Chapter 7
Bills discounted
Learning objectives :
1. To understand the different types of Bills
2. To understand the meaning of bills purchase and
discounting
3. To understand the advantages of bills discounting
7.1 INTRODUCTION
Bills purchase and discounting is another way of taking
an advance from the bank. Such advances are short-term
and self-liquidating in nature.
Often when goods are sold, as opposed to making payment
in cash or by cheque,the buyer draws a bill of exchange
instructing the buyer to make payment to the Bank
processing the documents or to a third party.
The reasons why this is popular are :
 The buyer can get some time to make payment
 The seller can, if he requires, have the bill
discounted and encash the bill.
 The buyer(usually the bank) gets good title
provided he discounts/buys the bill in good faith,
for consideration and without being aware of any
defect in the title of the person from whom he
purchased the bill.
7.2 DEFINITION
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 to, or to the order of certain persons or to the
bearer of the instrument” ( Section 5 of the Negotiable
Instruments Act)
7.3 TYPES OF BILLS OF EXCHANGE
The bills of exchange are classified into:
(a) Sight or demand bills and
(b) Usance bills
Sight or demand bills : When a bill is payable at
„sight‟ or „on demand‟ or „on presentation‟, it is
called a demand bill.
Usancebills : If a bill matures after a certain period
of time ( after 30, 60,90 or 160 days) after date or
after sight it is called an usance bill.
Bills may also be :
(a) Documentary bills or
(b) Clean bills
(a)Documentary bills : When the seller (drawer) of a
bill encloses with/attaches to the bill the documents
of title to goods such as railway receipt or motor
transport receipts to be delivered to the buyer (drawee
of the bill) on payment or against acceptance of the
bill as the case may be, the bill is called a
documentary bill.
(b) Clean bills :If the bill of exchange is on its own
and there are no documents attached to it, the bill is
called a clean bill. A clean bill also arises out of
trade transactions where the relevant documents of
title to goods are sent directly to the drawee.
When the creditor or the seller of the goods draws a
bill on the debtor or the buyer, he has options to deal
with the bill:
 To send the bill for collection through a bank, or
 To sell it to, or discount it with, a bank
7.4COLLECTION OF BILLS
When a seller sells goods he can sell them on
collection. The seller would draw a bill and then hand
the bill to the banker to collect the amount due from
the buyer. The banker acts as the agent of the drawer
and makes its payment to him only on realization of the
bill.
The collecting bank sends the bills to its own branch
at the place of the drawee for presentation to the
drawee either for acceptance or for payment. If the
bank has no branch of its own at that place , the bill
is sent to the branch of any other bank with which the
collecting bank ahs an arrangement.
The proceeds of the bill are remitted to the collecting
banker who thereafter credits it to the account of the
drawer. If the bill is dishonoured, the banker will
inform the customer and will recover from him expenses,
etc incurred in this regard.
The banker acts as agent of the drawer of the bill for
collection and so he does not lend his funds to the
drawer by giving credit before the actual realization
of the bill. No entry is therefore made in the account
of the customer at the time of receipt of the bill.
When a bill is submitted by the party and sufficient
limit is available in the account, the following points
should be looked into:
(a) The bills should be complete in all respects and
the documents attached to the bill should be
consistent with one another.
(b) The bills should represent the genuine trade
transaction, it should also cover the approved
commodities in which the party is dealing. There
should be no reason to suspect the genuineness of
the documents.
(c) The bill should be properly drawn; the name of
the bank should appear as payee.
(d) The prices charged in the invoice should be in
reasonable conformity with the market prices of
the commodity concerned.
(e) The railway receipt, if accompanied with the bill
should not be a stale one, should match with
particulars (such as description of goods, weight
etc) mentioned in the invoice or bill.
(f) The railway receipt/lorry receipt and other
documents presented earlier and returned unpaid
should not be accepted again.
