Demand Draft

It is a negotiable instrument issued in the name of the drawer by the bank.

A demand draft is a negotiable instrument issued in the name of the drawer by the bank. The primary characteristic of it is that it can not be transferred to any other person or payee in any situation.

A demand draft can be compared to cheques, but one of its characteristics that differs from cheques is that it can not be reversed or rescinded such that once it is issued through a bank, it can not be dishonored.

Although it is a safe mechanism for transferring payment, there are various loopholes through which some fraudulent practices can be done. Unfortunately, few regulations have been introduced in recent times to curb such practices.

It is also to be mentioned that the draft facilities are available to people regardless of whether they have a bank account or not, such that the payee has to present it at the bank at the time of maturity. The payment can be received in the form of cash or cheque.

Individuals can visit the bank at any time and fill out the draft form, or the following process can be done online.

The buyer's name has to be compulsorily printed on the demand draft even if the amount of draft is small, like $2,000.

Types Of Demand Drafts

Different types are:

1. Sight Demand Draft

This type of bill of exchange is honored on demand. This is prepared only after the payee presents some documents required by the bank. If the payee fails to present the documents, they fail to get the payment.

Usually, exporters issue sight drafts because they want to retain the ownership of the shipped goods. After all, the importer could default; this is a credit risk. Therefore, this type of draft is used mainly in international trade transactions.

One of the shortcomings of a sight draft can be that if the importing country disallows the shipment, then the agreement will not be honored, and the payee will not be able to reap its benefits.

2. Time Demand Draft 

A time-demand draft is only available after a specific period and can not be presented before the time mentioned. It is a short-term credit instrument to facilitate international or domestic transactions.

It gives time to the importer to pay for the transaction, as it is a type of instrument that ensures guaranteed payment after a specific period.

How To Make a Draft

The draft form can be filled in in person at the bank or online with the help of a form. 

Some important details have to be input when filling up the draft, like the mode of payment, name of the beneficiary, the place of encashing it, cheque number, and much more, depending on the requirements.

In India, a person must provide their PAN (Permanent Account Number) to fill the draft above the value of Rs. 50,000.

Certain charges are levied when issuing it depending upon a certain criterion.

Creating a demand draft can be done in the following steps:

  1. First, gather important information before filling up the form for the draft.
  2. Legally required information has to be provided regarding the goods in which the drawer and the payee are dealing as this can help define liability and improve customer relations.
  3. Information Regarding The Account Of The Client has to be obtained since the demand draft does not require a signature, so necessary details related to the client must be presented.
  4. Although the draft does not require a signature, it requires obtaining consent, whether the consent is written or verbal.
  5. An Official Form is required to be filled out, which can be bought from a bank or filled out online after gathering all the information mentioned above.
  6. After filling up the necessary information, the draft has to be printed because physical copies of the draft are needed to deposit it.
  7. After the draft has been prepared properly, it has to be deposited at the bank, just like how a cheque is deposited.

A draft has a validity of 3 months after the bank issues it; after the following period, the draft expires. Unfortunately, after the draft expiry, the drawer account does not get a refund, so the drawer has to approach the bank to revalidate the draft.

It is to be mentioned that the payee can not approach the bank to revalidate the draft.

After a draft has been revalidated, it can not be revalidated again. Instead, the refund reaches the drawer account after deducting a certain amount from the account for the draft cancellation.

Frauds

Despite being one of the safest mediums of exchange, a draft sometimes becomes the subject of fraud several times. This happens because of the misuse of digital information online.

For instance, a fake draft can be prepared in the payee's name, for which the payee could face legal charges, and it becomes harder to track down the main culprit behind all of this.

A payee must ensure the track of specific details to avoid fraud:

  • For example, proper details of the drawer must be kept, and the payee must verify in every case possible to remain out of the circle of suspicion.
  • A colored copy of the draft has to be kept to help identify the method in which the details are forged by the culprit, especially when the amount forged in the draft is significant.
  • After the fraud, the banks are bound to take legal action against the payee such that the payee shall file a counter FIR to avoid anything in the worst-case scenario.

The payee must track the fraudster and ask the bank to get the fraudster's CCTV footage or anything circumstantial that might help in finding him\her.

Demand Draft vs. The Cheque

A draft and the cheque might seem similar but differ in several aspects.

A demand draft is the payment mechanism where the drawer transfers the amount to a specific payee while a cheque is used to transfer a payment to whomever it may concern.

While a draft may be a safer way of transferring the payment, at the same time, a cheque may help in transferring the payment more easily. This is because the bank issues a draft, but the bank's customers can issue the cheques.

A cheque can be dishonored or bounced if a sufficient balance is not available in the drawer account, but the same is not the case with the draft as it is issued by the bank such that the bank ensures the draft is honored in each and every case scenario.

There is also a difference between the draft and a cheque based on the number of parties involved, as only the drawer and the payee are involved when preparing a draft. In contrast, at the time of preparation of the cheque, the drawer, drawee, and the payee are involved.

Educational institutions or government institutions always prefer a demand draft over a cheque because a certain amount of value is associated with it. Moreover, a draft is almost a guarantee for the promised money as a drawer is required to pay the fees or a certain amount needed to the bank, which can not be dishonored in any case scenario.

No cheque ensures the payment to the payee; for instance, there is an uncountable number of cheque bounce and fraud cases.

Summary

  • A demand draft is a type of bill of exchange that is used to transfer payment from one person to another.
  • Sighted Demand Draft and Time Demand Draft are the two types of drafts.
  • Gathering the required information is necessary before even filling up the form.
  • Despite being a secure source of payment various frauds do take place through a demand draft.
  • Demand Drafts are usually preferred over cheques.
Accounting Foundations Course

Everything You Need To Build Your Accounting Skills

To Help You Thrive in the Most Flexible Job in the World.

Learn More

Research and Authored by Arnav Chaudhary | Linkedin

Reviewed and Edited by Sakshi Uradi | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: