Definition
A bank draft is a payment method where the payer authorizes their bank to send money directly to another person’s or organization’s bank account. This is a secure form of payment as the bank will not issue the draft without sufficient funds in the payer’s account. It’s commonly used for larger transactions because it guarantees the availability of the funds upon clearance.
Key Takeaways
- A bank draft is a type of check where payment is guaranteed by the issuing bank. Unlike regular checks, the bank ensures that there is enough funds to cover the transaction by taking the amount of the check from the payer’s account when the check is issued, hence providing a secure method of payment.
- Bank drafts are often used for large transactions or purchases because they are considered safer than personal checks or cash. Given that the bank stands behind the bank draft, the recipient can be certain that the funds are available and will be paid in full.
- Despite its security, it’s crucial to treat bank drafts with caution as it is subjected to fraud activities. Check with the issuing bank to make sure the draft is legitimate before accepting it as payment.
Importance
A bank draft is an important financial instrument used in business transactions due to its reliability and security.
It is a type of check where payment is guaranteed by the issuing bank, meaning that the payer has the required funds to fulfill the payment.
By using a bank draft, the risk of the check bouncing due to insufficient funds is eliminated, providing the payee with the assurance of payment.
Additionally, the bank draft can provide evidence of payment, creating a paper trail that can be useful for accounting and legal purposes.
Therefore, a bank draft is a valuable tool in secure financial transactions, offering certainty for both parties involved.
Explanation
A bank draft serves as a practical tool when dealing with significant financial transactions and is intended to secure a reliable mode of payment. It functions much like a traditional check but with the added assurance that the payment will be honored by the bank that issued the draft.
The primary purpose of using a bank draft is to ensure the recipient or payee that the funds are available and secure. Oftentimes, when large quantities of money are being transferred, such as in property purchases or high-cost items, bank drafts become a preferred method of payment due to their credibility.
Another substantial use of the bank draft is in cross-border business transactions. Given that these drafts can be issued in foreign currency, they provide a convenient and safe way to make international payments.
The issuer bank holds itself accountable for paying the recipient, thus minimizing the risks associated with currency exchanges and providing a sense of security to both parties. Hence, in scenarios where trust plays a vital role, the use of a bank draft reinforces that trust by ensuring the guaranteed availability of funds.
Examples of Bank Draft
Property Purchase: In a real estate transaction, the buyer can use a bank draft as a more secure form of payment than a personal check. When paying a significant amount of money like the price of a house, a bank draft is more reliable because it guarantees the funds are available and will be paid to the seller.
Car Buying: When purchasing a car, especially when buying privately, sellers may request payment in the form of a bank draft. This means that the funds have already been withdrawn from the purchaser’s account by the bank, assuring the seller of payment clearance.
Tuition Payment: Some students use bank drafts to pay for their tuition fees, particularly for studying abroad. A bank draft is used to transfer a large sum of money securely from the student’s (or their parents’) bank in their home country to the university’s bank in the host country. This ensures the immediate availability of funds, which might not be the case with a regular check.
FAQ for Bank Draft
What is a bank draft?
A bank draft is a type of check where payment is guaranteed by the issuing bank after review of the account holder’s funds. It is a safe and reliable form of payment.
How does a bank draft work?
A bank draft is issued by a bank, ensuring the recipient that there are available funds set aside from the payer’s account for the payment. The receiver can redeem it like any other check. In case the bank draft is lost or stolen, it can be replaced.
What is the difference between a bank draft and a check?
The main difference between a bank draft and a check is that the bank guarantees a bank draft, not the account owner. That makes the bank draft a more secure form of payment as compared to a personal check.
What is the fee for a bank draft?
Bank draft fees vary depending on the institution. It is recommended to check with your local banking institution for accurate fee information. Some banks may also offer this service for free to their account holders.
Is a bank draft the same as a cashier’s check?
Yes, a bank draft is often used interchangeably with a cashier’s check. They both function similarly in which the bank guarantees the payment.
Related Entrepreneurship Terms
- Payee: This is the person or organization to whom the bank draft is payable.
- Drawer: This is the person or the entity that prepares and issues the bank draft.
- Drawee: It is the bank or other financial institution that is asked to pay a specific sum, usually to the person indicated on the bank draft.
- Clearance: This is the process of settling a bank draft through the banking system.
- Guaranteed Funds: Bank draft is considered as a type of guaranteed funds, as it assures the payee of the availability of funds.
Sources for More Information
- Investopedia: This site offers a vast amount of articles and lessons about all aspects of finance, including bank drafts.
- The Balance: It provides expert-written articles on personal finance and money management, which also cover topics like bank drafts.
- Bankrate: This source offers helpful guides and tools about banking and finance, including everything you need to know about bank drafts.
- Business Dictionary: It offers clear, in-depth definitions of business and finance terms, including bank drafts.
