Bill Discounting

BILL DISCOUNTING

1 INTRODUCTION:

Bills of exchange that are used in the course of normal trade and commercial activities are called commercial bills‗. Bill financing, is an ideal mode of short-term financing available to business concerns. It imparts flexibility to the money market, besides providing liquidity within the banking system. It also contributes towards the effectiveness of the monetary policy of the central bank of a country.

According to the Indian Negotiable Instruments Act 1881, ―Bill of Exchange is an instrument in writing containing an unconditional order, signed by the marker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of that instrument.

The bill of exchange is essentially a trade-related instrument, and is used for financing genuine transactions. Bill financing, is an ideal mode of short term financing available to business concerns. It imparts flexibility to the money market, besides providing liquidity within the banking system. It also contributes towards the effectiveness of the monetary policy of the central bank of a country.

2 BILL DISCOUNTING

When the seller (drawer) deposits genuine commercial bills and obtains financial accommodation from a bank or financial instit instead of discounting the bill immediately may choose to wait till the date of maturity.

When the seller (drawer) deposits genuine commercial bills and obtains financial accommodation from a bank or financial institution, it is known as 'bill discounting'. The seller, instead of discounting the bill immediately may choose to wait till the date of maturity. Commercial, the option of discounting will be advantageous because the seller obtains ready cash, which can be used for meeting immediate business requirements. However, in the process, the seller may lose a little by way of discount charged by the discounting banker.

3 Following are the salient features of bill discounting financing:

1. Discount charge:

The margin between advance granted by the bank and face value of the bill is called the discount, and is calculated on the maturity value at rate a certain percentage per annum.

2. Maturity:

Maturity date of a bill is defined as the date on which payment will fall due. Normal maturity periods are 30, 60, 90 or 120 days. However, bills maturing within 90 days are the most popular.

3. Ready finance:

Banks discount and purchase the bills of their customers so that the customers get immediate finance from the bank. They need not wait till the bank collects the payment of the bill.

4. Discounting and purchasing:

The term discounting of bills is used for demand bills‗, where the term purchasing of bills is used for usance bills‗. In both cases, the bank immediately credits the account of the customer with the amount of the bill, less its charges. Charges are less in case of purchasing of bill because the bank can collect the payment immediately by presenting the bill to the drawee for payment. Charges are, however, higher in the case of discounting of bill‗ because the bank charges include not only the charges for service rendered, but also the interest for the period from the date of discounting the bill to the date of its maturity. In addition, there are also charges when bills are dishonored. In such circumstances, the bank will debit the account of the customer with the amount of the bill along with interest and other charges. Since the bank is granting advance to the customers in both the discounting and purchasing of bills, bills discounted and purchased are shown as advances (Schedule 9) by a bank in its balance sheet.

4 Steps In Discounting And Purchasing Following steps are involved in the discounting and purchas8isng of commercial bills of exchange:

1. Examination of Bill: The banker verifies the nature of the bill and the transaction. The banker then ensures that the customer has supplied all required documents along with the bill.

2. Crediting Customer Account after examining the genuineness of the bill, the banker grants a

credit limit, either on a regular or on an ad net amount of the bill i.e. value of bill minus discount charges. The amount of discount is the income earned by the bank on discounting / purchasing. The amount of the bill is taken as advance by the bank.

3. Control over Accounts: To ensure that no customer borrows more than the sanctioned limit, a separate register is maintained for determining the amount availed by each customer. Separate columns are allotted to show the names of customers, limits sanctioned, bills discounted, bills collected, loans granted and loans repaid. Thus, at any given point in time the extent of limit utilized by the customer can be readily known.

4. Sending Bill for collection: The bill, together with documents duly stamped by the banker, is sent to the banker's branch (or some other bank‗s branch if the banker does not have a branch of  its own) for presenting the bill for acceptance or payment, in accordance with the instructions accompanying the bill.

5. Action by the Branch: On receipt of payment, the collecting bank remits the payment to the banker which has sent the bill for collection.

6. Dishonor: In the event of dishonor, the dishonor advice is sent to the drawer of the bill. It would be appropriate for the collecting banker to get the protested for dishonor. For this purpose, the collecting banker or branch of the bank maintains a separate register in which details such as date on which the bills are to be presented, the party to whom it is to be presented, etc. are recorded. The banker then presents them for acceptance or payment, as required. The banker debits the customers' (drawer / borrower) account with the amount of the bill and also all charges incurred due to dishonor of the bill. Such a bill should not be purchased in the event of its being presented again. However, the banker may agree to accept it for collection.

5 BILL SYSTEMS There are essentially two systems of bills, the drawer bill system and the drawee bill system, which are explained blow:

Drawer Bills System ‘Drawer Bills System‘s characterize sellers of goods on the buyer of the goods 2. Bills being discounted or purchased at the instance of the drawer of the bills 3. The banker primarily taking into consideration the credit of the drawer of bill, while discounting or purchasing these bills this system of financing goods is quite popular in our country.

Drawee Bills System „Drawee Bills System‘s characterized by : a. The banker accepting the bill drawn by the seller at the instance of the buyer (the drawee) b. The banker providing assistance, primarily on the strength of the creditworthiness of the buyer the two types of the drawee bills system are as follows:

1. Acceptance credit system: Under this system, the buyer‗s banker accepts the bill of exchange for the goods purchased by the drawee. Such a bill may either be drawn on the buyer or the banker. The banker also requires the borrower to show separately, the goods purchased under acceptance credit in periodical stock statements submitted to the banker.

2. Bills discounting system: Under this system, the seller directly draws the bill on the buyer's  bank discounts the bill and sends the proceeds to the seller. The buyer's banker will show the bill as bill discounted‗. Under both the systems, the banker keeps a record of the bills, both accepted and still outstanding. This is to ensure that the advance sanctioned does not exceed the credit limit. The main advantages of the Drawee bill scheme are as follows:  

1.  Assured payment: Since the banker has accepted the bill, the seller is assured of payment. Moreover, if the seller decides to get it discounted, the discount rate will be lower because the drawee is the banker itself.

2. Buying advantage: Due to the surety and standing of the banker, it is possible for the buyer to obtain goods at competitive rates.

3. Safety of funds: There is hardly any risk for the buyer‗s bank because the bill is accepted or discounted against the security of the goods purchased by the buyer. Moreover, the goods are under the control of the banker. It is equally advantageous for the seller's bank, since the discounted bill may be rediscounted with any other financial institution. This is because; a banker has accepted the bill.