The usage of financial bills of exchange as well as any other economic and financial instruments in real business practice involves a great number of components of the internal content of this process, and also conditions and factors that affect it.

As the components of the internal content as well as conditions and factors are closely related, forming the content of the process of using a bill of exchange, it is impossible to anticipate how the change of the characteristics of any component of the process of using a bill of exchange affects the final result, without regard for the mutual relations and interrelations between all components of the process of using a bill of exchange. That’s why the survey of real practice of using bills of exchange must follow after the theoretical study of the structure of the economic mechanism of action and use of a bill of exchange by economic entities.

Let us try to define the essence, the nature and the content of the economic mechanism of bill of exchange transactions of commercial banks.

To achieve the above mentioned aim, we set the following tasks:  

— wording and disclosure of the content of the economic mechanism of bill of exchanges transactions of banks ,

— peculiarities of the effective organization of the economic mechanism of bill of exchange transactions of  banks,

— analysis of conditions and factors for effective organization of the economic mechanism of bill of exchange transactions of banks.

The problem of systemic analysis of all interrelated components of the integral process of the economic use of a bill of exchange was not mentioned in any of the existing studies that touched the question of the interpretation of the economic content and use of a bill of exchange. As we see it, this is primarily caused by the researchers limiting their study to the analysis of individual, though relevant, aspects of the process of using a bill of exchange.

 As in our work we focused on a systemic approach to study of the nature and all aspects of use of a bill of exchange in business practice, we needed to develop and present our own understanding of the content of the economic mechanism of bill of exchange transactions of commercial banks.

In general, the economic mechanism of bill of exchange transactions of commercial bank is a complex of economic relationships, methods of organizational and technological instruments of business activity applied to carry out bill of exchange transactions of commercial banks.

The structure of the economic mechanism of bill of exchange transactions by banks consists of:

  1. Business relationships between the participants of the bill market.
  2. General types and varieties of bill of exchange transactions.
  3. Financial methods of management of bill of exchange transactions.
  4. Financial and economic levers of this transaction organization.
  5. Infrastructure of the financial mechanism of bill of exchange transactions: legal, information, technological and technical.

However, to understand how the structure of the economic mechanism of bill of exchange transactions of banks is formed and developed, we should describe the structure in details.

The detailed structure of the economic mechanism of bill of exchange transactions of commercial banks that helps to analyze in detail the mechanism evolution, stages of development, etc., in our view, consists of:

1. Business relationships between participants of the bill market.

The parties of these relationships are: issuers, investors, qualified agents.  The more detailed list of participants includes: borrowers, endorsers, payees, avalists, guarantors, pledgees, creditors, consultants, organizations serving bill market (depositories, trading sites, settlement organizations, consultancies), state regulation and financial control bodies, and legal regulation and support bodies.

2. General types and varieties of bill of exchange transactions. Bill of exchange transactions of commercial banks depend on many factors, develop along with bill market development and change in participants needs. The previous chapter of this study describes the general types of bill of exchange transactions of banks.

3. Financial methods of management of bill of exchange transactions.

The financial methods of organization of a bill circulation include:

— transaction planning and issue of bills;— analysis of bill of exchange transactions effectiveness and liquidity;

— assessment of bill of exchange transactions cost and yield;

— organization of bill of exchange transactions management;

— monitoring and control over fulfillment of obligations;

— stimulation of potential bill market participants to increase bill circulation and fulfill their obligations properly;

— influence on bill of exchange demand and supply;

— encouragement of competition between sellers and buyers;

— insurance and other methods of risk management.

4. Financial and economic levers of the organization of bill of exchange transactions of commercial banks

— determination of conditions of issue, bill payment as well as discount or interest size;

— endorsements, aval, issue, accept,  non-acceptance, protest, recovery of liabilities on bill of exchange, pledge, circulation, accounting, sale, redemption, payment;

— cession.

