What Is a Bill of Exchange?

A bill of exchange is a written order from one party instructing another to pay a fixed sum, either at sight (on presentation) or after a set period. In UK law, the Bills of Exchange Act 1882 defines it as an unconditional order in writing, addressed by one person to another, requiring the addressee to pay on demand or at a fixed or determinable future time a sum certain in money to a specified person or to bearer.

Three parties are named in the instrument: the drawer, who writes and issues the order; the drawee, who is instructed to pay and who becomes liable once they accept the bill; and the payee, who receives the money. In a typical trade transaction, the exporter is the drawer, and the drawee is the importer or, where a letter of credit is used, the importer’s bank. The payee is usually the exporter, or the exporter’s own bank if the bill has been endorsed over to it.

A sight bill is payable as soon as it is presented to the drawee. A term bill is payable after a period agreed between the parties, usually between 30 and 180 days after sight or after shipment of the goods.

Once the drawee accepts a bill of exchange, it becomes a binding obligation on the drawee, and the bill can be transferred to a third party as an asset to be collected. In this respect, a bill of exchange is similar to a postdated cheque: it can be sold or used as security for finance before it falls due, but it is only as good as the payer’s ability to pay.

How a Bill of Exchange Works: A Worked Example

A UK exporter sells £50,000 of machinery to a buyer in Brazil, with payment arranged under a letter of credit. The exporter draws a bill of exchange on the buyer’s bank for £50,000, payable 90 days after the bank accepts it. Once the bill is accepted, the exporter can either hold it and receive the full £50,000 when it falls due, or discount it, selling it to its own bank for slightly less than face value. Discounting lets the exporter turn a future payment into cash today, instead of waiting for the full credit period to expire. At a discount rate of 5% a year, the bank would pay approximately £49,380.

Origins of the Bill of Exchange in Medieval Italy

The bill of exchange began as exchange contracts between merchant-bankers in Genoa and Florence in the 12th century, but it did not take its mature form until the late 13th and early 14th centuries. Spreading through the Champagne fairs and later banking centres such as Bruges, it gave merchants a way to trade internationally with partners they had no prior relationship with, and who often operated under different laws and trading customs.

Before bills of exchange, merchants settling accounts across borders had to ship precious metals (gold and silver coins) between them. This had several drawbacks: it was slow, it was expensive, and it was risky, as coins could be lost or damaged in transit and ships could sink. There was no organised foreign exchange market to standardise conversion, and each country’s currency had its own value.

All of these drawbacks added to the transaction costs of trading. Transaction costs are the costs incurred in the process of exchange itself, separate from the price of the goods being traded.

The bill of exchange removed the need to transport currency to settle transactions. However, to trade successfully across borders, merchants also needed an enforceable promise that the seller would be paid, and a way of judging whether a stranger was creditworthy.

The bill of exchange provided a legally enforceable obligation. Once the drawee accepted the bill, they were obliged to pay whoever presented it at maturity, and the drawer was liable if the drawee failed to pay. As well as reducing transaction costs, the bill of exchange addressed the problem of information asymmetry: a merchant in one city could not easily tell whether a merchant in another was a good credit risk. Reputable merchant banks with correspondent relationships in other cities solved this by assessing creditworthiness on their customers’ behalf.

Bills of Exchange in Modern Trade Finance

Today, exporters still use bills of exchange, often called drafts, presenting them to their bank alongside the shipping documents under a letter of credit or a documentary collection.

The principle of being paid by bill of exchange when goods are shipped is the same today as it was 800 years ago. However, globalisation and technology have made trade finance less of an obstacle to doing business internationally. Lower transaction costs in trade finance have reduced the friction that limits trade openness, allowing firms to exploit their comparative advantage across many more markets.

Even so, the shortfall in trade finance remains large. World merchandise trade was worth $24 trillion in 2023, according to the World Trade Organization (WTO), and rose by a further 2% in value in 2024. The Asian Development Bank’s (ADB) 2025 Global Trade Finance Gap Survey estimates unmet demand for trade finance at $2.5 trillion, unchanged from the 2023 survey but well above the $1.7 trillion gap estimated for 2020.

Banks usually charge LC fees as a percentage of the amount guaranteed, typically around 0.75%, with advising and confirmation fees on top. Smaller exporters find trade finance harder to obtain, both because these fees weigh more heavily on them and because they lack the credit histories and collateral that larger exporters use to secure lower rates.

The bill of exchange was the original medieval solution to the problem of transaction costs. The instrument has evolved since then, but a $2.5 trillion trade finance gap between willing buyers and sellers still exists. The modern draft, today’s form of the bill of exchange, remains one of the tools used to bridge it.