A Bank Draft: What Is It? Examples, and How It Works

What Is a Bank Draft?

A bank draft is a negotiable instrument that functions as payment in the same way as a check.  Unlike a check, though, a bank draft is guaranteed by the issuing bank. The total amount of the draft is drawn from the requesting payer's account—their bank account balance decreases by the money withdrawn from the account—and is usually held in a general ledger account until the draft is cashed by the payee. Bank drafts provide the payee with a secure form of payment.

How a Bank Draft Works

Consumers have several avenues available when they need secure, certified payment options. They may require them to secure an apartment or for a deposit for a very large purchase. Certified payment options give the payee security, knowing that the funds are available. These options include certified checks, wire transfers, and bank drafts.

Bank drafts—also called banker's drafts, bank check, or teller's check—are just like cashier's checks. They are secure payment options that are guaranteed by the issuing bank—in many cases, for a large amount of money. When a customer requests a bank draft, the representative ensures they have enough money in their account to cover the amount requested. Once verified, the bank withdraws the funds from the customer's account and transfers it to a general ledger or internal account. The bank prepares the draft with the payee's name and the amount. The draft has a serial number—which identifies the remitting customer—watermarks, and may even have micro-encoding—identifying it as a legitimate financial instrument that can be negotiated when presented by the payee to their bank. Since the funds are already withdrawn from the requesting customer's account, the issuing bank ultimately becomes the payer.

As mentioned above, bank drafts act as a viable and secure form of payment. They may be required by a seller when they have no relationship with a buyer, when a transaction involves a large sale price, or if the seller believes collecting payment may be difficult. For example, a seller may request a bank draft when selling a home or an automobile. Of course, a seller may not collect funds with a bank draft if the bank becomes insolvent and does not honor outstanding drafts, or if the draft is fraudulent.

Banks normally charge customers for drafts. This means that in addition to the amount of the draft, the requesting customer may be liable for a fee—usually a flat rate, a flat fee based on the total amount of the draft, or for a percentage of the draft. Banks may waive the fee for customers who have a good relationship with the institution or for those who are considered high-net-worth individuals (HNWIs).

KEY TAKEAWAYS

•A bank draft is a negotiable instrument where payment is guaranteed by the issuing bank.

•Banks verify and withdraw funds from the requester's account and deposit them into an internal account to cover the amount of the draft.

•A seller may require a bank draft when they have no relationship with the buyer.

•Banks normally charge a fee for a bank draft.

Special Considerations

Some banks may not put stop payments on drafts once they're issued. That's because the transaction has already taken place, according to their records. If the purchaser wishes to reverse the transaction, the bank usually requires that they redeem the draft for the full amount. In some cases, it is possible to cancel or replace a lost, stolen, or destroyed draft as long as the customer has the right documentation.

Bank Drafts vs. Money Orders

A bank draft and a money order are both prepaid, with a specified amount printed on the instrument itself. Each is considered a secure method of payment from a third-party institution. The payer does not need to carry large amounts of money when using a bank draft or money order. However, a bank draft is a check drawn on a bank’s funds after accepting the amount from the issuer’s account, whereas cash is used when purchasing a money order.

You can only purchase bank drafts from a bank, while money orders can be purchased from certified stores, post offices, or banks.

Only a bank may issue a bank draft, while an approved institution, such as a certified store, post office, or bank, can issue a money order. Since money orders are often used to launder money, many governments limit how much money can be converted into a money order. Bank draft amounts can be much higher. Due to the limited amounts printed on money orders—and the process banks go through when issuing drafts—money orders cost less than bank drafts. Obtaining a bank draft is more difficult than obtaining a money order because the payer must go to their bank to purchase the draft, rather than using one of the more accessible institutions that sell money orders.

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