A commercial bill is one which arises out of a genuine trade transaction, i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a ‘self-liquidating’ paper and negotiable/; it is drawn always for a short period ranging between 3 months and 6 months.
Definition of Bill of Exchange
Section 5 of the negotiable Instruments Act defines a bill of exchange a follows:
“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 beater of the instrument”.
Types of Bills
Many types of bills are in circulation in a bill market. They can be broadly classified as follows:
- Demand and Usince Bills: Demand bills are others called sight bills. These bills are payable immediately as soon as they are presented to the drawee. No time of payment is specified and hence they are payable at sight. Usince bills are called time bills. These bills are payable immediately after the expiry of time period mentioned in the bills. The period varies according to the established trade custom or usage prevailing in the country.
- Clean Bills and Documentary Bills: When bills have to be accompanied by documents of title to goods like Railways, receipt, Lorry receipt, Bill of Lading etc. the bills are called documentary bills. These bills can be further classified into D/A bills and D/P bills. In the case of D/A bills, the documents accompanying bills have to be delivered to the drawee immediately after acceptance. Generally D/A bills are drawn on parties who have a good financial standing. On the order hand, the documents have to be handed over to the drawee only against payment in the case of D/P bills. The documents will be retained by the banker. Till the payment o0f such bills. When bills are drawn without accompanying any documents they are called clean bills. In such a case, documents will be directly sent to the drawee.
- Inland and Foreign Bills: Inland bills are those drawn upon a person resident in India and are payable in India. Foreign bills are drawn outside India an they may be payable either in India or outside India. They may be drawn upon a person resident in India also. Foreign boils have their origin outside India. They also include bills drawn on India made payable outside India.
- Export and Foreign Bills: Export bills are those drawn by Indian exports on importers outside India and import bills are drawn on Indian importers in India by exports outside India.
- Indigenous Bills: Indigenous bills are those drawn and accepted according to native custom or usage of trade. These bills are popular among indigenous bankers only. In India, they called ‘hundis’ the hundis are known by various names such as ‘Shah Jog’, ‘Nam Jog’, Jokhani’, Termainjog’. ‘Darshani’, ‘Dhanijog’, and so an.
- Accommodation Bills and Supply Bills: If bills do not arise out of genuine trade transactions, they are called accommodation bills. They are known as ‘kite bills’ or ‘wind bills’. Two parties draw bills on each other purely for the purpose of mutual financial accommodation. These bills are discounted with bankers and the proceeds are shared among themselves. On the due dates, they are paid. Supply bills are those neither drawn by suppliers or contractors on the government departments for the goods nor accompanied by documents of title to goods. So, they are not considered as negotiable instruments. These bills are useful only for the purpose of getting advances from commercial banks by creating a charge on these bills.
Operations in Commercial Bills Market
From the operations point of view, the bill market can be classified into two viz.
- Discount Market
- Acceptance Market
Discount market refers to the market where short-term genuine trade bills are discounted by financial intermediaries like commercial banks. When credit sales are effected, the seller draws a bill on the buyer who accepts it promising to pay the specified sum at the specified period. The seller has to wait until the maturity of the bill for getting payment. But, the presence of a bill market enables him to get payment immediately. The seller can ensure payment immediately by discounting the bill with some financial intermediary by paying a small amount of money called ‘Discount rate’ on the date of maturity, the intermediary claims the amount of the bill from the person who has accepted the bill.
In some countries, there are some financial intermediaries who specialize in the field of discounting. For instance, in London Money Market there are specialise in the field discounting bills. Such institutions are conspicuously absent in India. Hence, commercial banks in India have to undertake the work of discounting. However, the DFHI has been established to activate this market.
The acceptance market refers to the market where short-term genuine trade bills are accepted by financial intermediaries. All trade bills cannot be discounted easily because the paties to the bills may not be financially sound. In case such bills are accepted by financial intermediaries like banks, the bills earn a good name and reputation and such bills can readily discounted anywhere. In London, there are specialist firms called acceptance house which accept bills drawn by trades and import greater marketability to such bills. However, their importance has declined in recent times. In India, there are no acceptance houses. The commercial banks undertake the acceptance business to some extant.
Advantages of Commercial Bills
Commercial bill market is an important source of short-term funds for trade and industry. It provides liquidity and activates the money market. In India, commercial banks lay a significant role in this market due to the following advantages:
- Liquidity: Bills are highly liquid assets. In times of necessity, bills can be converted into cash readily by means of rediscounting them with the central bank. Bills are self-liquidating in character since they have fixed tenure. Moreover, they are negotiable instruments and hence they can be transferred freely by a mere delivery or by endorsement and delivery.
- Certainty of Payment: Bills are drawn and accepted by business people. Generally, business people are used to keeping their words and the use of the bills imposes a strict financial discipline on them. Hence, bills would be honored on the due date.
- Ideal Investment: Bills are for periods not exceeding 6 months. They represent advances for a definite period. This enables financial institutions to invest their surplus funds profitably by selecting bills of different maturities. For instance, commercial banks can invest their funds on bills in such a way that the maturity of these bills may coincide with the maturity of their fixed deposits.
- Simple Legal Remedy: In case the bills are dishonored, the legal remedy is simple. Such dishonored bills have to be simply noted and protested and the whole amount should be debited to the customer’s accounts.
- High and Quick Yield: The financial institutions earn a high quick yield. The discount is dedicated at the time of discounting itself whereas in the case of other loans and advances, interest is payable only when it is due. The discounts rate is also comparatively high.
- Easy Central Bank Control: The central bank can easily influence the money market by manipulating the bank rate or the rediscounting rate. Suitable monetary policy can be taken by adjusting the bank rate depending upon the monetary conditions prevailing in the market.
Drawbacks of Commercial Bills
In spite of these merits, the bill market has not been well developed in India. The reasons for the slow growth are the following:
- Absence of Bill Culture: Business people in India prefer O.D and cash credit to bill financing therefore, banks usually accept bills for the conversion of cash credits and overdrafts of their customers. Hence bills are not popular.
- Absence of Rediscounting Among Banks: There is no practice of re-discounting of bills between banks who need funds and those who have surplus funds. In order to enlarge the rediscounting facility, the RBI has permitted financial institutions like LIC, UTI, GIC and ICICI to rediscount genuine eligible trade bills of commercial banks. Even then, bill financial is not popular.
- Stamp Duty: Stamp duty discourages the use of bills. Moreover, stamp papers of required denomination are not available.
- Absence of Secondary Market: There is no active secondary market for bills. Rediscounting facility is available in important centers and that too it restricted to the apex level financial institutions. Hence, the size of the bill market has bee curtailed to a large extant.
- Difficulty in Ascertaining Genuine Trade Bills: The financial institutions have to verify the bills so as to ascertain whether they are genuine trade bills and not accommodation bills. For this purpose, invoices have to be scrutinized carefully. It involves additional work.
- Limited Foreign Trade: In many developed countries, bill markets have been established mainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to national income remains small and it is reflected in the bill market also.
- Absence of Acceptance Services: There is no discount house or acceptance house in India. Hence specialised services are not available in the field of discounting or acceptance.
- Attitude of Banks: Banks are shy rediscounting bills even the central bank. They have a tendency to hold the bills till maturity and hence it affects the velocity of circulation of bills. Again, banks prefer to purchase bills instead of discounting them.