Sunday, November 01, 2015

Time to bid good-bye to bank drafts?[1]

Most of us are familiar with negotiable instruments such as cheques, bank drafts (demand drafts or DDs) and payment orders (PO). These are instruments of payment. The difference among these traditional payment instruments is marginal. Generally speaking, a cheque is issued by an account holder on the branch of the bank where the account is maintained. In the case of a bank draft, the account holder (drawer, issuer) is that branch of the bank itself – drawing on another branch of the same bank. For payment orders, the account holder is also the branch of the bank, but drawing on itself. If one wishes to acquire a bank draft or a PO, one would have to first pay an equivalent amount (plus bank charges, if any) to the issuing bank. The DD or PO is issued against the amount received from its customer, the purchaser. The face value of the instrument is thus locked and secured till the payee claims the amount.

Drafts serve a very useful purpose for the transfer of funds within a country. (It’s to be noted that what generally are termed as foreign currency ‘drafts’ are in fact cheques.) Drafts, being physical instrument unlike telegraphic transfers, take a little longer, but are a very reliable and secure mode available to the common man. Depending on the geographical distance that separates the purchaser from the beneficiary, the purchaser may request for either a DD or a PO (also called banker’s cheque or cashier’s cheque) from the issuing bank.
From the point of view of the payee or the beneficiary, a cheque carries the maximum element of risk or uncertainty of payment. Drafts or POs, on the other hand, offer a high degree of safety because both the drawer and the drawee themselves are banks; the face value is also locked till claimed through the banking system. Precisely for these reasons institutions and organisations invariably stipulate that payments to them were to be made only through the means of bank drafts. For obvious reasons, personal cheques are not acceptable. Apart from the time it takes for any of these instruments to travel from the purchaser to the beneficiary, receipt of actual funds must be processed through the inter-bank fund settlement mechanism called ‘clearing’.

With the advent of centralised (or, core) banking in India, the rules of the game have changed. Among the multitude of developments, nearly all cheques nowadays bear a legend to the effect, ‘Payable at par at all our branches in India’, ‘Payable at par at all branches of xxx bank’ etc. Internally, the reconciliation process has become very much simpler. Yet, whether a cheque, a draft or a PO, the clearing system and the consequent delay are still unavoidable.

Development in technology, communication, the advent of centralised processing and ‘at par’ instruments are just a few signs of the times. It’s a fact that drafts and payment orders as payment instruments offer very similar degrees of security to the payee. Yet, the institutions continue to demand only drafts as the most preferred mode for receiving payment. May be the time has come for the commercial banks to seriously consider merging the draft and the banker’s cheque to create a single instrument of payment. Organisations should simultaneously wean themselves away from drafts, and ask only for banker’s cheques from the public, if not for direct credit to their accounts by electronic fund transfer. Paperless remittances should be the way to go.

In the interim, whether local or outstation, instead of DD or PO, why shouldn’t a cheque marked ‘payable at par’ be acceptable as payment? Both must necessarily be settled through the local clearing mechanism, taking the same amount of time! A DD or a banker’s cheque offers only marginally more comfort over cheques. But none of them is good enough (or safe enough) till actual credit of funds to the payee’s account. The change in the mind-set could translate in to savings in terms of bank charges, time and trouble to procure these instruments from banks.

[1] Posted on LinkedIn on 26 October 2015.

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