What it means
The mechanics are straightforward. You pay your bank the face value plus a fee, the bank issues a paper or electronic instrument naming the payee, and the payee presents it at their own bank for collection.
The attraction is credit certainty. Because the funds have already left the payer's account and sit with the issuing bank, the payee is relying on a bank's promise rather than on a customer's, which matters when two parties have never traded together before.
Businesses meet demand drafts most often in formal settings: government tenders that require a deposit, import payments in markets where electronic coverage is patchy, and situations where a supplier refuses to ship against an ordinary cheque. In several countries a draft is still the default way to prove that money is genuinely committed.
Cost is the drawback. Issuing commission is normally a small percentage of face value subject to a minimum, with courier, correspondent bank and sometimes stamp charges on top, which makes a draft dearer than a same-day electronic transfer for routine payments.
Cancellation is the nuance that catches people out. A draft is not simply reversible, and recovering the money usually means surrendering the original instrument or providing an indemnity, which can take weeks and attract a further fee.
In practice
Real-world examples.
Example
An engineering firm bidding on a municipal water treatment contract must lodge a $25,000 tender deposit. The council will only accept a bank draft, because it wants proof that the money exists before the bid is even opened.
Example
A furniture importer pays a new overseas supplier with a demand draft for the first three shipments. Once a trading history is built and the supplier grants 30-day credit terms, the importer switches to cheaper electronic transfers.
Example
An auction house requires a demand draft from the winning bidder on a $140,000 lot. The auctioneer will not release the item against a personal cheque, because clearing time and the risk of a stopped payment are both unacceptable.
Formula
Calculation
Total cost to the payer = face value + issuing commission + handling and courier charges, where commission is a percentage of face value subject to a stated minimum.
An importer needs to send $60,000 to an overseas machinery supplier. The bank charges 0.15% commission with a $25 minimum, a $35 courier fee and $15 of handling.
Commission: 60,000 x 0.0015 = $90, which is above the $25 minimum, so $90 applies.
Total charges: 90 + 35 + 15 = $140.
Total debited from the importer: 60,000 + 140 = $60,140.
Cost as a share of the payment: 140 / 60,000 = 0.23%, which is cheap on a single large payment but expensive if repeated on many small ones.
To see why, imagine the same $60,000 sent as twelve payments of $5,000. Commission on each would be 5,000 x 0.0015 = $7.50, below the $25 minimum, so $25 applies, and total charges become 12 x (25 + 35 + 15) = $900, or 1.5% of the value moved.Case study
Seen in the real world.
Verano Textiles is a fictional mid-sized fabric importer created to illustrate how draft costs accumulate. The company issued around 40 demand drafts a year, averaging $45,000 each, because that was how its founder had always paid overseas mills.
A finance manager priced the habit. Commission ran at 45,000 x 0.0015 = $67.50 per draft, and fixed courier and handling charges added roughly $50, so each draft cost about $117.50 and the annual bill came to 117.5 x 40 = $4,700. An electronic transfer through the same bank cost a flat $32, or 32 x 40 = $1,280 a year.
Verano kept drafts for two new suppliers who insisted on them and moved the rest of its payments to electronic transfer, saving $3,420 a year and cutting three days off the average settlement time. The saving was modest in absolute terms, but the faster settlement earned better pricing from two mills that valued prompt payment.
Watch out
Common mistakes.
- Believing a demand draft can be stopped like a cheque, when the funds have already been taken and cancellation needs the original instrument or an indemnity.
- Ignoring correspondent bank charges, which can be deducted from the amount the payee finally receives and cause a shortfall on the invoice.
- Using drafts for small routine payments, where the fixed courier and handling fees swamp the value of the payment.
Questions
People also ask.
Is a demand draft the same as a cashier's cheque?
They are close cousins, since both are drawn by a bank against prepaid funds, and the exact naming depends on the country and the banking system.
Can a demand draft bounce?
Not for lack of customer funds, though it can be refused if it is altered, expired, incorrectly endorsed or reported lost.
How long is a demand draft valid?
Validity is set by local banking rules and is commonly three to six months, after which the payee must ask the issuing bank to revalidate or reissue it.
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