Question

Explain discounting bills of exchange as one of the functions of the banks.

Answer 1

Discounting of bills of exchange means that the bank pays the amount of the bill to the holder before the date of maturity, after deducting some discount. This means that when a seller receives a bill of exchange from the buyer, which is payable on a future date, the seller can approach the bank to get the amount before the due date. The bank pays the value of the bill after deducting a certain discount commission. On the maturity date, the bank collects the full amount from the buyer or drawee. This service helps the seller get immediate funds, and also promotes credit-based trade and smooth financial transactions.

Answer 2

• Another important form of bank lending is through discounting or purchasing the bills of exchange. A bill of exchange is drawn by a creditor on the debtor specifying the amount of debt and also the date when it becomes payable. Such bills of exchange are normally issued for a period of 90 days.
• Thus, creditors cannot get it encashed from the debtors before the maturity period. However, if the creditor needs money before the maturity period (i.e., 90 days), he can get it discounted from the commercial bank. The bank makes a payment to the creditor after deducting its commission. When the bill matures, the bank will get payment from the debtors.