Definition of Bank Draft
A bank draft can be defined as a negotiable instrument similar to bills of exchange, usually, a payment cheque where issuing bank or another of its branch processes payment on behalf of their client (drawer) to drawee’s A/c where drawer had already deposited equivalent funds in issuing bank A/c along with the applicable charges payable.
It is also called a banker’s draft or teller’s cheque. It is issued to a customer for remittance purposes. The drawer needs to immediately transfer in an advance amount which he has requested to pay. It is drawn on the bank itself signed by an employee of the bank on behalf of the bank as a drawer and provided to the customer of the bank for remittance purposes. Usually, like any other negotiable instrument, Bank Draft cannot be transferred in favour of any other person, i.e. it will be payable only in A/c of an entity whose name is mentioned as drawee initially.
Characteristics of Bank Draft
Following are the basic characteristics are given below:
- The amount of money payable by the bank draft remains certain.
- Drawn by one branch of a bank on another branch of the same bank, or sometimes it can also be drawn on another bank also.
- The Payee of the draft must be certain. According to section 85A of the negotiable instrument act 1881, it should be payable to order on demand and not to the bearer.
- Like other negotiable instruments, it is also an unconditional instrument that posseses an order to pay.
- Easily accessible as by depositing money in the bank, any person can get a bank draft issued.
- Banks usually charge the commission on issuing the draft.
How Does It Work?
Bank Draft cycle right from start to end is very simple. An individual who has to obtain a bank draft needs to head towards a bank. As per instructions bank will withdraw money from the individual account and transfer the same in the account of a bank’s name. The bank draft will be issued as per the customer’s directions regarding the amount, payee details, etc. The name and amount of an individual (Payee) will appear on the document. This draft can also be used in foreign countries to close a transaction or process payment. It can be prepared in the currency of one’s choice. Once a bank issues it, the customer will forward same to the payee. The payee will further deposit the same in its bank A/c. Once after depositing bank draft amount will get transferred to the payee’s a/c. If due to any reason, a bank draft has been lost, stolen or destroyed, it can be cancelled or replaced as long as the individual purchasing the draft has the required document.
Examples of Bank Draft
Some commonly used examples are:
- Demand Draft
- Certified Cheque
- Money Orders
Practical example: Usually, government organizations require payment to be paid via bank payment instruments like Demand Draft, certified cheques etc. Suppose a company needs to process annual statutory payment like motor vehicle tax. The company will reach its bank, transfer the equivalent amount to the bank and get a demand draft issued in favour of the government agency.
Types of Bank Draft
There are three types of the draft:
- Money Orders: In this type of bank draft, a specified amount of money is transferred from one place to another. The banks issue this on behalf of their customers. It is a financial instrument where the bank takes the responsibility to remit the amount when the order is presented before them.
- Certified Checks: It is a typical type of bankers cheque in which money is transferred to the recipient’s bank a/c via a bank for which the bank charges commission. It is the easiest method of money transfer.
- Demand Draft: It is a type of bank draft where the payer and the recipient are not at the same place. The receiver receives the money once the draft is deposited. In this method, day to day financial transactions goes on.
Bank Draft vs Cheque
A cheque is issued by the customer of the bank and is not backed by any bank guarantee for honouring payment( i.e. chances of cheque getting bounce due to varied reason). Whereas Bank Drafts are issued and guaranteed by the bank, as in this case, the amount is pre-deposited by the customer. An individual uses a cheque to settle the transactions, and the person who makes the payment and rights the cheque is called the drawer of the cheque and the person who receives the cheque and obtains fund from it is called the payee. The bank issues it at the request of the bank customer for making large payments. It does not require a signature; however, a bank official must sign a certified bank draft to make it more secure and fraud-proof. A cheque is a negotiable instrument that can be further endorsed in favour of another person, but a Bank draft cannot be further endorsed and credited only to the payee’s bank A/c.
Below are some advantages are:
- Beneficial for Large Transactions: It is useful in case of large transactions such as purchasing of house, car or any valuable items. It is a guaranteed payment tool and can be drawn for a large amount of sum involved. Hence it is beneficial for the parties to process a large number of transactions.
- Usefulness: It is easy to use and has a high value in the market to settle the transactions.
- Authenticity: Highly authenticated tool as it is non-transferable without required formalities. There is the least chance for forgeries in bank drafts as the bank issues it once all the formalities are fulfilled.
- Risk: A negligible amount of risk is involved in this type of draft. Security measures are well established as compared to other means of financial tools.
Below are some disadvantages are:
- Time-Consuming: The process is time-consuming as the draft can be taken through banks only. An individual has to visit the bank and collect the draft personally. Similarly, the receiver has to present the draft before the bank for remittance.
- Cost: Additional charges and commission of the bank are charged based on the amount to be transferred. The different bank has different charges depending upon the number/ value of drafts to be made.
- Deadline: Bank has a proper time limit to present the draft before it; if the drafts are older than the prescribed limit, the bank may refuse the remittance, and then the refund process also takes time.
It is one of the payment mechanism generally used in processing various government, educational institutions related payments. It is important for the security measures involved in it as it is authenticated and has the least risk factor. But as it is not a liquid asset, it has some formalities that make it a bit cumbersome. However, with the philosophy of digitalisation, nowadays, online transactions are becoming popular.
This is a guide to Bank Draft. Here we also discuss the definition and how does bank draft work? Along with advantages and disadvantages. You may also have a look at the following articles to learn more –
- Bank Draft vs Certified Cheque
- Retail Banking
- Commercial Bank vs Investment Bank
- Acquisition Financing