Bill Discounting is a method of trading the bill of exchange to the financial institution before it gets matured, at a price that is smaller than its par value. The discount on the bill of exchange is based on the remaining time to maturity and the amount involved.It also depends upon the risk assumed and exporter’s credibility.
Bills are discounted by charging a discount/fee which a bank takes from a seller to release funds before the credit period ends. At the due date, the seller’s client pays the full amount to the Bank. It is mostly applicable in scenarios when a buyer buys goods from the seller and the payment is to be made through a letter of credit also known as LC discounting. Bill discounting is a major trade activity. It aids the sellers to get funds earlier for working capital finance in exchange for a small fee or discount. It also helps the bank earn some revenue. When the due date of the credit period comes, the borrower or (seller’s client) customer pays the money to the bank. Discounting of bills of exchange is a win-win situation for both the seller and the buyer of the goods as the buyer gets a credit period against the letter of credit and the seller gets his advance payment.
Bill discounting is a major trade activity. It aids the sellers to get funds earlier for working capital finance in exchange for a small fee or discount. It also helps the bank earn some revenue. When the due date of the credit period comes, the borrower or (seller’s) customer pays the money to the bank.
Discounting of bills of exchange is a win-win situation for both the seller and the buyer of the goods as the buyer gets a credit period against the letter of credit and the seller gets his advance payment.
Let’s suppose, a businessman sold goods to Mr. X worth of $10,000, but Mr. X does not have the money to pay today but Mr. X is certain to pay after two months so, the businessman draws a bill in the businessman’s favour which Mr. X accepts promising to pay the amount of $10,000 after two months. The businessman can’t wait for two months as he needs cash for financing his daily business activities. So, he discounts the bill with his bank 2 months before the due date at 18% p.a. rate of discount. The bank pays the businessman an amount of $9,700 [$10,000 – $300 (commission)] after deducting an applicable commission of $300.
The businessman (drawer) sold the goods and also got paid without having to lose either his customer or the business, Mr. X got the goods by not having to pay today, and the bank earned a commission on bill discounting.
There are two types of Bill Discounting:
Recourse: Recourse discounting means that the seller is liable for debts not paid by the buyer. If the bank is not able to collect payment, the seller is required to refund the cash advance for that invoice. It usually means that a higher percentage of each invoice is made available because the bank knows that they can reclaim the amount if necessary.
Non-Recourse: In case of non-recourse discounting, the bank accepts full financial liability for non-payment of buyer’s debt on account of financial insolvency. This arrangement is suitable for the seller as it allows for true sale realisation. Charges of non-recourse discounting are higher than recourse discounting.
The Process Of Bill Discounting:
Bill discounting and Factoring are two different types of short-term trade finance.
Is Bill Discounting a type of loan?
Bill discounting is a type of loan as the Bank takes the bill drawn by borrower on their customer and pays them immediately like a loan, deducting some amount as discount/commission The Bank then presents the Bill to the borrower’s client on the due date of the Bill and collects the whole amount on the bill. If the bill is delayed, the borrower or their client pay the Bank a pre-determined interest depending upon the terms of the transaction. Since it is a loan, the Bank will check the credit quality and trading history of their borrower.
Bill Discounting Process:
Bill Discounting Charges :
Bill discounting charges are charged based on the risk of non-payment by the buyer and the credit profile of the seller. Interest is payable in respect of amount of money borrowed and involves a service fee or other charges.
Bill Discounting Rate of Interest
Interest rates on discounting services are decided based upon the risk perceptive of the bank on its client. The rates differ from exporter to exporter. There are few factors which play major role like whether the bills are backed by a Letter of Credit or not. If the bills are backed by Letter of Credit, then which is the Letter of Credit issuing bank. If it is a good bank then the exporter gets a better rate. If it is a lesser known bank or has smaller operations, the discounting bank can decline the transaction.
Advantages of Bill Discounting
Disadvantages of Bill Discounting
Bill Discounting Limits
Globalization has given a boost to importers and exporters therefore, increasing the demand for import and export trade finance facilities like buyer’s credit, supplier’s credit, export factoring, export LC bill discounting. A lot of importers and exporters need bill discounting on a daily basis to improve their cash flows and working capital. To avail this facility, exporter must approach a bank where the bank fixes a threshold limit for the discounting service for a given period. When a seller approaches a bank, he needs to facilitate the bank with required financial documents for discounting of the bills. Then according to the financial documents submitted by the exporter the bank does a credit analysis and checks the credit score. This analysis consists of past credit history, financial condition, viability, background of the business and nature of it. Then the exporter application is placed for sanction of limit. After sanctioning a limit, banks may ensure that the risk is spread across several bills. Even at the time of reviewing the limits banks look for earlier sanctioned limits and whether they are fully utilized by the client, and if the payments are regular on due date or not.
Bill Discounting Companies In India
Discounting provides immediate access to funds to sellers by using their unpaid bills or goods received notes (GRN) as collateral. Currently, many banks and non-banking financial companies (NBFCs) are providing Bill/GRN discounting services NBFCs are sweeping the market with Bill discounting services to its clients to improve their working capital needs through an online platform for domestic bills to make it even more convenient. Hence, a seller has the option to choose from a wide range of service providers. Choosing a good provider that is also cost effective will make the process of discounting hassle free and cost friendly for businesses. For export LC bill discounting, the discounting is generally offered by banks in India as they take credit exposure on the LC issuing bank.
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