5. Infrastructure of the financial mechanism of bill of exchange transactions:

— legal support. The Civil Code and other legislative acts that regulate bill circulation, as well as internal rules for transactions among the professional participants, and regulations for these transactions, existing traditions and norms of behavior among the professionals, regulated by professional associations of the participants;

— information support: Financial press, stock indices, information data bases of banks, consultancies that help to make judgments about the bill market participants, statements release, as well as information collected and accumulated by parties to a bill about their business partners;

 — technological and technical support: Computer and other technical support of bill of exchange transactions, trading sites and other places for retail sales and wholesales of bills of exchange, equipment and the related machines.

The economic mechanism of bill of exchange transactions of commercial banks is divided into mechanism of action and mechanism of use of these transactions.

 Mechanism of action of bill of exchange transactions means all relationships between parties of transactions, as well as instruments and forms of realization of such relationships. The parties of the relationship receive a mechanism of action as it is – this mechanism does not depend on their activity and their specific interests.

Mechanism of use of bill of exchange transactions is included into the system of conscious influences on the existing mechanism components. This system of conscious managerial influences adapts general forms and instruments to individual needs and interests of the participants of the relationship, and to individual circumstances.  

The mechanism of use of bill of exchange transactions, on the one hand, should be built on internal objective links and trends of the mechanism of transaction action development, and, on the other hand, in any individual case it depends on the activity of the participants of the particular relationships, their skills, interests and ability to reach civilized agreement.

As a result of the improvement of the existing mechanism via the most active and competitive participants the newly created improved forms of the relationship under the influence of competition become widely spread and are perceived as given, i.e. become an element of an objective mechanism of action of bill of exchange transactions.  

The structure of the economic mechanism of action and use of bill of exchange transactions of commercial banks can be drawn up as shows Figure 1.

However, for the purpose of deeper study it is worth focusing on some elements of the economic mechanism of use of bill of exchange transactions.

To our view, this detailed structure of use of the economic mechanism of bill of exchange transactions represents a series of the following actions:

1.      identification of the commercial need in bill of exchange transactions;

2.      legal regulation – external (state legal acts) and internal  (rules, regulations, contracts)

3.      transaction planning, including setting of targets, tasks and restrictions according to risk level and applied resources;

4.      preliminary analysis of the alternatives to the planned transactions (for its compliance with established restrictions and current tasks);

5.      analysis of yield, risk, progress in achievement of the set tasks, various alternatives to transactions;

6.      final selection of an alternative;

7.      management of the achievement process of the set tasks in situations that cause deviation of the process flow from the predetermined plan;

8.      post-transaction control;

9.   splitting, transfer, insurance of risks and other methods of risk management

 

 10. receipt of payment on bills (in a general way, through protest of a bill, recovery of debtor liabilities through court proceeding).

Classic scheme of settlements by means of bills of exchange is represented in Figure 3.

 

The arrows in the figure indicate the following actions and events of the participants of settlement transactions by bills of exchange:

1 – execution of the contract for goods delivery (performance of work, services) via settlement of a bill, and delivery of goods;

2 – payment by bill of exchange (bill of exchange amount includes goods price and interests);

3 – settlement of bill;

4 — delivery of goods (performance of work, services);

5 – presentation of a bill of exchange to bank for discount;

6 – settlement of a bill of exchange ;

7 – presentation of a bill of exchange to Central bank for rediscount;

8 – settlement of a bill of exchange ;

9 – application for a redemption of a rediscounted bill;

10 – redemption (settlement) of a bill of exchange ;

11 – application for payment of a bill of exchange (presentation of a bill of exchange );

12 – payment of a bill of exchange (settlement of a bill of exchange ).The primary parties to bill are businesses and banks. The need of commercial units in bill of exchange transactions is quite high, and the economic relevance of the bill market is defined by these estimations – every year by means of bills of exchange trillions of rubles of bank and commercial credits are extended.

Taking into account the fact that commercial banks play their role of creditors of national economy sectors insufficiently, the positive role of a bill of exchange cannot be overstated, despite all its problems.  

There are some problems regarding the legal regulation of bills of exchange transactions. There is no bill discipline, i.e. «strict observance of all requirements – both formal and material – for bill liabilities… when anyone, holding a bill of exchange, is confident that it gives all rights anticipated by such a bill of exchange and that people with liabilities under that bill of exchange will definitely fulfill, and if necessary will be forced by government to fulfill their obligations»[1].

