Bills Purchased and Discounted

Bills purchased and discounted is a form of bank credit in which a bank pays a customer today for a trade bill that will be paid later, keeping a discount or charge for the wait and the risk. The bill is usually a bill of exchange drawn by a seller on a buyer, often with shipping documents attached. Businesses use it to turn credit sales into cash at once; banks treat it as a short-term, self-liquidating loan that is repaid when the buyer pays the bill.

The phrase is best known as a line item. Banks in India and Pakistan report "bills purchased and discounted" (or "bills discounted and purchased") as a separate heading within advances, next to overdrafts, cash credits and term loans. In banking practice a bank usually "discounts" a usance bill, payable some days after sight or acceptance, and "purchases" a demand or sight bill, payable on presentation, by paying out before the money has been collected. The facility sits within trade finance and is a close relative of invoice discounting and factoring.

Imagine a tailor who has sold a suit to a regular customer on the promise of payment in three months. The tailor needs cloth today, so he takes the signed promise to a moneylender, who gives him most of the price now and keeps the rest as a fee. In three months the moneylender, not the tailor, collects from the customer.

Bill discounting is that arrangement done by a bank with a formal, legally enforceable paper. The seller gets cash early; the bank earns the difference between what it paid and what it later collects. If the buyer does not pay, the bank usually goes back to the seller for the money, because the deal was made "with recourse".

A typical domestic or export transaction follows these steps:

1. The seller ships goods and draws a bill of exchange on the buyer, attaching documents such as a commercial invoice and, for sea freight, a bill of lading.
2. For a usance bill, the buyer (or the buyer's bank) accepts it, agreeing to pay on a fixed future date.
3. The seller presents the bill to its bank, which checks the documents and the underlying trade, then credits the seller with the face value minus the discount.
4. On the due date the bank collects from the buyer, often through a documentary collection or under a letter of credit, and the advance is closed.

The discount is normally simple interest on the face value for the days remaining:

• $D$ is the discount the bank keeps.
• $F$ is the face value of the bill.
• $r$ is the annual discount rate, as a decimal.
• $d$ is the number of days until the bill falls due (some markets use a 360-day year).

For a bill of 1,000,000 rupees due in 90 days, discounted at 12% a year, the discount is $1{,}000{,}000 \times 0.12 \times \frac{90}{365} \approx 29{,}589$. The seller receives about 970,411 rupees now, and the bank collects 1,000,000 rupees in 90 days. Banks usually price the rate as a margin over a benchmark such as KIBOR in Pakistan, and may add handling and collection fees.

The two words describe the timing of the bill rather than a different product. A purchased bill is payable on demand, so the bank is in effect advancing money for the time it takes the documents to travel and be paid, often a few weeks for export bills. A discounted bill has a fixed future maturity, typically 30 to 180 days, and the bank's charge reflects that term. In both cases the seller remains liable if the bill is dishonoured, unless the bank has expressly bought it without recourse, a structure closer to forfaiting.

In India, the balance-sheet format in the Third Schedule to the Banking Regulation Act 1949 lists advances under three headings: bills purchased and discounted; cash credits, overdrafts and loans repayable on demand; and term loans. Pakistani banks' financial statements show a similar heading within advances, split into bills payable in Pakistan and bills payable outside Pakistan, and the State Bank of Pakistan's statistics on scheduled banks' advances include it as a category. Because these bills are short-dated and linked to identifiable trade, banks and supervisors have traditionally seen them as among the more liquid parts of a loan book. They are still counted when supervisors measure credit risk, the advances-to-deposit ratio (ADR) and non-performing loans; an unpaid bill that stays overdue is classified like any other bad loan.

The main risk is that the buyer does not pay and the seller cannot repay the bank either. A second risk is fraud. "Accommodation bills", drawn between related parties with no real sale behind them, have long been used to raise cheap credit, and fake or recycled shipping documents can support trade-based money laundering. Banks therefore check invoices, transport documents and the parties' trading history before discounting.

The law of bills rests on long-standing statutes: the Bills of Exchange Act 1882 in the UK and the Negotiable Instruments Act 1881, inherited by both India and Pakistan. Historically, central banks themselves rediscounted eligible bills for commercial banks, and the price they charged is the origin of the term discount rate. Today many firms use alternatives such as receivables finance, commercial paper or open-account trade backed by supply chain finance, but bill discounting remains common in South Asian and Middle Eastern trade, and it sits alongside commodity operations financing as a short-term use of bank deposits.

• Bills of Exchange Act 1882 (legislation.gov.uk)
• International Chamber of Commerce