Bill discounting Dealing with Defaults

The cycle of liabilities in a bill discounting transaction is as follows:

The drawee is liable to the drawer; and the drawer to the discounting agency. However, the bank / NBFC looks mainly to its customer (drawer or drawee) for recovery of its dues. In case of default, the discounting agency can resort to noting and protesting as laid down by the Negotiable Instrument Act. In reality, however, since litigation is both cumbersome and expensive, a combination of negotiation and compromise is used. At worst, some dues may be written off.

NBFCs generally build in a large number of safeguards to guard against default. Banks generally discount LC–baked bills which are default proof.

Grey areas: There are certain features of the Indian industry which have impeded the growth of a healthy Bills Discounting market (BD).

Participants: Most of the customers approaching banks/NBFCs for BD are SSI units. For such enterprises, it is very difficult to under take proper credit assessment.

Kite Flying: The practice of discounting accommodation bills is known as kite flying. When A draws a B/E on B without there being any underlying movement of goods and B accepts it to accommodate A, the B/ E is called an accommodation/kite bill. If A now discounts it, he has uninterrupted use of funds for the maturity period of the bill. These funds are generally routed into the capital market to earn a very high return. On the due date, the amount of the B/E is repaid by A. This practice has severely stilted the genuine bill market, by imparting false liquidity to the system.

Supply Bills: B/E drawn by suppliers/ contractors on Government departments are called supply bills. These are not accepted by the government. However, contractors are able to get them discounted with nationalized banks. If there is a default on the due dates, banks simply debit the dues to the Government a/c. This practice depresses the level of cash in the bill market because a B/E is being discounted without a corresponding flow of cash.

Reduced Supply: Several corporate houses and business groups do not accept B/E drawn on them. Accepting such bills is seen to be damaging to their pride. Such attitudes reduce the supply of bills and discourage the culture of drawing and discounting bills.

Stamp Duties: No stamp duties are levied on LC (letter of credit) backed bills up to 90 days. This has resulted in a lop-sided growth in the bills market with practically no bills being drawn for a period exceeding 90 days. The market therefore, lacks depth.

Present Position of bills discounting:

Financial services companies had been acting till the early nineties as bill broker for sellers and buyers of bills arising out of business transactions. They were acting as link between banks and business firms. At times, they used to take up bills on their own account, using own funds or taking short term accommodation from banks working as acceptance/discount houses. They had been handling business approximately Rs 5,000 crores annually. Bills discounting, as a fund based service, made available funds at rates 1 per cent lower than on cash credit finance, and bill finance constituted about one-fourth of bank finance.

However, the bills re-discounting facility was misused by banks as well as by the bill brokers. The Janakiraman Committee, appointed by the RBI which examined the factors responsible for the securities scam identified the following mis-uses of the scheme:

1) Banks have been providing bill finance outside the consortium informing the consortium bankers.
2) They have been drawing bills on companies and they themselves discounted such bills to avail of rediscount facilities.
3) In cases, where banks provided additional finance outside the consortium arrangement by way of bill limits covering sales of goods, the sales proceeds had been available to them to provide production finance.
4) Bill finance had been provided to dealers/ stock lists of large manufacturing companies without proper appraisal of their credit needs;
5) Bills discounted by front companies set up by industrial groups on their parent companies which were obviously accommodation bills were discounted / rediscounted by banks;
6) The rediscounting of bills by finance companies with banks was done at a much lower rate of interest;
7) Although bills are essentially trade documents related to electricity charges, custom charges, lease rentals etc. were also disconnected. This was mainly due to the lack of depth in the bills market and NBFCs felt the need for new instrument or schemes to increase their business.
8) No records regarding bills were ever maintained by banks.

In order to stop misuse of the bills discounting facility by banks, the RBI issued guidelines to banks in July 1992.The main elements of these guidelines are as follows:

1) No fund/non-fund facility should be provided by banks outside the consortium arrangement
2) Bill finance should be a part of the working capital / credit limit;
3) Only bills covering purchase of raw materials/inventory for production purposes and sale of goods should be discounted by banks;
4) Accommodation bill should never be discounted;
5) Bills re-discounting should be restricted to usance bills held by other banks. The banks should not re-discount bills earlier discounted by finance companies;
6) Funds accepted by banks for portfolio management should not be deployed for discounting bills.
7) Overall credit limit to finance companies including bills discounting should not exceed three times the net worth of such companies and
8) For discounting LC – backed bills by NBFCs the bill must be accompanied by a no-objection certificate from the beneficiary bank.

As a result, there was substantial decline in the volume of bills discounting. Presently he volume are on an average Rs 80 – 100 crore per month and Rs 800-900 crore per year. The ban on re-discounting has also resulted in failing margins for the NBFCs They are not able to find cash rich companies / individuals ready to discount / rediscount bills.