and over 31,000 individual franchised units (with this figure continuing to grow), you begin to appreciate
the importance of this business format. Given the lower failure rate, this can represent a safer route into
self-employment than starting a business from scratch.
14.5.1
What is franchising?
Basically, franchising is where a successful business format is replicated. When a business owner (the
franchiser) has established systems and procedures with a track record of success, they document these
in a manual. Franchising, or to give it its full name, business format franchising, is the granting of a
licence by one person (the franchiser) to another (the franchiser), which entitles the franchisee to trade
under the trademark/trade name of the franchisor and to make use of an entire package, comprising all
the elements necessary to establish a previously untrained person in the business and to run it with
continual assistance on a predetermined basis.
The principle is simple - some companies choose to grow, not by developing in the conventional way, but
by granting a licence to others to sell their product or service. The franchiser is paid an initial fee from
the franchisee and a management service fee for the licence. This is usually based on a percentage of
the business’s annual turnover or the mark-up on supplies. The franchiser then provides the franchisee
with a complete, proven business concept including:



94
use of the franchiser’s name or brand
agreement to produce or sell products and services as described
associated goodwill
3: CREDIT PRODUCTS AND SERVICES




14.5.2
training
product development
marketing advice/advertising
promotional activities.
Benefits to the franchisee
Apart from the above and entering a proven business with a high chance of success, the franchisee can
benefit from the franchiser’s knowledge of the sector in the following ways:

No need to come up with a new idea – someone has had it tried and tested

Larger, well-established franchise operations will often have national advertising campaigns and a
solid trading name

Good franchisers will offer comprehensive training programmes in sales and business skills

Assistance with determining the franchisee’s financial requirements

Details of competitors readily available

Provision of ‘buying power’ in attaining group discounts from suppliers

Assistance with problem solving

Management support – to measure progress, celebrate success, plan for the future.
Much of this could take years to achieve for a normal business start-up. Being in business can be a
solitary function in many aspects; as a franchisee you have the benefits of your own business while
enjoying a management or team type of environment. This is one of the major reasons attributed to the
success of franchising. While the franchisee owns and operates the business, the franchiser retains
control over the manner in which the products and services are marketed and sold. The franchiser’s
business concept, combined with the self-motivation and industry of the franchisee, should lead to the
growth of the franchise and subsequently to mutual benefit for both parties.
14.5.3
14.5.4
Disadvantages to the franchisee

Levels of success (or otherwise) can vary from sector to sector and from business to business.
Not every business is suitable for franchising. The situation requires to be fully researched.

How strong is the brand or image and is it transportable over a wide area? If there is a heavy
dependency and if damage is inflicted, it can severely undermine the franchisee.

Is the product or service adaptable to reflect any shift in market demand? For example, McDonalds
have tried to change both their perception and their menu to reflect heightened awareness of a
healthy diet, while still maintaining their core business – it can prove a difficult balance.

While franchising generally requires less capital investment than a normal start-up situation,
financial requirements should not be underestimated. This is a medium to long term investment
and initially it still requires a sizeable amount of finance to cover start-up costs, fees, etc.
Benefits to the franchiser

Opportunity for a business with a proven product or service to sell, to expand rapidly without a
prohibitive outlay of capital. While it is not a quick way to make money, it represents growth at a
controlled rate.

It can provide a broad distribution network and rapid market penetration.

High level of commitment from franchisees who have a stake in the business. This can make a notable
difference from say, a manager or staff working for a salary, who may tend to be less motivated.

Benefit of the entrepreneurial skills which the franchisee can introduce, resulting in a better
performance than otherwise might have been achieved.
In order to derive the above benefits, the franchisor must ensure that their business model is researched
and refined, and that documented procedures are comprehensive and easily understood in order to be
replicated.
95
CREDIT AND LENDING
14.5.5
Disadvantages to the franchisor

Major problems can arise if the franchisees are poorly chosen or become resentful of existing
arrangements.

The franchiser needs to ensure that firm management and monitoring systems are established
and maintained to control and provide support. Failure on the part of a franchisee can impact on
the overall brand.

The franchiser has no share in the equity of the franchisee’s business.
[www.british-franchise.org.uk] and [www.whichfranchise.com]
Some other examples of franchises are:








14.6
Avis – car hire
The Body Shop International PLC – natural skincare products
Knobs & Knockers – brass, etc door furniture
Olivers – bread and cakes
Prontaprint – fast print centres
Pronuptia de Paris – bridal attire
Spud U Like – fast food
Thorntons – chocolate and sugar confectionery
Some other sources of finance
The alternative sources of finance listed below have already been covered in this chapter. It is important
that you cross refer as they all represent key alternative sources of finance:




14.7
Leasing/asset finance
Hire purchase
Invoice discounting
Factoring
Equity finance
The raising of equity finance involves the owner giving up a share of their business in exchange for an
investment in the business. Equity finance can be raised through business angels or venture capitalists.
This type of finance is available only to limited companies. What the directors do is to issue new shares
in their company to the new investor in exchange for cash to finance the growth and development of the
business.
14.8
Business angels
These are private investors who tend to invest in small and medium sized businesses with good growth
prospects. On average they tend to invest anything from £10,000 to £500,000, making them suitable for
new businesses or those in the early stages of growth.
Advantages

Security is not usually required.

On average the investment is from three to six years, enabling the formulation of long term
planning.

