Bank Draft – Definition, How It Works, Advantages, Disadvantages
What Is a Bank Draft ?
A bank draft is a negotiable instrument and just like a check can be used for payment, but it is guaranteed by the issuing bank. The guarantee of the issuing bank is what makes a bank draft different from a normal check as they look alike. A bank draft is drawn on the issuing bank’s account and under normal circumstances should never bounce.
The amount on the draft would usually be moved from the requesting payer’s account to the bank’s general ledger account before the instrument is issued and will remain there until it is cashed by the payee. Bank drafts are a secure form of payment and banks often charge a fee for providing this service.
A bank draft is also called bank check, banker’s drafts or teller’s check.
How a Bank Draft Works
People require secure payment options to carry out their personal or business transactions effectively and some of these options include certified checks, bank drafts and wire transfers.
A bank draft is guaranteed by the issuing bank and is most often used where large amounts of money is involved.
A customer requesting for a bank draft would apply to the bank, stating the amount and payee, while ensuring that there is enough money in their account to cover amount requested and the bank’s fees where applicable. The bank debits the customer’s account for the requested amount and moves it to its general ledger where it will remain until it is cashed by the payee. The bank then prepares the draft with the payee’s name and amount.
A bank draft will have a serial number and other security features and is signed by the bank’s authorized signatories, making it a legitimate instrument that can be negotiated when presented by the payee to their bank.
As earlier mentioned, a bank draft is a secure form of payment but it isn’t fool proof and could go bad if it’s fraudulent issued or the issuing bank becomes insolvent before its cashed.
Banks would usually charge a fee for offering this service and it could be a flat fee or a percentage of the draft amount. The bank could also decide to waive this fee where it makes business sense, like for high net worth customers or those they have a good relationship with.
It is very difficult to stop a bank draft once it has been issued and this is intended to protect the payee. However, it is possible to cancel or replace a lost, stolen or destroyed draft if the customer provides the right documentation.
If the purchaser desires to reverse the transaction or repurchase it, then the bank collects the physical draft and liquidates it back into the account it originated from.
What are the Advantages of a Bank Draft ?
Guaranteed availability of funds
A bank draft is guaranteed by the issuing bank and this means that the payee has no worries about the availability of funds. This makes bank drafts more reliable than personal checks as it won’t bounce for reasons of insufficient funds in the payer’s account.
A bank draft has the advantage of being much easier and convenient to use compared to other methods of payment. It doesn’t have a maximum amount limit and does not require the banking information of the payee. Bank drafts are a preferred options when making large purchases, like buying a car or house.
Can be used for cross-border purchases and investments
Bank drafts can be used for international transactions which may involve payments in different currencies. Drafts can be issued in most currencies and can be cashed in foreign countries.
What are the Disadvantages of a Bank Draft?
Cannot be canceled after delivery
It is difficult to cancel a bank draft once the payee has taken delivery. This can be a disadvantage in situations where the payer needs to do so.
Subject to fraud
Another disadvantage of a bank draft is that the bank is not responsible for replacing lost money if draft is cashed out by a wrong person, lost, stolen or altered.
Bank Drafts vs. Money Orders
A bank draft and a money order are both secure forms of payment and the issuing institution ensures that the amount has been taken from the customer before the instrument is issued.
These forms of payment in addition to being secure also have some advantages. The payer feels comfortable not having to carry large amounts of money , while the payee also feels secured knowing that the instrument is issued by a reputable third party institution and will be cleared.
However, a bank draft can only be issued by a bank while money orders can be purchased from approved institutions like post offices, certified stores and even banks.
Also a customer can use cash to purchase a money order, whereas bank drafts are usually issued from a customer’s account with the bank.
Money orders also have a disadvantage of often being used to launder money and as a result many governments have a limit on how much money can be converted into a money order. They also tend to be cheaper than bank drafts because of this limit and the simpler issuing process.