Cheques and Demand Drafts

Cheques

Demand Drafts (DDs)

History and Evolution in India

How a Cheque Works

1. Issuance (Drawer): An individual or entity (the 'drawer') writes a cheque from their chequebook, instructing their bank (the 'drawee bank') to pay a specific amount to another person or entity (the 'payee'). The cheque must include the date, payee's name, amount in figures and words, and the drawer's signature.
2. Deposit (Payee): The payee receives the cheque and deposits it into their own bank account (the 'presenting bank').
3. Clearing Process:
   • Physical Clearing (Traditional): Historically, the presenting bank would physically send the cheque to the drawee bank for verification and payment.
   • Cheque Truncation System (CTS): In India, most cheques are now processed through CTS. The presenting bank captures an electronic image of the cheque along with its MICR (Magnetic Ink Character Recognition) data and transmits it to the clearing house. The physical cheque does not travel.
4. Verification and Payment (Drawee Bank): The drawee bank receives the electronic image and data. It verifies the signature, date, amount, and crucially, checks if the drawer has sufficient funds in their account.
5. Settlement: If all checks are successful, the drawee bank debits the drawer's account and credits the presenting bank. The presenting bank then credits the payee's account. If there are issues (e.g., insufficient funds, signature mismatch, post-dated cheque presented early), the cheque is 'dishonoured' or 'bounced', and the drawee bank returns it with a reason.

How a Demand Draft Works

1. Purchase (Purchaser): An individual or entity (the 'purchaser') approaches their bank (the 'issuing bank') to obtain a Demand Draft. They fill out a DD application form, specifying the payee's name, the amount, and the city where the DD is to be payable.
2. Payment to Bank: The purchaser pays the bank the full amount of the DD plus a small commission fee. This payment can be made in cash (up to certain limits set by RBI, typically ₹50,000 for non-account holders), by debiting their bank account, or by cheque.
3. Issuance by Bank: Upon receiving payment, the bank issues the Demand Draft. The DD contains details like the issuing bank's name, branch, DD number, date, amount, payee's name, and the branch where it is payable. The bank effectively guarantees the payment.
4. Delivery to Payee: The purchaser then delivers the physical Demand Draft to the payee.
5. Encashment (Payee): The payee deposits the DD into their bank account (the 'paying bank'). Since the funds are already secured by the issuing bank, the paying bank typically credits the payee's account quickly, often on the same day or the next working day, after verifying the DD's authenticity. There is no risk of the DD bouncing due to insufficient funds from the original purchaser.

Benefits

For Cheques:

• Record Keeping: Cheque stubs and bank statements provide a clear audit trail of payments made.
• Convenience for Large Sums: Safer than carrying large amounts of cash for significant transactions.
• Payment Control: The drawer retains control until the cheque is cleared, allowing for stop-payment instructions if needed.
• Accessibility: Widely accepted for various payments, including government dues, utility bills, and institutional fees.

For Demand Drafts:

• Guaranteed Payment: Since the bank issues and guarantees the payment, there is no risk of a DD bouncing due to insufficient funds from the purchaser.
• Security: Safer than cash for sending money across locations, especially for non-account holders.
• Acceptance: Highly trusted and accepted by institutions and individuals who require assured payment.
• No Account Required (for Payee): A payee can often encash a DD even if they don't have an account with the paying bank, though depositing into an account is generally safer.

Limitations

For Cheques:

• Risk of Dishonour: Cheques can bounce due to insufficient funds, signature mismatch, or other errors, leading to penalties and legal consequences.
• Clearing Time: Despite CTS, cheques still take 1-3 working days to clear, which can be slower than digital payments.
• Security Risks: Susceptible to fraud, forgery, or theft if not handled carefully.
• Physical Handling: Requires physical delivery and deposit, which can be inconvenient.

For Demand Drafts:

• Pre-payment Required: The full amount must be paid upfront to the bank, blocking funds immediately.
• Charges: Banks levy a commission fee for issuing DDs.
• Not Suitable for Frequent Payments: Inconvenient and costly for small, recurring transactions compared to digital methods.
• Cancellation/Refund: Cancelling a DD or getting a refund if it's lost or not used can be a cumbersome process.

Common Mistakes

• Incorrect Details: Writing wrong payee name, amount, or date on a cheque.
• Unsigned Cheques: Forgetting to sign the cheque or having a signature mismatch.
• Not Crossing Cheques: Issuing bearer cheques for large amounts, increasing the risk of theft and unauthorized encashment.
• Ignoring Validity: Presenting a cheque or DD after its three-month validity period, making it stale.
• Insufficient Funds: Issuing a cheque without ensuring adequate balance in the account, leading to dishonour.
• Overwriting: Making corrections on a cheque without proper counter-signature, which can lead to rejection.
• Not Keeping Records: Failing to note down cheque details (number, date, payee, amount) from the cheque stub.

Best Practices

• Always Cross Cheques: For enhanced security, always cross cheques, especially for large amounts, and write "Account Payee Only" to ensure funds are credited only to the payee's account.
• Fill Details Carefully: Ensure all details – date, payee name, amount in figures and words – are accurate and legible. Avoid overwriting.
• Maintain Sufficient Balance: Always ensure your account has enough funds before issuing a cheque to avoid dishonour penalties.
• Keep Cheque Stubs: Maintain a record of all cheques issued in the chequebook stub for future reference and reconciliation.
• Secure Storage: Keep unused cheque leaves and chequebooks in a safe and secure place to prevent theft or misuse.
• Verify DD Details: When receiving a DD, verify the payee name, amount, and issuing bank details. When purchasing, double-check all details before the bank issues it.
• Consider Digital Alternatives: For routine or urgent payments, explore digital options like NEFT, RTGS, IMPS, or UPI for faster and often cheaper transactions.
• Report Loss Immediately: If a cheque or DD is lost or stolen, immediately inform your bank to stop payment or initiate cancellation procedures.

Real-world Examples

• Paying Rent: Many landlords still prefer post-dated cheques for monthly rent payments.
• Educational Fees: Universities and schools often require Demand Drafts for admission fees or examination fees, especially for out-of-station applicants.
• Government Payments: Certain government departments or tax payments may still require payment via cheque or DD.
• Large Purchases: For buying a car or property, a cheque or DD might be used for down payments or final settlements.
• Inter-bank Transfers: While NEFT/RTGS are common, for very large, critical inter-bank transfers where a physical instrument is preferred, a DD might be used.

Comparison: Cheque vs. Demand Draft