Legal Definitions - rediscount

Rediscount refers to a financial transaction where a negotiable instrument, such as a promissory note or a bill of exchange, is discounted for a second time.

When a financial institution (like a commercial bank) initially purchases a future payment obligation from a client at a reduced price (this is the first "discount"), it might later need to convert that obligation into immediate cash itself. The act of selling that already discounted instrument to another, usually larger, financial institution (often a central bank) at a further reduced price is called a rediscount. It also refers to the instrument itself after it has been discounted a second time. This process allows the initial financial institution to obtain liquidity or manage its financial position.

• Example 1: Commercial Bank Managing Liquidity

  A small regional bank has provided numerous loans to local businesses, receiving promissory notes that promise repayment in six months. The bank initially bought these notes from the businesses at a discounted rate to provide them with immediate funds. Unexpectedly, the regional bank experiences a sudden increase in customer withdrawals and needs immediate cash to maintain its required reserves.

  To quickly obtain funds, the regional bank takes these promissory notes, which it had already discounted once, and sells them to the country's central bank (e.g., the Federal Reserve in the United States) at a further discounted rate. This transaction, where the central bank buys the already discounted notes from the regional bank, is a rediscount. It provides the regional bank with the immediate liquidity it needs.

• Example 2: Finance Company Freeing Up Capital

  A specialized finance company provides short-term working capital to small businesses by purchasing their future invoices or promissory notes at a discount. The finance company has accumulated a large portfolio of these discounted notes and wants to free up capital to fund new clients without waiting for the notes to mature.

  The finance company approaches a larger commercial bank and sells a portion of its portfolio of these already discounted promissory notes. The commercial bank buys them at an even deeper discount than the finance company initially applied. This transaction is a rediscount because the notes are being discounted for a second time, allowing the finance company to quickly access capital for new lending opportunities.

• Example 3: International Trade Financing

  An exporter in Canada sells a large shipment of goods to an importer in France. The French importer provides a bill of exchange, promising to pay the full amount to the Canadian exporter in 90 days. To get immediate cash, the Canadian exporter sells this bill of exchange to their local Canadian bank at a discounted rate.

  The Canadian bank now holds the bill of exchange. If the Canadian bank needs to manage its foreign currency exposure or its overall liquidity, it might then sell this bill of exchange to the Bank of Canada (Canada's central bank) or a larger international bank, again at a further discount. This second discounting of the bill of exchange by the Canadian bank is a rediscount, providing the bank with immediate Canadian dollars or other desired currency.