Two of the most widely used financial instruments in India are cheques and demand drafts. Although the primary purpose of these two instruments is the same, which is for making payments, they are quite different from one another.
Understanding the differences between these two payment instruments can help you choose the right option for the situation. In this article, we will explore the concept of a cheque and a demand draft in detail.
What is a Cheque?
A cheque is a negotiable instrument that an account holder (drawee) can use to instruct their bank to pay a specified amount to a certain individual or entity (payee). Cheques can be issued irrespective of whether you have a savings bank account or a current account and are accepted by banks and other financial instruments as a valid form of payment.
Key Features of Cheques
Cheques have certain characteristics that set them apart from other similar payment instruments. Here are some key features of cheques that you must be aware of.
- Involves Three Parties
Every transaction involving a cheque involves three parties: the drawer, the drawee and the payee. The drawer is the individual or entity issuing the cheque. The drawee, meanwhile, is the bank in which the drawer has an account. Finally, the payee is the individual or entity to whom the drawer instructs the drawee to make the payment.
- Supports Multiple Types of Payment
The payee can receive the payment in cash by presenting the cheque to the drawee bank. Alternatively, the payee can receive the payment directly in their own account by presenting the cheque to their bank.
- Payment is Subject to Fund Availability
Cheques are paid out to the payee only if the drawer’s account has sufficient funds. In the case of inadequate balance in the drawer’s account, the cheque would be dishonoured or bounced. Cheque bounce can lead to severe penalties or legal consequences.
Types of Cheques
Cheques can be classified into different types depending on their nature and purpose. Let us explore some of them in detail.
- Bearer Cheque
A bearer cheque does not have the name of the payee mentioned. Therefore, it is payable to anyone who presents it to the drawee bank. Although this type of cheque might be convenient, it poses a major risk.
- Order Cheque
An order cheque has the name of the payee mentioned clearly and, therefore, is payable only to the intended payee. Banks and other financial institutions often prefer order cheques since they are more secure than bearer cheques.
- Crossed Cheque
A crossed cheque has two lines drawn parallel on the top left corner. Sometimes, the parallel lines are also accompanied by the terms ‘Account Payee’ or ‘A/c Payee’ between them. A crossed cheque can only be deposited into a bank account. It cannot be converted into cash directly. This adds an extra layer of security by only allowing the payee to receive the payment directly in their bank account.
- Open Cheque
An open cheque, also known as an uncrossed cheque, allows the payee to either convert it to cash directly or deposit it with their bank to receive funds in their account. Open cheques can either be made into a bearer cheque or an order cheque.
- Post-Dated Cheque
A post-dated cheque has a future date mentioned on it. This essentially means that it can only be encashed on or after the mentioned date. These types of cheques are useful for making scheduled payments, such as rent or loan instalments.
- Stale Cheque
A stale cheque is one that has exceeded its validity period, which is three months from the date mentioned on it. Banks and other financial institutions will not accept stale cheques as they are past their validity.
- Self Cheque
A self cheque has the word ‘self’ written in the payee section. It allows the drawer to withdraw cash from their own bank account.
- Traveller’s Cheque
Unlike other types of cheques, a traveller’s cheque is prepaid with a fixed amount mentioned on it. Such cheques are accepted internationally and are often considered to be a safe way to carry money.
- Certified Cheque
A certified cheque is one where the drawee bank guarantees that sufficient funds are available in the drawer’s bank account. The funds mentioned in a certified cheque is usually put on hold to ensure that the payment is guaranteed.
- Banker’s Cheque
A banker’s cheque, also known as a bank draft, is issued by the drawee bank on behalf of the drawer. It guarantees payment to the payee as the amount mentioned on the cheque is deducted from the customer’s account at the time of issuance.
- Gift Cheque
A gift cheque is specially designed for gifting purposes. It is often used to gift the payee a specific amount of money and is used as an alternative to cash. These cheques can either be encashed or deposited into the payee’s bank account.
- Cancelled Cheque
A cancelled cheque has the word ‘cancelled’ written diagonally across it. This ensures that the cheque cannot be used for payment. Banks and other financial institutions often request for cancelled cheques for verifying bank details.
Advantages of Using Cheques
Cheques are highly useful traditional payment instruments. Let us explore some of the key benefits of cheques.
- Convenience
Since cheque books are issued at the time of account opening, the drawer can begin issuing them to make payments right away without visiting a bank branch. Furthermore, the drawer can place a new cheque book request online and have it delivered to their address.
- No Issuance Charges
Neither the drawer nor the payee will have to pay any charge for issuing or encashing a cheque. This makes them one of the most cost-effective types of payment options available for individuals and businesses.
Disadvantages of Using Cheques
Despite the many benefits, cheques carry certain risks. Here is a quick overview of some of their disadvantages.
- Dishonour Risk
Cheque payments can be dishonoured if the drawer does not maintain adequate balance in their bank account. A cheque bounce can lead to penalties for both the drawer and the payee. Moreover, the payee can choose to pursue legal action against the drawer.
- Stop Payment Risk
With bank cheques, the drawer has the right to request their bank to stop the payment. While this can be useful in cases of fraud or errors, it also introduces uncertainty since the payee may not receive the promised funds if the drawer decides to stop the payment.
What is a Demand Draft?
A demand draft (DD) is a prepaid, negotiable instrument that is issued by a bank on behalf of an individual or an entity. The issuing bank (drawer) debits the account of the individual or the entity first before issuing a demand draft. This makes them a more secure way to make payments and is often preferred by banks and other financial institutions for high-value transactions.
