Vinu: Hey Manu, I’ve been hearing about bill purchase and bill discounting a lot lately, but I’m still not sure what the difference is. Can you explain?

Manu: Sure, Vinu! Let's break it down. Bill discounting is when you, as a seller, provide goods to a buyer and issue an invoice or bill. The buyer agrees to pay in, say, 60 days, but you need the money now. So, you go to the bank with the bill, and the bank gives you the money immediately after charging a fee or a discount. The bank will collect the full amount from the buyer once the bill matures.

Vinu: So in bill discounting, I get the cash early, but the bank charges a fee for it. What happens if the buyer doesn't pay the bank?

Manu: Good question! In bill discounting, if the buyer defaults, you—the seller—are still responsible for the payment. The bank has the right to come back to you to recover the amount. This is called with recourse, which means the risk isn't fully transferred to the bank.

Vinu: Got it. So what about bill purchase? How is that different?

Manu: Bill purchase is used mostly in international transactions, though it can happen domestically too. In this case, the bank purchases the bill from you. This usually involves higher risk, especially when dealing with foreign buyers. The bank assumes more responsibility for collecting the money from the buyer. Unlike bill discounting, here the bank could take on the collection risk.

Vinu: So, in bill purchase, the bank buys the bill, pays me, and handles collecting from the buyer?

Manu: Exactly. But banks don’t just take on that risk lightly—they protect themselves in several ways. For example, they’ll assess the buyer’s creditworthiness. They’ll also ask for things like a Letter of Credit (LC) from the buyer’s bank, which guarantees payment. And sometimes, they’ll purchase the bill with recourse too, meaning you’d still be liable if the buyer doesn’t pay.

Vinu: So in both cases, the bank is giving me the money upfront, but with different levels of risk involved?

Manu: Right. In bill discounting, you get the money early but are still responsible if the buyer doesn’t pay. In bill purchase, the bank takes on more of the risk but compensates by charging higher fees or using protections like insurance or letters of credit.

Vinu: But why would a bank even go for bill purchase if it's riskier?

Manu: Well, because there’s potential for higher earnings. The bank can charge higher fees for taking on that extra risk. They also spread their risk by buying bills from many sellers and buyers across industries. Plus, they might have insurance, and they keep a margin by not advancing the full value of the bill. For example, they might only advance 80% of the bill amount, holding the rest until the buyer pays.

Vinu: That makes sense! But in case the buyer defaults, how else can the bank protect itself?

Manu: The bank has multiple safeguards. Besides credit checks and letters of credit, they may take out export credit insurance for international deals. This covers them if the buyer can’t pay due to reasons like political instability or insolvency. They also have legal teams to chase payments if needed. In short, they minimize the risk through due diligence, proper margins, and collection expertise.

Vinu: So, in summary, bill discounting is lower risk for the bank because I’m still responsible, and bill purchase is higher risk, but the bank charges more and uses tools like letters of credit and insurance to protect itself?

Manu: Exactly! You've got it, Vinu. Each method serves a different purpose, depending on the situation and the level of risk the bank is willing to take.

Vinu: Thanks for explaining, Manu! Now it’s all clear.

Manu: Anytime, Vinu! Happy to help.