Advantages of Bill Discounting

The advantages of bills discounting to investors and banks and finance companies are as follows:

To Investors:

1) Short term sources of finance;
2) Bills discounting being in the nature of a transaction is outside the purview of Section 370 of the Indian companies Act 1956, that restricts the amount of loans that can be given by group companies;
3) Since it is a lending no tax at source is deducted while making the payment charges which is very convenient not only from the cash flow point of view, but also from the point of view of companies that do not envisage tax liabilities.
4) Rates of discount are better than those available on ICDs and
5) Flexibility not only in the quantum of investments but also in the duration of investments.

To Banks: Safety of Funds: The greatest security for a banker is that a B/E is a negotiable instrument bearing signatures of two parties considered good for the amount of bill; so he can enforce his claim.

Certainty of payment: A B/E is a self liquidating asset with the banker knowing in advance the date of its maturity. Thus, bill finance obviates the need for maintaining large, unutilized, ideal cash balances as under the cash credit system. It also provides banks greater control over their drawals.

Profitability: Since the discount on a bill is front ended the yield is much higher than in other loans and advances, where interest is paid quarterly or half yearly.

Evens out Inter-bank Liquidity Problems: The development of healthy parallel bills discounting market would stabilize the violent fluctuations in the call money market as banks could buy and sell bills to even out their liquidity mismatches.

Discount rate and effective Rate of Interest: banks and finance companies discounting bills prefer to discounting L/C (letter of credit) – backed bills compared to clean bills. The rate of discount applicable to clean bills is usually higher than the rate applicable to L / C based bills. The bills are generally discounted up front, i.e. the discount is payable in advance. As a consequence, the effective rate of interest is higher than the quoted rate (discount). The discount rate varies from time to time depending upon the short term interest rate. The computation of the effective rate of interest on bills discounting is shown below in Illustration:


The innovative finance Ltd, discounts the bills of its clients at the rate specified below:

1) L / C backed bills 22 per cent per annum
2) Clean bill 24 per cent per annum


Compute the effective rate of interest implicit in the two types of bills assuming usance period of (a) 90 days for the L/C based bill and (b) 60 days for the clean bill and value of the bill, Rs 10,000


Effective rate of Interest on L / C based bill:

Value of the bill, Rs 10,000

Discount charge, Rs 550 {Rs 10,000 x 0.22 x 90 / 360}

Amount received by the client, Rs 9,450 (Rs 10,000 – Rs 550)

Quarterly effective interest rate, 5.82 percent (Rs 550 / Rs 9,450 x 100)

Annualized effective rate of interest,
[(1.0582)4 – 1] x 100,25.39 per cent

Effective rate of interest on clean Bill:

Value of bill, Rs 10,000

Discount charge ( Rs 10,000 x 0.24 x 60/ 360), Rs 400

Amount received by the client (Rs 10,000 – R 400), Rs 9,600

Quarterly rate of interest (Rs 400 / Rs 9,600 x 1000, 4.17 percent

Effective rate of interest per annum, [(1.0417)4 – 1] x100 = 17.75 percent