Also strict and quick legal enforcement of a dishonored bill collection is not fully provided. The information on dishonored bills of exchange is not available. Regulation of bill of exchange circulation is complicated as the provisions of the International Bill of Exchange Law, passed in Geneva, is given a priority.

Anyway it is quite possible to reach the following results indirectly, through wide-spread use of reliable commodity and financial bills of exchange (commercial papers) and displacement of fraud and unsecured bills as they are bad and unreliable elements of bill of exchange circulation:

  1. move the industrial lending to a higher level that would be defined according to the client’s ratio of volume, terms and reliability factors.
  2. provide economic security of business entities and people of higher level, supply potential bill acquirer with trustworthy data about the solvency of businesses and banks issuing bills of exchange.
  3. provide services that market participants need.

In our view, we need an effective economic mechanism of influence on bill of exchange circulation and feed-back in the form of trustworthy information about it.   Without it the effective monetary policy becomes more difficult, given that there is in essence a second issuing center in the economy nowadays (spread among the industries and territories), that issues monetary substitutes, and which activities must be restricted and brought under control.

Effective economic mechanism is a mechanism that ensures the best correlation between costs of measures taken to achieve the intended effect and the actually received results (received returns of whatever size, performed set tasks) given the current restricted resources and current conditions.

In order to specify the notion of the effective organization of economic mechanism of bill of exchange transactions of commercial banks, it is necessary to explain the criteria of the effective organization of the economic mechanism of bill transactions management (see this criteria system in Figure 2), aimed at:

— assessment and increase of each transaction effectiveness in terms of expenses/benefits ratio.

— development of system of methods and instruments for carrying out transactions appropriate for specific conditions;

— achieve best correlation between organization targets and tasks system and applied instruments for transaction management;

— maximize the aggregate profit from all transactions per 1 ruble of expenses;

— selection of the most competitive instruments and technologies of carrying out transactions at this stage of bill market development.

Below we will explain the meaning of each criteria from the Figure 5.

  1. Macroeconomic criterion of the effective organization of the economic mechanism of bill transactions by banks. The organization of bill transaction, meeting this criterion, should ensure the best out of all possible variants correlation between economic results and expenses in the context of time and risks taken.
  2. Business criterion of the effective economic mechanism of bill transactions of commercial banks. The economic mechanism, meeting this criterion, is the mechanism where managerial and engineering instruments and methods, and forms of business relationships ideally match each others and also external and internal environment of the organization.
  3. Criterion of the strategically effective organization of the economic mechanism of bill transactions of commercial banks. The mechanism, meeting this criterion, should ensure achievement of organization targets of the fist priority.
  4. Operating criterion of the effective organization of the economic mechanism of bill transactions of commercial banks. The mechanism, meeting this criterion, should ensure best resolution of each economic problem in the context of best expenses/benefits ratio.
  5. Historical and genetic criterion. The economic mechanism of bill transactions went through a long process of evolution and selection of individual, most effective instruments, applied by different economic entities due to high competition between them.

That’s why in the context of historical and genetic criterion the effective mechanism of bills of exchange transactions is the mechanism where its elements, links, managerial and engineering instruments represent the most competitive mechanism components, selected in the course of historic development of commercial transactions with bills of exchanges. Selection of separate mechanism components according to the historical and genetic criterion guarantees competitive benefits to an economic entity applying these instruments in its business practice.

 In order the identify social and economic conditions necessary for the effective organization of bill of exchange circulation, we should examine each criterion of effective organization of bill of exchange circulation and try to define the specific conditions necessary for realization of this criterion in the context of modern economic theory and real experience of countries with effective organization of bill of exchange circulation.

Realization of the first criterion implies reduction of expenses on bills of exchange transaction performance, creation of conditions for bill of exchange circulation improvement, stimulation of participants to raise profits.

