Bill discounting, as a fund-based activity, emerged as a profitable business in the early nineties for finance companies and represented a diversification in their activities in tune with the emerging financial scene in India. In the post-1992 (scam) period its importance has substantially declined primarily due to restrictions imposed by the Reserve Bank of India. The purpose of the Chapter is to describe bills discounting as an asset-based financial service. The aspects of bills discounting covered include its concept, advantages and disadvantages, bills market schemes, procedures and processing, post- securities scam position and some gray-areas. The main points are also summarised.
According to the Indian Negotiable Instruments Act, 1881:
“The 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 that instrument.”
The bill of exchange (B/E) is used for financing a transaction in goods which means that it is essentially a trade-related instrument.
Types of Bills
There are various types of bills. They can be classified on the basis of when they are due for payment, whether the documents of title of goods accompany such bills or not, the type of activity they finance, etc. Some of bills are:
Demand Bill This is payable immediately “at sight” or “on presentment” to the drawee. A bill on which no time of payment or “due date” is specified is also termed as a demand bill.
Usance Bill This is also called time bill. The term usance refers to the time period recognized by custom or usage for payment of bills.
Documentary Bills These are the B/Es that are accompanied by documents that confirm that a trade has taken place between the buyer and the seller of goods. These documents include the invoices and other documents of title such as railway receipts, lorry receipts and bills of lading issued by custom officials. Documentary bills can be further classified as: (i) Documents against acceptance (D/A) bills and (ii) Documents against payment (DIP) bills.
D/ A Bills In this case, the documentary evidence accompanying the bill of exchange is deliverable against acceptance by the drawee. This means the documentary bill becomes a clean bill after delivery of the documents.
DIP Bills In case a bill is a “documents against payment” bill and has been accepted by the drawee, the documents of title will be held by the bank Dr the finance company till the maturity of the B/E.
Clean Bills These bills are not accompanied by any documents that show that a trade has taken place between the buyer and the seller. Because of this, the interest rate charged on such bills is higher than the rate charged on documentary bills.
Creation of a B/E Suppose a seller sells goods or merchandise to a buyer. In most cases, the seller would like to be paid immediately but the buyer would like to pay only after some time, that is, the buyer would wish to purchase on credit. To solve this problem, the seller draws a B/E of a given maturity on the buyer. The seller has now assumed the role of a creditor; and is called the drawer of the bill. The buyer, who is the debtor, is called the drawee. The seller then sends the bill to the buyer who acknowledges his responsibility for the payment of the amount on the terms mentioned on the bill by writing his acceptance on the bill. The acceptor could be the buyer himself or any third party willing to take on the credit risk of the buyer.
Discounting of a B/E The seller, who is the holder of an accepted B/E has two options:
Hold on to the B/E till maturity and then take the payment from the buyer.
Discount the B/E with a discounting agency. Option (2) is by far more attractive to the seller.
The seller can take over the accepted B/E to a discounting agency bank,
NBFC, company, high net worth individual] and obtain ready cash. The act of handing over an endorsed B/E for ready money is called discounting the B/E. The margin between the ready money paid and the face value of the bill is called the discount and is calculated at a rate percentage per annum on the maturity value.
The maturity a B/E is defined as the date on which payment will fall due. Normal maturity periods are 30,60,90 or 120 days but bills maturing within 90 days seem to be the most popular.
Advantages : The advantages of bill discounting to investors and banks and finance companies are as follows:
Short-term sources of finance;
Bills discounting being in the nature of a transaction is outside the purview of Section 370 of the Indian Companies Act 1956, that restricts the amount of loans that can be given by group companies;
Since it is not a lending, no tax at source is deducted while making the payment charges which is very convenient, not only from cash flow point of view, but also from the point of view of companies that do not envisage tax liabilities;
Rates of discount are better than those available on ICDs; and
Flexibility, not only in the quantum of investments but also in the duration of investments.