In this article, we’re answering “What is a bill of exchange?” This will be particularly useful to anyone getting started in the world of cross border transactions and international trade.
Not surprisingly, this article is part of our free series on corporate banking solutions and features around the world, which you can access by clicking here.
Feel free to use the table of contents to jump ahead to the sections most relevant to you.
Table of Contents
- What Is a Bill of Exchange?
- Example of Bill of Exchange
- Frequently Asked Questions
- Do You Want Help Opening Bank Accounts?
What Is a Bill of Exchange?
A bill of exchange is a payment method that is commonly used in international trade and trade finance. It is a short-term negotiable instrument that forms a payment obligation. Like other financial instruments, acceptance and payment of a bill of exchange is secure, as it is an unconditional commitment to complete payment.
The role of banks in bill of exchange is that of the drawee. In other words, the drawer (bank customer) authorizes the drawee (the bank), to pay the other party (payee), at a specified future date. This process helps to facilitate cross border commercial transactions. This is especially true in transactions between newly transacting parties who do not have a long term foundation of trust established.
That said, banks play another role related to bills of exchange as well, which is that of a buyer. Banks offer commercial entities (an LP for example) short term financing through a method known as discounting bills of exchange. In this process, the bank will buy the rights to the bill from the payee and then receive the payment at the specified date.
A bill of exchange is different from other forms of payment in the banking system, such as a promissory note. While a promissory note includes two parties (the issuer and the payee) a bill involves three parties (drawer, drawee, and payee).
That said there are different types of bills of exchange, which include a trade bill, inland bill, foreign bill, sight bill, time bill, demand bill, documentary bill, and clean bill. Each of these different options shapes its own definition of a bill of exchange, while still maintaining the same core features.
What Is the Purpose of a Bill of Exchange?
The primary purpose of a bill of exchange is to provide a promise of payment from one party to another in international transactions. Similar financial instruments also exist for domestic transactions, though these are typically referred to as a draft.
By using a bill of exchange, parties are able to reduce the risk associated with a cross border transaction where different financial institutions may be involved. Likewise, bills allow for credit to be extended between parties in different countries, which is often difficult to do without consistent credit mechanisms.
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Examples of Bill of Exchange
The five most common examples are trade bill, sight bill, time bill, demand bill, and documentary bill. We share an overview of each of these bills below for your consideration.
Trade Bill of Exchange
The trade bill is used in international transactions where the drawer instructs the bank to pay the payee the specified amount at a certain time in the future.
Sight Bill of Exchange
A sight bill refers to payment “on sight”. In other words, when the payee presents the bill to the bank, prompt payment is expected.
Time Bill of Exchange
The time bill is payable on a specific maturity date. This can either be a specific date in the future or a specific period of time, usually up to a few months in the future.
Demand Bill of Exchange
A demand bill is payable by the bank when requested by the payee. In other words, there is no specific payment date. Instead, the payee can choose when to request payment, which must be provided immediately.
Documentary Bill of Exchange
The documentary bill requires the payee to present specific supporting documents in order to receive payment. These documents may include invoices, commercial documents, bills, etc. After presenting the required documents, payment is released.
Frequently Asked Questions
Below are a few of the most common questions we receive from people looking into this topic. If you have further questions you would like to ask our team, don’t hesitate to get in touch.
What Are Types of Bill of Exchange?
There are various types of bills of exchange. These include trade bills, sight bills, time bills, demand bills, documentary bills, and more. Each bill has its own unique characteristics that may apply to different commercial arrangements.
What Is a Bill of Exchange in History?
Bills of exchange have a long history, dating back several centuries. They are thought to have first appeared in Mediterranean trading centers, including Florence, Genoa, and Venice. The role of the bills historically, like today, were to facilitate international trade, reduce risk, and extend credit from sellers to buyers.
What Are the Advantages of a Bill of Exchange?
The main advantages of a bill of exchange include facilitating secure and reliable cross border transactions, reducing the risk of non-payment by providing an unconditional payment obligation, and providing flexibility and liquidity to all parties involved.
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