Bills of exchange are negotiable instruments, drawn by the seller (drawer) of the goods on the buyer (drawee) of the goods for the value of the goods delivered. These bills are known as trade bills. Trade bills are called commercial bills when they are accepted by commercial banks. If the bill is payable at a future date and the seller needs money during the currency of the bill, he may approach his bank to discount the bill. The maturity proceeds or face value of a discounted bill from the drawee is received by the bank. If the bank needs funds during the currency of bill, it can rediscount the bill that has been already discounted by it in the commercial bill rediscount market at the available market discount rate. The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later modified into the New Bills Market Scheme (NBMS) in 1970. Under the scheme, commercial banks can rediscount the bills, which were originally discounted by them, with approved institutions.
With the intention of reducing paper movements and in a bid to facilitate multiple rediscounting, the RBI introduced an instrument called Derivative Usance Promissory Notes (DUPN). Consequently, the need for the physical transfer of bills has been waived and the bank that originally discounts the bills only draws DUPN. These DUPNs are sold to investors in convenient lots of maturities (from 15 days up to 90 days) on the basis of genuine trade bills, discounted by the discounting bank.
Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. It enhances he liability to make payment in a fixed date when goods are bought on credit. According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a written instrument containing an unconditional order, signed by the maker, directing to pay a certain amount of money only to a particular person, or to the bearer of the instrument. Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks, they are called commercial bills. The bank discounts this bill by keeping a certain margin and credits the proceeds. Banks, when in need of money, can also get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days, depending on the credit extended in the industry.
Characteristics of Commercial Bill
- Securities offered to the public must be registered with the Securities and Exchange Commission according to the Securities Act of 1933. Registration requires extensive public disclosure, including issuing a prospectus on the offering. It is a time-consuming and expensive process. Most commercial paper is issued under Section 3(a) (3) of the 1933 Act which exempts from registration requirements short-term securities as long as they have certain characteristics.
- Commercial paper is typically a discount security (like Treasury bills): the investor purchases notes at less than face value and receives the face value at maturity. The difference between the purchase price and the face value, called the discount, is the interest received on the investment.
- Commercial paper is, occasionally, issued as an interest-bearing note (by request of investors). The investor pays the face value and, at maturity, receives the face value and accrued interest. All commercial paper interest rates are quoted on a discount basis.
- The exemption requirements have been a factor shaping the characteristics of the commercial paper market. The following are requirements for exemption: – The maturity of commercial paper must be less than 270 days. In practice, most commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the average maturity.
- Many issuers continuously roll over their commercial paper, financing a more-or-less constant amount of their assets using commercial paper. The nine-month maturity limit is not violated by the continuous rollover of notes, as long as the rollover is not automatic but is at the discretion of the issuer and the dealer. Many issuers will adjust the maturity of commercial paper to suit the requirements of an investor.
- That proceeds from commercial paper issues be used to finance “current transactions,” which include the funding of operating expenses and the funding of current assets such as receivables and inventories. Proceeds cannot be used to finance fixed assets, such as plant and equipment, on a permanent basis.
- A safekeeping agent hired by the investor held the certificates, until presented for payment at maturity. The “settling” of the transaction, (the exchange of funds for commercial paper first at issuance and then at redemption, occur in one day. On the day the commercial paper is issued and sold, the investor receives and pays for the notes and the issuer receives the proceeds. On the day of maturity, the investor presents the notes and receives payment. Commercial banks, in their role as issuing, paying, and clearing agents, facilitate the settling of commercial paper by carrying out the exchanges between issuer, investor, and dealer required to transfer commercial paper for funds.
Types of Commercial Bills
Commercial bill is an important tool finance credit sales. It may be a demand bill or a usance bill. A demand bill is payable on demand, that is immediately at sight or on presentation by the drawee. A usance bill is payable after a specified time. If the seller wishes to give sometime for payment, the bill would be payable at a future date. These bills can either be clean bills or documentary bills. In a clean bill, documents are enclosed and delivered against acceptance by drawee, after which it becomes clear. In the case of a documentary bill, documents are delivered against payment accepted by the drawee and documents of bill are filed by bankers till the bill is paid.
Commercial bills can be inland bills or foreign bills. Inland bills must (1) be drawn or made in India and must be payable in India: or (2) drawn upon any person resident in India. Foreign bills, on the other hand, are (1) drawn outside India and may be payable and by a party outside India, or may be payable in India or drawn on a party in India or (2) it may be drawn in India and made payable outside India
A related classification of bills is export bills and import bills. While export bills are drawn by exporters in any country outside India, import bills are drawn on importers in India by exporters abroad. The indigenous variety of bill of exchange for financing the movement of agricultural produce, called a ‘hundi’ has a long tradition of use in India. It is vogue among indigenous bankers for raising money or remitting funds or to finance inland trade. A hundi is an important instrument in India; so indigenous bankers dominate the bill market. With a view to eliminating movement of papers and facilitating multiple rediscounting, RBI introduced an innovation instruments known as ‘Derivative Usance Promissory Notes,’ backed by such eligible commercial bills for required amounts and usance period (up to 90 days). Government has exempted stamp duty on derivative usance promissory notes.
This instrument, being a negotiable instrument issued by banks, is a sound investment for rediscounting institutions. Moreover rediscounting institutions can further discount the bills any time prior to the date of maturity. Since some banks were using the facility of rediscounting commercial bills and derivative usance promissory notes of as short a period as one day, the Reserve Bank restricted such rediscounting to a minimum period of 15 days. The eligibility criteria prescribed by the Reserve Bank for rediscounting commercial bills are that the bill should arise out of a genuine commercial transaction showing evidence of sale of goods and the maturity date of the bill should to exceed 90 days from the date of rediscounting.