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Bank Draft

An instrument for making large payments without having to withdraw cash from one’s account

What is a Bank Draft?

A bank draft is a convenient and secure instrument for making large payments without having to withdraw cash from one’s account. Bank drafts are guaranteed by financial institutions and can be used by individuals to make payments to third parties.

 

Bank Draft

 

In most cases, bank drafts can be used to make payments in most currencies. The person receiving the bank draft can deposit it at any bank, just like cash. Bank drafts by most financial institutions do not expire.

However, certain financial institutions may not accept bank drafts that are more than a few months old. Bank drafts are also commonly known as bankers’ drafts and bank checks.

 

How Does It Work?

First, the individual making the payment submits a request for a bank draft with their financial institution. Once the request is submitted, the bank reviews the individual’s account to see if he or she has sufficient funds to transfer.

If the individual has sufficient funds, the bank approves the request, withdraws funds from the individual’s account, and issues a bank draft for an equivalent amount. The funds withdrawn from the individual’s account are generally transferred to the bank’s reserve account until the draft is presented for payment by the beneficiary.

Bank drafts usually come with a small fee. However, most banking accounts offer a certain number of free bank drafts per year.

The bank draft is issued in the form of a document and is drafted in the name of the individual who will be depositing it and receiving the money. The individual purchasing the bank draft is responsible for ensuring that the bank draft is delivered to the payee.

Once the payee presents the bank draft for payment, his or her identity is verified with the name on the bank draft. After the identity verification process, the funds are deposited into the payee’s account. The funds can take anywhere between 1-4 business days to process.

 

Can a Bank Draft be Canceled?

A bank draft is difficult to cancel since the funds have already been withdrawn from the buyer’s account and transferred into the bank’s reserve account. However, if the bank can confirm that the bank draft has not been cashed out by the payee, it might agree to cancel the bank draft and refund the buyer’s account.

If the bank draft gets destroyed or stolen before being delivered to the payee, the buyer can go to their bank to get a new draft and cancel the existing one. Similarly, if the transaction gets canceled for any reason, the buyer can request the bank to cancel the draft unless it has already been cashed out by the payee.

 

What are the Advantages of a Bank Draft?

 

1. Guaranteed availability of funds

Unlike a personal check, a bank draft is guaranteed by the bank. It means that the payee is guaranteed the availability of funds. In such a way, bank drafts are safer than personal checks, which might bounce if there are no sufficient funds in the payer’s account.

 

2. More convenient

Another advantage of a bank draft is that it is a much easier and more convenient method for transferring a large sum of money than withdrawing a large sum of cash. Unlike an e-transfer, a bank draft does not have a maximum amount limit and does not require the banking information of the payee. Thus, bank drafts are commonly used when making large purchases, such as buying a house or car.

 

3. Can be used for cross-border purchases and investments

Bank drafts can also provide funds in most currencies and are commonly used for cross-border purchases and investments in foreign countries.

 

What are the Disadvantages of a Bank Draft?

 

1. Cannot be canceled after delivery

Since bank drafts represent a transaction that has already taken place, it cannot be canceled once it is delivered to the payee.

 

2. Subject to fraud

Another major disadvantage of a bank draft is that if it is lost, stolen, or altered with, and the funds are cashed out by the wrong person, the bank is not responsible for replacing the lost money. In such cases, the buyer can lose a lot of money, especially since bank drafts are generally used for larger purchases.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep learning and advancing your career, the additional CFI resources below will be useful:

  • Bank Reconciliation
  • Banking Fundamentals
  • Cash Reserves
  • Bank Account Overdraft

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