Bank Draft

What Is a Bank Draft?

A bank draft is a payment instrument issued by a bank. The purchaser pays the bank the amount of the draft, plus any fee, and the bank then issues a draft payable to a named recipient. Because the bank itself is the party making the payment, the recipient relies on the bank's credit rather than on the purchaser's personal account balance. Bank drafts are often used when a payee wants more assurance than a personal check provides.

How a Bank Draft Works

The process usually follows a few steps:

• The purchaser pays the bank the face amount and any service fee, either in cash or from an account.
• The bank issues the draft and gives it to the purchaser, who passes it to the recipient.
• The recipient deposits the draft or presents it for payment.
• The bank verifies the draft and pays the funds, typically through its own banking relationships.

Because the funds are set aside before the draft is issued, the purchaser's account balance at the time of payment generally does not matter to the recipient.

Advantages and Disadvantages

Bank drafts can offer several benefits. The payee has a stronger guarantee of payment than with a personal check, and the transaction is often used for large or time-sensitive payments, such as some real estate closings. Some institutions also set limits on the amount they will issue.

There are also drawbacks. Issuing a draft usually costs a fee. Once the draft is issued, stopping payment is typically difficult and may not be possible, so the purchaser may have limited recourse if the transaction goes wrong. Counterfeit bank drafts are a known fraud risk, so recipients often verify a draft directly with the issuing bank, using a phone number obtained independently rather than one printed on the draft itself.

Why It Matters to Investors

Bank drafts are sometimes used in investing and property transactions, such as paying for securities purchases, earnest money, or fees where a payee requires a guaranteed form of payment. Understanding how a bank draft differs from a personal check helps investors recognize when a counterparty is asking for a more secure form of payment and what protections that form does and does not provide.