Key Features of a Demand Draft
Understanding the key features of a demand draft is essential and can help you use it effectively. Here are three major characteristics of this payment instrument.
- Involves Two Parties
Demand drafts only involve two parties: the drawer and the payee. The drawer, in this case, is the bank issuing the DD. The payee, meanwhile, is the recipient of the funds.
- Prepaid Payment Instrument
The amount mentioned on the demand draft is deducted from the bank account of the individual or entity requesting the DD at the time of issuance itself. The prepaid nature of DDs makes them a more reliable payment instrument, especially for transactions that require guaranteed payments.
- No Risk of Dishonour
Since the funds are already deducted from the bank account, DDs eliminate the risk of dishonour or bouncing due to insufficient funds.
Types of Demand Drafts
Demand drafts can be classified into two major types depending on when they become payable. Here is a detailed explanation of the two types of DDs.
- Sight Demand Draft
A sight demand draft becomes payable as soon as it is issued. The payee can present a sight DD to the bank and get paid immediately. This type of a demand draft is useful for when payments need to be made promptly.
- Time Demand Draft
A time demand draft, meanwhile, only becomes payable after a specified period. The payee can only present it to the bank on or after the specified date. Time DDs are often used in transactions that warrant deferred payments.
Advantages of Using Demand Drafts
Demand drafts offer quite a few advantages over other payment instruments like cheques. Let us explore two of their key benefits.
- Guaranteed Payment
Since a demand draft is only issued by a bank after the drawer’s account is debited, there is zero risk of it being dishonoured due to lack of funds. DDs are ideal for critical and high-value financial transactions as they guarantee payment to the payees.
- Widely Accepted
Unlike other types of payment options, demand drafts are accepted by individuals, business entities, banks and other financial institutions, educational institutions and government agencies due to their highly secure nature.
Disadvantages of Using Demand Drafts
Demand drafts are not without any drawbacks. Here is a quick overview of two of the most common disadvantages.
- Charges
Banks levy a service charge for issuing demand drafts. The service charges vary depending on the bank and its policies.
- Inability to Stop Payment
A demand draft can neither be canceled nor the payment stopped once it is issued to the payee. This can be highly problematic if the DD is lost.
Key Differences Between Cheque and Demand Draft
A cheque and a demand draft are both negotiable instruments used for making payments. However, they are quite different from one another in several aspects. Here is a table displaying the key differences between the two traditional payment instruments.
| Particulars | Cheque | Demand Draft |
| Issuer | A cheque is issued by individuals or entities. | A demand draft is issued by a bank on behalf of an individual or an entity. |
| Payment Guarantee | A cheque does not guarantee payment as it depends on the availability of funds in the drawer’s account. | A demand draft guarantees payment since it is a prepaid instrument issued by the bank. |
| Parties Involved | A cheque involves three parties: the drawer, the drawee and the payee. | A demand draft involves only two parties: the drawer and the payee. |
| Stop Payment Facility | The drawer can request the bank to stop the payment before the cheque processing is complete. | Once a demand draft is issued, its payment cannot be stopped. |
| Charges | Generally, there are no charges involved for cheques. However, a penalty may apply if a cheque bounces due to insufficient funds. | The bank charges a nominal fee for issuing a demand draft. |
| Risk of Fraud | Cheques have a higher risk of fraud as they can be forged or altered. | Demand drafts are more secure since they are issued directly by banks and cannot be altered or forged easily. |
When to Use Cheques?
Although cheques are the more popular option for making payments, knowing when to use them is crucial. Here are some scenarios that might warrant the use of a cheque.
- For Routine, Low-Value Transactions
Cheques are ideal for making everyday payments like rent, utility bills and other small financial transactions. Since the clearing time can take a few days, they are also ideal for situations that do not warrant immediate payment of money.
- For Post-Dated Payments
Cheques are highly useful for meeting instalment-based transactions like loan repayments. By issuing post-dated cheques, you can ensure that the funds are deducted on or after a specified future date. However, you must maintain adequate funds at the right time to avoid issues like a cheque bounce.
- For Payments Between Trusted Parties
The usage of cheques is better suited for transactions between trusted parties due to the risk of them bouncing due to insufficient funds. Individuals and businesses with long-standing financial relationships and minimal risk of default can use cheques to make payments.
When to Use Demand Drafts?
Demand drafts are prepaid negotiable instruments and guarantee payment. This makes them the ideal choice for certain types of transactions. Here is a quick look at some of the situations that warrant the use of demand drafts.
- For High-Value Transactions
Since the issuing bank guarantees payment, demand drafts are more suitable for high-value transactions, such as vehicle and property purchases.
- For Situations Requiring Guaranteed Funds
Educational institutions and government offices often ask you to make payments via demand drafts to ensure that they receive funds without the risk of fraud or cheque bounce.
- For Payments Between Unknown Parties
DDs provide a higher level of financial security since banks issue them only after receiving funds. This makes them ideal for transactions involving unknown parties whose credibility is not established or where there is little to no trust.
Conclusion
Cheques and demand drafts, being traditional payment instruments, still play important roles in financial transactions. If you are someone who makes payments regularly, knowing when to use them is essential. Cheques are more flexible and convenient but carry slightly more risk, whereas DDs are more secure but can be more cumbersome to draw. Therefore, it is advisable to consider the differences between bank cheques and demand drafts when deciding which of the two payment instruments to use.
