Demand drafts
The payment instrument mutual funds accept and reimburse up to the limit stated in the offer document, for investors in locations with no branch or Investor Service Centre nearby.
In plain language
Not every investor lives near a branch or an Investor Service Centre. For those locations, mutual funds fall back on a payment instrument the banking system already makes universal: the demand draft (DD).
A DD is drawn on a bank rather than on the investor's own account, so it removes the geography problem a cheque has — a DD payable at the fund's nearest office is honoured just like a local cheque there, wherever it was purchased.
How it works
The workbook's rule is narrow and specific: where a mutual fund is unable to provide a branch or an Investor Service Centre (ISC), it accepts demand drafts and bears the charges up to the amount specified in the offer document (SAI). Beyond that limit, the cost is the investor's own.
A DD used for a mutual fund purchase has to be payable on a bank in the clearing area of the nearest ISC or mutual fund branch — not just any bank, anywhere. Once received, it is sent by the collecting bank for local clearing, exactly like a local cheque, because a DD does not carry the outstation-cheque problem of two clearing houses and slow realisation.
A worked example
Mr Thoiba lives in a small town with no ISC or AMC branch nearby, some distance from the nearest one. He wants to invest Rs 1,00,000 in a debt scheme.
He buys a demand draft for Rs 1,00,000, payable on a bank in the nearest ISC's clearing area, and sends it with his application form. Say the SAI caps DD-charge reimbursement at Rs 100 per application; his bank charged him Rs 60 for the draft, so the AMC reimburses the full Rs 60.
Had his bank charged Rs 150 instead, only Rs 100 would come back to him — the SAI limit, not the actual cost, decides how much the fund bears. Compare this to an outstation cheque for the same Rs 1,00,000: the workbook says mutual funds simply do not accept it, because it would sit through two clearing houses before the money is realised, delaying the applicable NAV.
Why NISM asks about it
Chapter 13 (Banking Operations in Mutual Funds), section 13.1.2, introduces the demand draft immediately after third-party cheques, as the fund's answer to locations without a branch or ISC. Expect a question contrasting a DD (accepted, with a capped reimbursement) against an outstation cheque (not accepted at all).
Common exam traps
- The AMC bears DD charges only up to the SAI limit — not the full charge, whatever the investor's bank actually billed.
- A DD must be payable at the nearest ISC or mutual fund branch's clearing area, not necessarily the investor's own city.
- An outstation cheque is not accepted at all; a DD is the fund's substitute for exactly that gap.
- Demand drafts still go through the same registrar checks as any payment instrument — the scheme name, the amount in words and figures, and the signature all have to be in order.
Check yourself
1.Which of the following payment modes is accepted for investing in a mutual fund?
- a)Cash, demand draft and bank transfer — all of these options
- b)Cash only
- c)Demand Draft only
- d)Bank Transfer only
Show the answer
Answer: (a) Cash, demand draft and bank transfer — all of these options
The acceptable modes of payments are through online transactions or different payment mechanisms such as cheque, demand draft and cash.
All three named modes appear, so no single one of options B, C and D can be right.
The four forms in full: Electronic / Online mode · Physical cheque mode · Cash Payments with limitations · E-Wallets with limitations.
Note "with limitations" against two of them.
Cash is permitted but capped: investors have the option of investing in mutual funds through cash, to the extent of Rs. 50,000 per investor per mutual fund per financial year. Only resident individuals, sole proprietorships and minors (through their guardians), who are KYC compliant, can make cash investments.
And beyond the cap it is refused: mutual funds do not accept cash (beyond the specified limits), money orders or out-station cheques.
Demand drafts have their own condition. They are accepted in cases where mutual funds are unable to reach investors in certain locations and are unable to provide for a branch or Investor Service Centres (ISC), the fund bearing charges upto the amount as may be specified in SAI, and the draft being payable on any bank in the nearest ISC or mutual fund branch's clearing area.
Bank transfers are the mainstream route, including NEFT, RTGS, Auto Debit and Standing Instructions, ASBA and digital modes — Net Banking, Debit cards, Unified Payment Interface (UPI) are amongst the accepted modes of payments for mutual fund schemes currently.
The general requirement over all of them: payments for mutual fund transactions need to be made through the banking channel modes that have been approved by the regulators.
2.Which instrument is NOT valid for direct mutual fund subscription?
- a)Outstation cheque
- b)Demand draft
- c)Electronic bank transfer
- d)NEFT
Show the answer
Answer: (a) Outstation cheque
Outstation Cheque: If the paying bank account is located in another city, the cheque will have to go through two clearing houses at two different locations. These are not accepted now as it impacts the NAV applicability as realization takes time.
And the point is repeated among the outright refusals: mutual funds do not accept cash (beyond the specified limits), money orders or out-station cheques.
Why NAV applicability is the reason. Units are allotted at a NAV determined by when valid funds are available; an instrument that takes days to realise makes that determination impossible without prejudicing either the investor or the scheme.
Option B is accepted, with conditions. In cases where mutual funds are unable to reach investors in certain locations and are unable to provide for a branch or Investor Service Centres (ISC), they accept Demand Drafts (DDs) and also bear the charges upto the amount as may be specified in SAI. Demand drafts have to be payable on any bank in the nearest ISC or mutual fund branch's clearing area. It is sent by the collection bank for local clearing.
A draft is pre-funded and locally clearable — the opposite of an outstation cheque.
Options C and D are both mainstream electronic routes. NEFT is a nation-wide payment system... available on 24/7 basis on all days of the year, and electronic payment generally is a mode where the clearing process need not be initiated by the mutual fund.
The two cheque types that remain valid: Transfer Cheque, where the investor holds accounts in the same bank as that of the mutual fund, and Local Cheque, where the account is with another bank but in the same city.
Though the distinction has faded in practice. At par implies that the instrument is as good as drawn on any other branch of the same bank... In modern banking, there is no practical difference between a local cheque and outstation cheque, and under CTS physical cheques do not move between locations for clearing.
Where this is taught
Free preparation for NISM Series II-BRelated terms
- Cheque Truncation SystemAn RBI system, started in 2010, in which the physical cheque stops at the presenting bank and an electronic image travels to the drawee bank for payment, cutting clearing time, transit cost and delay.
- NIGOA transaction the registrar has flagged as "Not in Good Order" because the application and the money do not reconcile or the paperwork is defective — units are not issued until it is fixed.
- Official Point of AcceptanceA location a mutual fund has formally designated to receive transaction requests, where the application is time-stamped — and that stamp, not the moment the investor handed the form over, decides which NAV applies.
- Third-party chequeA payment for a mutual fund investment drawn from a bank account of which the first holder is not an account holder — not acceptable, and the reason registrars run third-party verification on every subscription.