Source: The Ascent of Money: "The Origin of Credit"
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This video from the PBS documentary The Ascent of Money traces the evolution of credit, beginning in 16th century Venice. Historian Niall Ferguson discusses how the invention of credit has had a major impact on world development. The concept of interest—compensation for the use of someone else’s money—is also explored.
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Creditworthiness is the likelihood that a borrower will be able to repay a loan in an agreed-upon period of time. When you apply for a loan, the lender does an analysis of risk based on several factors, and that determination can impact whether or not you get a loan and how much interest you have to pay. The riskier a lender thinks you are, the more they are going to make you pay for the loan in interest.
One primary measurement of creditworthiness for individual borrowers is a credit score. A credit score is a statistical formula made up of a borrower’s payment history, amounts of money that are owed, length of credit history, new credit applications, and types of credit used. They are calculated by private organizations, like the Fair Isaac Corporation, which produces the “FICO” score. Generally, a higher FICO score means lower interest rates.
In order to determine creditworthiness for business borrowing, some banks utilize the “5 Cs” of credit: character, capacity, capital, conditions, and collateral. Character refers to the integrity of the borrower, or the borrower’s reputation. The lender is trying to determine how trustworthy you are and ascertain your willingness to repay your debts. In order to determine character, a bank may look at credentials and references.
Capacity refers to your credit history: what is your business’s track record for paying back debt? An important element of your credit history is whether or not you have paid loans back on time, or missed payments, or even defaulted on a loan. Capacity also looks at your business’s financial ability to repay the debt. In financial terms, this means whether or not you have sufficient cash flow to repay the debt on schedule.
Capital means that your business has sufficient cash, including the amount of indebtedness, to get through a difficult financial period. Banks also want to see that you have a financial commitment to your company and have sufficiently invested in the business so that you would stick with the company, even through tough times.
Conditions take account of the overall economic picture, including the climate within your industry and in other industries that could affect your business. The bank wants to know that you are prepared for any risks facing your company.
Collateral means that you have a second source of repayment, if you don’t have the cash flow to repay the loan. Specifically, the lender wants to know that you have assets of the equivalent value that can be taken if the debt is not repaid. For example, the lender may request the building where your business is located as collateral so that if you cannot repay the loan, the lender becomes the new owner of the building.
NIALL FERGUSON: There was one huge possibility created by the emergence of money as a system of mutual trust—a possibility that would revolutionize world history.
It was the idea that you could rely on people to borrow money from you and pay it back at some future date.
That’s why the root of “credit” is “credo”, the Latin for “I believe.”
Without the invention of credit, the entire economic history of our world would have been impossible.
Because we take it for granted, we tend to under--estimate the extent to which our entire civilization is based on the borrowing and lending of money. No, it doesn’t literally make the world go round. But it does makes vast quantities of people, goods and services go round the world from Babylon to Bolivia.
The provision of credit has underpinned the transformation of a planet of subsistence farmers into a globalized economy worth tens of trillions of dollars.
The idea has been with us for centuries. But nowhere was the credit business further advanced by the 16th century than Venice.
And the home of literature’s most notorious moneylender: Shylock, in William Shakespeare’s The Merchant of Venice.
BASSANIO: May you stead me? Will you pleasure me?
Shall I know your answer?
NIALL FERGUSON: Crucially, Shylock’s only prepared to lend the money if Bassanio’s friend, the merchant Antonio, is providing the security:
SHYLOCK: Three thousand ducats for three months and Antonio bound.
BASSANIO: Your answer to that.
SHYLOCK: Antonio is a good man.
NIALL FERGUSON: By “good,” Shylock doesn’t mean virtuous, he means “good” for the money he’s about to lend Bassanio; In other words, creditworthy.
BASSANIO: Have you heard any imputation to the contrary?
SHYLOCK: Oh, no, no, no, no: my reason in saying that he’s a good man is to have you understand me that he is sufficient.
SHYLOCK V/O: Three thousand ducats. I think I may take his bond.
NIALL FERGUSON: With any loan things can go wrong. Ships can sink. And that is precisely why anyone who lends money to a merchant—if only for the duration of an ocean voyage—needs to be compensated. We usually call the compensation “interest”: the amount paid to the lender over and above the sum lent or “principal.”
Overseas trade of the sort that Venice depended on couldn’t operate without such transactions. And they remain the foundation of international trade to this day.
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