Mutual credit is a form of credit that is used instead of currency to settle a transaction. Often considered to be an alternative currency, this form of credit is created when the transaction is executed. Unlike some other credit situations, the use of this form of credit takes place within a closed community. The end result of using mutual credit is somewhat like using a loan to settle a transaction, although there are key differences in how the process works.
The process of mutual credit requires looking closely at the current credit and debt balances associated with the individual’s account. Based on that intelligence, it is determined if the individual will be granted credit to complete a given transaction. This arrangement makes it possible to trade and cancel balances with other individuals, which does provide the potential for paying off a mutual credit debt in an indirect manner.
While mutual credit does share a number of characteristics with loans, there are a few key differences. One has to do with the fact that no interest is charged on the mutual credit balance. In addition, the credit balance can be transferred or traded to someone else with relative ease, a move that is somewhat common with deals involving this type of payment method. Since this type of credit arrangement is normally utilized within a select group of participants that have been screened before being allowed to make use of this type of credit option, there are often opportunities to trade the balance without any loss of benefit to either party involved in the original transaction.
In terms of advantages associated with the use of mutual credit, the fact that the alternative currency is self-regulating can be a distinct advantage for all parties concerned, since the supply of the currency can be expanded or contracted based on the circumstances surrounding the transactions involved. To a degree, this makes the management of the debt somewhat easier. At the same time, this aspect of mutual credit can be abused by creating huge negative balances that eventually impact everyone involved. While limits or caps on negative balances may be imposed, running up the debt to reach those caps can make the entire transaction somewhat more unstable, especially if one or more of the participants experiences some sort of financial reversal. For this reason, it is not unusual for mutual credit systems to qualify participants very closely before allowing those individuals to participate in the community and enjoy the benefits associated with the credit.