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DISCOUNTING OF BILLS IN INDIA

Rajeev KMBA FTRoll No. 35

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Bill Discounting- A fund/asset based financial service

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Definition

• Section 5 of the negotiable instruments Act, 1881, defines a bill of exchange as “A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, 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 the instrument”.

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Key Terms

• Drawer is the maker of the bill of exchange. A seller/creditor who is entitled to receive money from the debtor can draw a bill of exchange upon the buyer/debtor. The drawer after writing the bill of exchange has to sign it as maker of the bill.

• Drawee is the person upon whom the bill of exchange is drawn. Drawee is purchaser of the goods or debtor

• Payee is the person to whom the payment is made. The drawer of the bill himself will be the payee if he keeps the bill with him till the date of its payment.

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Bill of Exchange

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Bill of Exchange

Payee

Drawee Drawer

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Key Terms• Endorsement

An endorsement on a negotiable instrument has the effect of transferring all the rights represented by the instrument to another individual. To endorse means the endorser guarantees payment in case the principal borrower defaults

• Negotiable Capable of being transferred by delivery or endorsement

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How B/E is to be created ?

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Discounting of B/E• The seller who is the holder of a accepted

B/E has two options :

1. Hold on the B/E till maturity and then take the payment from buyer.

2. Discount the B/E with discounting agency.

Note : However the option (2) is much more attractive as seller gets ready cash

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Discount :

– Seller can take the accepted B/E to a discounting agency and obtain ready cash.

– The act of handing over an endorsed B/E for ready money is call discounting the B/E.

– The difference between ready money paid and the face value of the bill is called the discount.

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Types of Commercial Bills• Demand Bill

Payable on demand. i.e, immediately at site / on presentation to the drawee.A bill on which no time of payment/ “due date” is specified.

• Usance BillPayable after a specified period.Called as Time bill.Usance refers to time recognized by custom/ usage

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Types of Commercial Bills (contd.)

• Documentary Bills- Bills accompanied by documents that confirm that a trade has been taken place b/w buyer and seller of goods.- Documents: railway receipts, bill of lading, lorry receipts, delivery orders, etc- It may be D/A(against acceptance) Bills or D/ P Bills (against payment)

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Types of Commercial Bills (contd.)

• Clean Bills- No documents are accompanied to show that a trade has taken place.- So interest charged will be more than documentary bills- Ex: Cheques, drafts, etc

• Bill Purchase facility for Clean bills and Bill Discounting facility for Usance bill.

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Types of Commercial Bills (contd.)

• Inland Bills- drawn or made in India and must be payable in India/ drawn up on any person resident in India.

• Foreign Bills- drawn out side India and may be payable in or outside India or- drawn in India and payable out side India.

• Hundi- Indigenous variety of B/E, mainly for movement of agricultural produce

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Types of Commercial Bills (contd.)• Derivative Usance Promissory Note

- Innovative instrument- Eliminating movement of papers and allows multiple rediscounting- Backed by eligible commercial bills and usance period up to 90 days.- Exempted stamp duty- Active secondary money market

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Important Features:• Essentially a Trade related instrument (Trade

Bills)• Trade bills, when accepted by commercial banks

are called as Commercial Bills.• Banks, when in need, get such bill discounted

by financial institutions like LIC, UTI, GIC, IRBI, ICICI, etc.

• Maturity period – 30 days, 60 days, 90 days, etc(depending on the credit extended in the industry).

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• With RecourseWith subsequent liability. As a legal term it signifies that a seller (and not the buyer) of an asset, or the drawer (and not the holder) of a negotiable instrument, is assuming the risk of non-performance of the asset or the non-payment of the instrument. Written also as with full recourse.

• With out recourse Without subsequent liability. As a legal term it signifies that a buyer (and not the seller) of an asset, or the holder (and not the drawer) of a negotiable instrument, is assuming the risk of non-performance of the asset or the non-payment of the instrument.

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Advantages of Bills Discounting• To Investors

1) Short term sources of finance

2) Bills discounting being in the nature of a transaction is outside the purview of the Indian companies Act, that restricts the amount of loans that can be given by group companies

3) Since it is a lending no tax at source is deducted while making the payment charges which is very convenient not only from the cash flow point of view, but also from the point of view of companies that do not envisage tax liabilities.

4) Rates of discount are better than those for other sources of finance.

5) Flexibility not only in the quantum of investments but also in the duration of investments.

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Advantages to Banks:

• Safety of Funds : Bearing signatures of two parties

• Certainty of payment: A B/E is a self liquidating asset with the banker knowing in advance the date of its maturity

• Profitability : Discount is front-ended, so as yield is much higher than loans

• Even out Inter-bank Liquidity Problems : Stabilized the fluctuations in the call money market

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Bill Market Scheme

• Bill Market Scheme – 1952

• Bill Market Scheme – 1970

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Problems or Issues• Most of the customers approaching bank for BD are SSI

units – credit assessment is difficult. • Kite Flying: practice of discounting accommodation bills• Business in bills are declined drastically, DFHI concentrates

more on other money market instruments.• Its mostly foreign trade is financed through bill market and

the size of the same is small. • Cash credit system is more preferred• Several corporate houses and business groups do not accept

B/ E drawn on them, since it seems to damage their pride.• No Stamp Duties are levied on LC backed bills up to 90 days

and so no bills being drawn for a period exceeding 90 days.

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Revised guidelines by RBI• Banks are directed to purchase/ discount/ negotiate bills only

after opening LC with them.• Accommodation bills shall not be purchased/ discounted/

negotiated by Banks.• The practice of drawing bills of exchange with the clause

"without recourse" should be discouraged• Bills rediscounting shall be restricted to usance bills held by

other banks.• While discounting bills of service sector, banks shall ensure

that actual services are rendered.• Banks should not enter in to repo transactions using bills

discounted/ re discounted as collateral.

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Precautions by Finance Companies• Ensure that bills are not accommodation bills.• Bills are drawn on places where co. is operating.• Goods covered by documents are those which the party deals.• Bills are not stale.• Scrutiny of Credit report and financials of the drawer and integrity of

the drawee shall be ensured.• Banks will check the frequently published IBA bulletins which

indicate the names of unsatisfactory drawees.• The truck receipt is in the form prescribed by IBA.• Bills are drawn in favor of the finance co. and have been accepted

by the drawee.• Goods covered under the bill are not perishable in nature.• It must have been accepted and bear at least two good signatures

(e.g. of reputable individuals, companies or banks etc.)

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Difference b/w Bills Discounting & Factoring

BILL DISCOUNTING FACTORING Individual transaction –

each bill is separately assessed.

Provision of bulk finance

Stamp duty is charged on certain usance bill

No stamp duty is charged

Involves more paper works Less paper works involved Original documents to be

submitted Only copies shall be

submitted It is a balance sheet item It is an off balance sheet

item

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BILL DISCOUNTING FACTORING Does not involve assignment

of debts Involves assignment of debts

Bill discounting is always of recourse type

It can be either with or without recourse

There is only provision of finance

Factor provides in addition to finance facility other facilities like sales ledger maintenance, collection etc

Discounted bills may be re-discounted several times before they mature for payment

No provision for re discounting.

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Reference

• Financial Services – M Y Khan• The Indian Financial System – Bharati V. Pathak• Modern Banking – D Muraleedharan• SME in India – IIBF• www.rbi.org• www.iibf.org.in• www.investopedia.com• en.wikipedia.org

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