To achieve this, the organization of effective and diverse wholesale of bills of exchange added by short-term encouragement of competition between participants is necessary. Also it is worth developing bill of exchange legislation and creating data bases necessary for all parties to a bill. In the middle-to-long-term high effectiveness of the transactions is ensured by proper protection of rights and interests of the parties to a bill. The legislation must be arranged so, that there would be no loopholes for rogues – it must react to any needs of the bill market in a regular and flexible way. 

For realization of the second criterion the mechanism of bill of exchange transactions must be quite sophisticated and must include many alternatives, schemes and technologies of transaction to solve individual problems. In this case the parties to a bill would get an opportunity to choose, and this would enable to solve set problems in the best way. It should be noted, that technologies of bill of exchange transactions applied in Russia not always may be effective for the set targets.

For realization of the third criterion it is necessary to develop quite different instruments and technologies of bill of exchange transactions, which in aggregate may help organizations to manage their profits, risks and liquidity effectively and sufficiently.

For realization of the forth criterion it is necessary to manage bill of exchange transactions on the following levels:

— control over current operating expenses,

— flexible interest policy for bills of exchange,

— reduction of the costs of bill recovery to a minimum,

— effective organization of the information support of the economic circulation with bills of exchange, i.e. monitoring of the economic and financial position and fair behavior of the parties to bill.

Realization of the fifth criterion suggests that in the process of bill of exchange circulation evolution the natural selection of the best technologies and mechanisms of commercial bill of exchange transactions takes place. That’s why in the selection of the specific technologies and instruments of bill of exchange transactions each business has to take into account the newly appearing trends in the market that signal about the most prospective and effective ways of bill circulation organization for the solution of set problems. Note, that each country has its own historic, culture and social characteristics, which should be taken into consideration when forming the legal base of bill of exchange transactions.

Note, that when developing the economic mechanism of bill of exchange transactions it is necessary to take into consideration the importance and the features of effective and proper protection of the property rights of all market participants. In order that all bill market participants will be proper motivated to carry out transactions and perform their economic functions on a high level, as well as in order that the decisions about resources distribution and use made by them as much as possible comply with the benefits of the society, it is important that negative and positive external effects of the transactions won’t transfer to the third parties.  

In this context let’s think about the possibility to apply Coase theorem to the public organization of bill of exchange circulation.

The Coase theorem is about the problem of “external” effects. This is the name for any side effects of any activity that influences not an individual, but third parties. According to his theorem, in a certain conditions a market (including the bill market) is able to deal with the external effects on its own, so that the possible deviations of optimal allocation of resources will be temporary.

The Coase theorem says: “If the property rights are clearly defined, and the transaction expenses are zero, then the allocation of resources (structure of production) will be unchanged irrespective of changes in property rights distribution, if we put aside the profit effect”.

The theorem works in two conditions: precise statement of the property rights and zero transaction expenses, namely costs of information seeking, negotiations, contract execution, their legal protection, etc.

The resources should be distributed in sectors where they ensure the maximum feed-back. Anyway, the property rights pass to that party for which they are mostly valuable. When there is a legal opportunity to effect a transaction, all external effects will be interiorized regardless to how the rights are distributed among the parties. “If all the rights were clearly defined and assigned, if transaction expenses were zero and if people agreed to strictly conform with the results of voluntary exchange,  there would be no external effects”.

Voluntary negotiations about a transaction may eliminate all differences between individual and public expenses/benefits ratios.  So, the government has no grounds to intervene with the intention to adjust market process.  Its role can be called as “pre-market” – it’s task is to specify and protect property rights of the parties.

You should remember the problems of technological, information, and legal development of bill market infrastructure.

Absence of the conventional technology of transaction execution, according to Zagalova Z.A.[2], is related to the absence of the unified procedure of issue and payment of bills, authentication, completed circulation of documents and settlement procedure of the secondary market transactions.

Our view coincides with that of Ms Zagalova Z.A. Indeed, it is a widely spread situation when the set of documents necessary for payment of a bill of one drawer differ from the documents of the other, and thus the order changes. The transactions are executed on mutual agreement between the parties. And the things that matter most are the positions of the parties in the market in terms of their reliability and reputation. The procedure depends on the agreements between the parties. Besides, the inside bank instructions on bill of exchange transaction technology significantly differ between the banks, as each bank develops its own operating policy that reflects its position in the market, main areas of business, risk sentiment, etc.

