CRITICAL EVALUATION OF BILL OF DISCOUNTING IN INDIA

What is bill of discounting?

Bill Discounting is a fund/asset based financial service. A bill discounting is a
process that involves effectively selling a bill to a bank or similar entity for an
amount that is slightly less than the par value and before the maturity date
associated with the bills of exchange. The debtor tenders payment to the new
owner of discounted bill in the full amount agreed upon originally. This approach
allow the issuer of the bill to receive cash before the actual due date associated
with the bill, while also allowing the buyer to make a modest profit on the cash
advance extended to the bills originator.
Technically Bill discounting is defined as the selling of bill to bill discounting
company before the due date of payment at a value which is less than the invoice
amount. The difference between the bill amount and the amount paid is the fee of
the bill discounting company. The fee will depend upon the period left before
payment date and the perceive risk.
EXAMPLE- 0ne of the easiest way to understand how bill discounting work is to
consider a bill of exchange issued by ABC company to its client, XYZ company. ABC
company decides to cash in the outstanding bill in order to make use of the revenue
now rather than later. To this end ABC approaches a bank with an offer to sell the
bill for 90% of the par value. The bank looks over the transaction and decide the
deal is viable. Upon approval, ABC receives 90% of the par value of the bill and
instructs XYZ company to remit payment to the bank. Once the bank receives full
payment from XYZ, the deal is considered complete. (www.wisegeek.com)
CONCEPT
The bill under bill discounting are legally the bill of exchange A bill of exchange is a
negotiable instrument which is negotiable mere by endorsing the name
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 the 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.
Why Bill Discounting ?
The seller who is the holder of a accepted B/E has two option:
1. Hold on the B/E till maturity and then take the payment from buyer.
2. Discount the B/E with Discounting Agency.

The buyer and seller of goods have conflicting objectives. The seller wishes to get
paid immediately and the buyer wants as long credit period as possible. Bill
discounting is the solution to the problem which creates win-win situation. The seller
gets his money almost instantly on payment of a small change and is able to satisfy
its customer with credit period. The invoice discounting is an easy way of getting
finance.
BILL DISCOUNTING PROCEDURE:
The process of bill discounting is simple and logical.

The seller sells the goods on credit and raises invoice on the buyer.
The buyer accepts the invoice. By accepting, the buyer acknowledges to pay
on the due date.
Seller approaches the financing company to discount it.
The financing company assures itself of the legitimacy of the bill and
creditworthiness of the buyer.
The financing company avails the fund of the seller after deducting
appropriate margin, discount and fee as per the norms.
Seller gets the funds and uses it for further business.
Om the date of payment, the financial intermediary or the seller collects the
money from the buyer. who will collect the money depends on the
agreement between the seller and financing company. (http://
www.efinancemanagement.com/working-capital-financing/bill-discounting)

TYPES OF BILLS
DEMAND BILL: Payable immediately at sight or on presentment to the drawee.
Bill on which no due date is specified is also termed as a demand bill.
USANCE BIL: (time bill) bill of exchange drawn on a term governed by the usage
in that Trade. Usance refers to the time period recognized by custom or usage for
payment of bills.
DOCUMENTARY BILLS: B/Es that are accompanied by documents that confirm that a
trade has taken place. Documents include the invoice and other documents of title
such as railways receipts, lorry receipts and bills of lading.
Further classified as:
i.

ii.

Documents against acceptance (D/A) bills- documentary

evidence accompanying B/E is deliverable against
acceptance by drawee.
Documents against payment (D/P) Bills- in case a bill is a
document against payment bill and has been accepted by
the drawee, documents of tittle will be held by bank till
maturity of B/E.

CLEAN BILLS: not accompanied by any documents that show that a trade has taken
place. Thus interest rate charged on such bills is higher than rate charged on
documentary bills. (http://eravandi.blogspot.com/bill-discounting)

ADVANTAGES: The advantages to bill discounting to investors and banks

and financial companies are as follow:
TO INVESTOR
1. Short term sources of finance
2. Bill discounting being in the nature of 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;
3. Since it is not lending, no tax at source is deducted
4. Rates of discounts are better than those available on ICDs
5. Flexible, not only in the quantum of investments but also in the
duration of investments.
TO BANKS
1. Safety of funds: the greatest security for a banker is that a B/E is
negotiable instrument bearing signatures of two parties consider
good for the amount of bill; so he can confirm his Claim easily
2. Profitability: since the discount on a bill is front ended, the yield is
higher than other loans.
3. Certainty of payment: a B/E is a self- liquidating asset with the
banker knowing in advance the date of its maturity.
4. Evens out inter-bank liquidity problems- the development of healthy
parallel bill discounting market would have stabilized the violent
fluctuations in the call money markets as bank could buy and sell bills
to even out their liquidity mismatches. (journal- management of
financial services)