Often provide support in the form of expertise or network contacts.
Disadvantages


96
Dilution – the owner gives up part of the business and does not own 100% of the shares.
Proportion of the business profits goes to the investors.
3: CREDIT PRODUCTS AND SERVICES
14.9
Venture capitalists
Effectively the owner sells a stake in the business in return for a capital injection. Venture capitalists
usually invest in excess of £500,000 and this tends to be a long term investment suitable for supporting
sizeable expansion plans.
Advantages

Security is not usually required provided there is an experienced management team with a solid,
viable business plan.

Investment is usually for a period of three to ten years, enabling adoption of long term plans.

Venture capitalists often provide strategic input but do not usually get involved in the ongoing
day-to-day management.
Disadvantages


Owner requires to provide detailed information about the company.
Part of the ownership or control transfers to the venture capitalists.
[www.businesslink.gov.uk] has information on how to find business angels and venture capitalists in
the guide to equity finance.
14.10
Working with universities and colleges
Where appropriate, customers can seek to work with universities and colleges, gaining the benefits of
government-sponsored research and development programmes. Apart from the financial support this
offers, the benefits of these programmes can enhance the competitiveness of the business.
14.11
Borrowing money tax efficiently
Business owners should always consult with their advisers to ensure they gain the benefits of reducing
their overall tax bill. Initially they will be looking to identify tax advantages for starting up a business,
first year allowances, capital allowances, etc, but they should also look to obtain the maximum relief on
their borrowed funds. Tax relief on borrowings is not always maximised by some businesses. Tax relief
may offset the costs of some types of borrowing and this benefit should be factored in when determining
the right finance for a business.
You should refer to the undernoted website which includes a guide illustrating tax-efficient methods of
borrowing, including:






tax relief on renting or leasing assets
tax relief on borrowing to purchase an asset
example of tax relief for different ways of acquiring an asset
borrowing money for capital investment from pension schemes
claiming loan interest against tax
The Enterprise Investment Scheme.
Borrowing Money Tax Efficiently: www.businesslink.gov.uk
14.12
The Enterprise Investment Scheme (EIS)
Some limited companies can raise funds under the EIS. The scheme applies to trading companies but not
generally service or investment companies. There are potential tax advantages for individuals (including
sole traders and partners acting in their capacity as individuals) who invest in such companies, including:

the buyer of shares gets tax relief at the lower rate of income tax
97
CREDIT AND LENDING

when they sell the shares it is also possible that they can defer the capital gains tax on any gain
on the shares.
Interest on loans taken for the purpose of investing in qualifying companies is not tax deductible.
Details of the EIS can be downloaded from the HM Revenue and Customs website:
www.hmrc.gov.uk/pdfs
98
3: CREDIT PRODUCTS AND SERVICES
KEY WORDS
Key words in this chapter are given below. There is space to write your own revision notes and add
any other key words or phrases you want to remember.

Bridging loans

Covenants

Drawdown

Equity/capital release loans

Equity finance

Factoring

Financial lease

Franchising

Invoice discounting

Operating lease

Overdraft

Regional Selective Assistance (RSA)

Small Firms Loan Guarantee Scheme (SFLGS)

Term loan
99
CREDIT AND LENDING
REVIEW
The main learning points introduced in this chapter are summarised below.
Go through them, check back to the learning outcomes at the beginning of the chapter, and then move on only
when you are happy that you fully understand each point.
Re-read any section you are unsure of.
100

An overdraft is the negative balance on a current account. There are no maximum or minimum amounts
involved. Overdrafts are a flexible form of short term borrowing.

Term loans are for a fixed amount usually to finance the purchase of a long term asset, with the loan being for
an agreed period of up to10 years or more. These loans are usually secured, often with lending covenants.

Bridging finance is used when a major purchase precedes a major sale. It is most commonly encountered
when dealing with the purchase and sale of property. The bridging loan is secured either by an
irrevocable mandate in Scotland, or a letter of undertaking in England and Wales. Bridging loans may be
either open ended or closed ended.

Hire purchase is a hiring and purchase agreement, with the asset only becoming the property of the
customer when the final payment is made. Leasing is akin to a rental agreement.

Factoring/invoice discounting allows a business to obtain cash against its book debts.

Self-build loans are given to customers who are building their own home. Drawdown of the loan is
usually in tranches at certain stages of the building. Repayment normally comes from the drawdown of a
mortgage on completion of the project.

House purchase loans were traditionally offered by building societies, but are now also offered by banks.

A personal loan is usually an unsecured form of credit and the customer’s application will normally be
credit scored. Personal loans may be granted for a variety of purposes, including cars and large domestic
appliances.

Budget account loans are bank current accounts, separate from the customer’s main operating current
account, to which monthly and other recurring items of annual expenditure are debited as they fall due.
The budget account is funded by monthly transfers from the operating account with the amount based
on the total annual bills divided by twelve.

A revolving credit is a loan facility where the loan agreed is for a multiple of the monthly payment made
into the account. Customers can draw and redraw up to this limit without having to take out a separate
loan for example, for a holiday, new car or other consumer goods.

A credit card is a form of money transmission that may also be used to take credit. The customer may
choose either to repay the total balance or a smaller amount. It is possible to obtain up to 56 days’
interest-free credit with a credit card.

Equity/capital release loans enable individuals who own a house with a mortgage substantially lower in
amount than the value of the house to borrow against the security of their dwelling to finance
expenditure similar to that financed by personal loans. Equity release loans are secured and the
borrowing is cheaper for the customer than for a personal loan.

Alternative sources of finance include grants and loans available from various public bodies to stimulate
the growth and development of business. The Enterprise Finance Guarantee Scheme is one source of
loan finance for SMEs. Franchising, leasing, factoring and several different types of equity finance also
come under the heading of alternative sources of finance.