The market informational closeness, in our opinion, is caused by the information inaccessibility and inefficacy in terms of the current bills of exchange in circulation, facts of loss or theft, as well as by unavailability of information about dishonored bills to many market participants.

Further it should be noted that the development of bill of exchange circulation raised the problem of creating the infrastructure for quoting (collection, structuring of the information and arranging of a bill quote listing in one format), transportation and collection of bills, coordination of the market participants’ actions. This led to the imbalance between primarily and secondary bill market in the Russian economy. It was reflected in a noticeable predominance of the secondary stock market institutions, agents in payment instrument flow– banks, financial companies, firms, operators in the bill market.  The participants of the primary commodity market, first of all manufacturing companies, turned out to be less disciplined.  We reckon that the problem is strengthened by the following factors:

— long distances;

— large scale of the bill market;

— large number of agents;

— complex relationships between regions.

That’s why it is necessary to form a single information space, uniform rules for execution of bill of exchange transactions and government control, and create bill of exchange service centers for corporate debts.

According to Lvov O.M.[3] and Gudkov F.[4], approaches to solve the problems of recovery of bills of exchange need to be seriously revised. It is necessary to entrench an appropriate legal mechanism in the legislation, establish a special organization to accept dishonored bills and exercise legal rights of the bill holders, determine the content of the recourse actions, set alerts about protests and economic boycott for people who cause the protests to a bill, guarantee that sanctions for failure to pay a bill will come into force. Our view coincides with that of the authors.

Another important factor of the effective organization of bill of exchange transactions of commercial banks is the policy of the Central Bank of Russia on refinancing interest rate, currency exchange rate and public debt.

At the moment banks execute the following most popular transactions with bills of exchange:

— discount of bills of exchange;

— lending secured on bills of exchange;

— bill avalization;

— collection of bills.

Let’s look at the conditions and factors of the effective organization of bill of exchange transactions of commercial banks.

According to Feldman A.A. and Voronina D.V., the main conditions that help the above mentioned transactions to spread are:

— development of the bill market in Russia;

— high yield of the transaction;

— effective mechanisms of risk reduction.

Our view completely coincides with that of the authors.

In our view, a bank may use the following tools for the risk reduction in some bill of exchange transactions:

— extend credit of payments via bill discounting only for its own clients, which financial position is well-known, and only on the condition of collateral;

— extend settlement credit via bill discounting, when commercial bills, namely bills of exchange secured by goods, have to be bought in the first place;

— it is possible to discount bills of exchange issued to clients together with acceptance credits;

— do not discount «friendly» bills of exchange that are used by a drawer to receive a credit from a third party;

— bills of exchange cannot be discounted in the absence of the certain information about the parties;

— it is necessary to find out the origin of the bills of exchange and the authenticity of the signatures, as this helps to avoid discounting of «bronze» bills;

— reduce the term of the credit. In average the credit is given for the term from 10 to 90 days;

Let us outline the main factors of development and effective organization of bill of exchange transaction by commercial banks:

— development of bill of exchange circulation in regions;

— strengthening of the parties confidence in bills of exchange as a means of commercial credit collateral, what helped to change the scheme of bill of exchange circulation;

— depreciation of the transactions where the bank interests are taken into consideration.

So, let us define the main conditions and factors of development of bill of exchange transactions by commercial banks in the bill market.

To date the main conditions that hamper the development of the bill market are:

— regional closeness of bill of exchange settlements;

— low liquidity of bills of exchange outside the region boundaries;

— low level of control of the bill market from the government and other authorities, as well as not always clear and accurate legal base;

— absence of the information base for the assessment of bill of exchange reliability.

Look at the most attractive market segments according to preferences, focusing on the most interesting and perspective sectors.

With the current level of interest rates in the bill market fund raising looks attractive. However, you shouldn’t forget about the potential risks.