7.5 PURCHASE AND DISCOUNTING OF BILLS
In purchase and discounting of bills, the banker
credits the customers account with the amount of the
bill after deducting his charges or discount. As demand
bills are repayable on demand the banker is entitled to
demand their payment immediately on presentation before
the drawee as there is no maturity period. Demand bills
discounting is known as purchase of bills.
In case of anusance bill maturing after a period of
time, the banker retains the bill for that period and
realizes the amount of the bill from the drawee on its
due date. This practice is called discounting of the
bill. The discount is charged by the banker at a higher
rate than the charge made in case of purchase of a
bill. The discount includes not only the expenses
incurred in realization of the bill but also the
interest on the amount of the bill credited to the
drawers account. If the bill is dishonoured on the due
date the amount due on the bill together with interest
and other charges are debited to the drawers account.
7.6 BANKERS POSITION
The banker
collecting
documents.
acts
or
as an agent
negotiating
of his customer while
bills
with
relevant
The position of the discounting banker as owner or
agent of the customer was considered by Madya Pradesh
High Court in Dena Bank vs M.P. National Textiles
Corporation Ltd and held “ if the bills and the
relevant documents presented by its drawer are accepted
by a banker with the endorsement in its favor and the
same are immediately discounted by the banker without
waiting for its collection, by giving full credit for
the entire amount of the document, so presented, the
banker itself becomes a purchaser and the holder hereof
for full value. In such a case it is responsibility of
the bank to collect the amount of the bills from the
drawee and to reimburse itself and if the drawee
refused to present the documents back to the drawer and
collects the value thereof.”
7.7ADVANATGES OF DISCONTING OF BILLS
1.Safety of bank funds: Though the banker does not
charge over any tangible asset in case of discounting
of bills, the greatest security for him is that the
bill
is
a
negotiable
legal
instrument
bearing
signatures of two parties considered good for the
amount of the bill. To be on the safer side a banker
should discount bills of exchange offered by parties of
standing and good reputation.
2. Certainty of payment: A bill of exchange is
considered an ideal self liquidating asset because it
originates from n actual commercial transaction and the
debtor meets his obligation to pay by disposing of the
goods acquired from the creditor within a short period
of time. As the bill matures within short period of
time, the banker recovers his money on the due date
with certainty. So the bills are called „semi-liquid‟
assets.
3. Facility of the refinance: When a banker is in need
of funds, he can rediscount the bills with Central Bank
or any other bank/financial institution and thus the
need for cash balances can be met more easily and
quickly.
4. Stability in the value of the bill: The value of the
bills as a security doesn‟t fluctuate while the value
of all tangible goods and securities are liable to
fluctuate. The amount payable on account of a bill is
fixed and the acceptor or the drawer is liable to pay
the same in full.
5. Profitability: While discounting the bills the
banker deducts interest(in the form of discount) from
the amount of the bill. The yield from discounting of
bills is a little higher.
7.8 DRAWEE BILLS
Bills of exchange discounted by banks fall into two
categories:
(a) Drawer bills
(b) Drawee bills
The
the
the
the
basic difference between the two is that in case of
former, the bill is discounted at the instances of
drawer and in case of the later; at the instance of
drawee.
The drawer bills are also called sales bills. They
finance receivables and replace cash credit against
book debts. The drawee bill, on the other hand, finance
purchase of raw materals.
7.9ACCOMODATION BILLS
All bills are not genuine trade bills, as some times
they may be drawn for accommodating a party. An
accommodation bill is quite similar to a bill of
exchange but it is distinguished from an ordinary bill
by the fact that such a bill is not supported by any
consideration or transaction. The drawer does not give
any consideration to the drawee.
The party lending his name to oblige the other party is
known as the accommodation or accommodating party and
the party being obliged is known as accommodated party.
The
accommodating
party
is
not
liable
to
the
accommodated party on the instrument as there is no
consideration and the instrument was drawn only to help
the accommodated party. But the accommodating party is
liable to the „holder for value‟.
The practice of discounting
known as kite flying
accommodation
bills
are
As
there
is
no
underlying
trade
transaction,
accommodation bills should not be discounted.