When it's inadvisable to use a personal check or when a recipient won't accept one, a bank draft is an alternative form of payment. In practice, a bank draft often serves to make a remittance from one area of the country to another.
The bank draft is a certified payment option and, as such, it's a secure payment option to use when placing a significant deposit on a high-value purchase or when you need to give a payee confidence that you have the funds available to comply with a purchase and sale agreement.
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What Is a Bank Draft?
A bank draft, which is sometimes referred to as a banker's draft or teller's check, is the obligation of the issuing bank, rather than that of a person who requests the bank draft. This fact is a basis of the certified payment's security which, in turn, is the basis of the draft's acceptance by other banks.
A bank draft is not a form of legal tender, or cash, until it's collected. Rather, it's a confirmation of a bank's legal obligation to pay a certain amount to another financial institution. As such, the bank draft is a negotiable instrument that documents a promise to pay a certain amount to a certain person or organization.
Why Use a Bank Draft?
While both a check and a bank draft are negotiable instruments that may serve as payments, only the bank draft is guaranteed by its issuing bank. Consequently, the payee may require the draft if no prior business relationship exists between the payee and the payor.
Likewise, in the event of a high-dollar transaction or in a situation in which it would be exceedingly difficult to collect on an obligation should one party fail to honor it, a bank draft may be in order. For instance, a seller might require a home buyer to make a down payment using a bank draft.
The Security Offered by the Draft
The secure nature of a bank draft is evidenced in many ways: a serial number that identifies you, the remitting customer; a watermark or micro-encoding that confirms the document is a genuine, negotiable financial instrument; and the identity of the issuing bank that is the draft's official payer.
Also, by having drawn the bank draft in your name and endorsing it to a payee, your endorsement of the draft to the payee serves as direct evidence of the transaction, or payment.
How Does a Bank Draft Work?
If you have a checking account, you can purchase a bank draft at a financial institution. The draft is made payable at another institution. To obtain a bank draft, you write a check that's payable to a financial institution with the word "draft."
Role of the Financial Institution
Once you present your check to your financial institution, that institution confirms the cash is available in your account, then issues a bank draft in exchange for your check. At that time, your institution withdraws the draft's amount from your account. In turn, the balance of that account is reduced by the amount of the bank draft. Typically, the cash is held in a general ledger account until such time as the payee presents the draft to a bank for payment.
Typically, the financial institution will prepare a bank draft that's drawn to the order of you, the purchaser, so your name will appear on the draft as payee. You will endorse the bank draft to the person you intend to receive the cash that the draft represents, then send it by mail to your recipient.
Once the bank draft is presented for deposit or payment by the recipient, it is charged against the account of the financial institution that issued the draft.
How to Cash a Bank Draft
As the intended payee of a bank draft, you can make a bank draft deposit in a bank account as you would any other transaction. You simply endorse the draft by signing it. For added security, enter your account number and the phrase "for deposit only."
The time required for the cash to be transferred to your account so you can withdraw it varies, but you might speed the process by completing the deposit with a teller at your financial institution, rather than relying on an electronic device, such as an ATM or mobile phone.
When it's inadvisable to use a personal check or if a recipient won't accept one, a bank draft is an alternative form of payment. The bank draft is a secure payment option to use when placing a significant deposit on a high-value purchase or when you need to give a payee confidence that you have the funds available to comply with a purchase and sale agreement.
- Corporate Finance Institute: Bank Draft
- National Bank: What Is a Bank Draft?
- Cornell Law School: Negotiable Instrument
- Electronic Code of Federal Regulations: Subpart A—Collection of Checks and Other Items by Federal Reserve Banks
- TD Newsroom: How Do Bank Drafts Work?
- Bank for International Settlements: A glossary of Terms Used in Payments and Settlement Systems