Also it is interesting to note the opportunity to develop the bill of exchange program of banks without entering into the open bill market. Issue of bills as a settlement instrument for the clients is also a very interesting area of commercial bank business. It is proved by the following statements:

— first, the bank offers its clients comfortable settlement system;

— second, with bank bills of exchange the clients can receive interest (discount) income and do not freeze their funds;

— and, third, the clients’ funds do not leave the correspondent account.

When issuing bills (as well as bonds, deposit certificates and other similar instruments) into the external market the bank develops the image of stable, reliable and progressive partner. And here applies a well-known saying: “First the Bank works for image, then the image works for the Bank!”

It should be noted that investment in bills of exchange (as in any other debt instrument) is an alternative to lending. But as mentioned above, bills of exchange are more liquid assets than loans. And bank, in our view, is interested in investing funds into a more liquid asset even at the expense of yield. We think that the bill/credit portfolio ratio will be about 40 to 60% depending on the market conditions.

To date we have fairly low level of interest rates on debt instruments in rubles that hardly offset the inflation rate.   One of the ways to boost commercial bank profits can be buying of instruments that are not widely known to the market, and also reasonable diversification of debt portfolios towards bigger portion of high-yielding instruments. For example, bills of exchange of not well promoted issuers.

The next way for the commercial banks to gain is to buy bills of exchanges of companies just joining the market and hence not having enough liquidity. Such a constraining factor for investors leads to the increase of such bill rates above market average. Note that the financial position of many of these companies is stable, so buying of their debt does not involve any risks, and it can well be included into the investment portfolio for redemption.Indeed, the credit and corporate risk on investments increases, but if the investment was weighted, then the yield premium may well offset the potential risk. Also it should be noted, that work in the bill market need to involve minimum material costs to support bank activities in the market.

Let us sum up. Commercial banks are now one of the most active institutions in the bill market. They act both as issuers and investors, and also as agents providing its customers with a wide range of services from underwriting to bill depositing.

The bill market, being disorganized and chaotic for quite a long time, now seems to show clears signs of improvement. Many commercial banks along with stock companies merge into associations. One of the examples is AUVER (Association of bill market participants) that adopts uniform standards for information disclosure, issue, payment and circulation of bills of exchange, which are obligatory for the participants. These standards fully comply with the legislation.

An active position also take Russian National Association of securities market participants (NAUFOR) and RTS that have collectively organized and are now developing a new bill of exchange trade floor “National Quoting System (NKS)”. NKS along with long existing bill of exchange system RVS not only provides “transparency” of the bill market, but also makes it more organized. As a result the access of counterfeit bills of exchange to the market was limited, and “norms of honour” were established in the bill market.

For example, REGION Company does an interesting and necessary work. It tries not only to carry out transactions with liquid bills of exchange with good reputation, but also “promote” and support new drawers in the market.

It is particularly important when new and interesting bill of exchange programs appear in large numbers.

We think that the system of bill avalization by banks will continue to develop, which, in turn, will give rise to factoring transactions, and banks will receive additional profits on the back of thorough inspection of the transaction security, or pledge of tangibles and property. It requires a legal base regulating bank potential to sale pledges.

So, we think that commercial bank work in the bill market can be divided into three main areas: issuance of own bills of exchange in order to receive extra borrowings, allocation of own funds, and customer service and intermediately activity.

The “pro” argument for this classification is the fact that all types of the above mentioned activity play an important role for banks and represent a sufficient measure of specification of activities in the bill market. 

By issuing its own bills of exchange a bank seeks not only to raise extra funds, but also to expand customer base and strengthen its own reputation; investments in sufficiently reliable bills of exchange ensure higher yield than that of the alternative sources of the same level of reliability.  Customer service not only brings profit, but also strengthens client-to-bank relationships. 


[1] Banking. Edited by F.K. Radetsky – Fin. publisher NKF USSR. M.: 1928. 
[2] Zagalova Z.A. Modern bill markets: Foreign and Russian practice.  — Vladikavkaz: NOSU, 2000.
[3] Lvov O.M. Bill of exchange as a means of payment and credit, and its practical application. -SPb.: Piter, 2002.
[4] Gudkov F. A “bomb” under the bill market//Economy and life, №5, 2000.