DISADVANTAGES OF BILL DISCOUNTING

It can be expensive form of financing compared to other modes of financing
such as bank overdraft etc.
It is not successful due to various misuses by financing brokers, banks etc.
Suppose there are two sister companies A And B, A draws bill on B without any
judicious transaction. B accepts it and A discounts it with the bank and utilizes the
credit illegitimately. If the intentions are bad, A And B may default on payment and
the banks will have to suffer.

TYPES OF BILL DISCOUNTING:

Bills discounting Is of two types
1. PURCHASE BILL DISCOUNTING- investor discounting the purchase bill of the
company and pays the company, who in turn pay their suppliers. Investor
gets his money back from the company at the end of discounting period
2. SALES BILL DISCOUNTING: Investor discounts the sales bill of the company
and pays directly to the company. The investor gets his return from the
company at the end of the discounting period.
Usually, the bank want some conditions to be fulfilled to be able to
discount a bill:
A bill must be a usance bill
It must have been accepted and bear at least two good signatures (eg. Of
reputable individual, companies or banks etc.)
where a usance bill is drawn at a fixed period after sight , the bill must be accepted
to establish the maturity.
The advising or confirming bank will hide the reimbursement instrument from the
beneficiary so that his bank must present the documents to the nominated bank for
negotiation in order to obtain payment under the DC terms .
Bills which are financed by the receiving branch, whether drawn under a DC or not ,
are treated as bills receivable by both the remitting branch and the receiving
branches. (http://hsbc.co.in/corpotate-banking/bill-discounting)

DISCOUNT RATES : the rate depend upon following factors

THE BROKER- his relation with the company and the investor do make a
difference of a couple of percentage point in discounting rates.
LIQUIDITY- liquidity crunch in the market tends to hike up the rates even in
the best of the companies.
VOLUME/ VALUE OF DISCOUNTING- when the volume of discounting done by
investor is high, he is looking at security more then returns. The company on

its part is looking at savings by way of reduced legal paper work and a higher
amount of dedicated funds.
FREQUENCY- regular bill discounter may get upto 1% to 1.5 % points higher
interest rates than a new investor. Investor trying out with a new company
and will agree to a lesser rate to ensure safety. (journal on management on
financial services)

BILL DISCOUNTING DEALING WITH DEFAULTS

The drawee is liable to the drawer, and the drawer to the discounting agency.
However the bank / NBFC looks mainly to its customer( drawer or drawee) for
recovery of its dues. In case of default, the discounting agency can resort to nothing
and protesting as laid down by the Negotiable Instrument Act. In reality, however,
since litigation is both cumbersome and expensive, a combination of negotiation
and compromise is used. At worst, some dues may be written off.
NBFCs generally build in a large number of safeguards to guard against default.
Banks generally discount LC- baked bills which are default proof.
Grey areas: these are certain features of the Indian industry which have impeded
the growth of a healthy bills discounting market (BD)
Participants: most of the customers approaching banks for BD are small scale
industry units. For such enterprises, it is very difficult to undertake proper credit
assessment.
Kite Flying: the practice of discounting accommodation bills is known as kite flying.
When one person draws a bill on other without there being any underlying
movement of goods and other accepts it.
Supply bills: B/E drawn by suppliers contractors on Government departments are
called supply bills. These are not accepted by the government . however,
contactors are able to discount them with nationalized banks. This practice
depresses the level of cash in the bill market
Reduced supply: several corporate houses and business groups do not accept B/E
drawn on them. Accepting such bills is seen to be damaging to their pride. Such
attitude reduce the supply of bills and discourage the culture of drawing and
discounting bills.
Stamp Duties: no stamp duties are levied on letter of credit backed bills up to 90
days. This has resulted in a lop-sided growth in the bills market with practically no
bills being drawn for a period exceeding 90 days. The market therefore, lacks depth.
(http://www.citeman.com/6622-bill-discounting-dealing-with-defaults.html)