What Is a Banker’s Acceptance (BA)?
Banker’s acceptance (BA) is a negotiable piece of paper that functions like a post-dated check. A bank, rather than an account holder, guarantees the payment. Banker’s acceptances (also known as bills of exchange) are used by companies as a relatively safe form of payment for large transactions. BAs can also be short-term debt instruments, similar to U.S. Treasury bills, that trade at a discount to face value in the money markets.1
- The banker’s acceptance is a form of payment that is guaranteed by a bank rather than an individual account holder.
- The bank guarantees payment at a later time.
- BAs are most frequently used in international trade to finalize transactions with relatively little risk to either party.
- Banker’s acceptances are traded at a discount in the secondary money markets.
- Thus, unlike a post-dated check, BAs can be investments that are traded, generally at a discounted price (similar to Treasury bills).
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Understanding Banker’s Acceptance
For the company that issues it, a banker’s acceptance is a way to pay for a purchase without borrowing to do so. For the company that receives it, the bill is a guaranteed form of payment. A banker’s acceptance requires the bank to pay the holder a set amount of money on a set date.
BAs are most commonly issued 90 days before the date of maturity but can mature at any later date from one to 180 days. They are typically issued in multiples of $100,000.
BAs are issued at a discount to their face value. Thus, like a bond, they earn a return. They also can be traded like bonds in the secondary money market. There is no penalty for cashing them in early, except for the lost interest that would have been earned had they been held until their maturity dates.
History of Banker’s Acceptance
Banker’s acceptances have been around since the 12th century. Just like now, BAs were used as a method of facilitating trade. In the 18th and 19th centuries, BAs started to become an actively traded market in London.
The U.S. launched the Federal Reserve in the early 1900s to help create banker’s acceptances that compete with London’s. The Fed’s goal was to boost U.S. trade and it was given the authority to purchase certain BAs. While the Fed still buys government bonds, it no longer buys BAs.
If you are looking to obtain a BA, go to a bank that you have a good working relationship with. (Note that not all banks offer BAs.)
Banker’s Acceptance as Checks
Banker’s acceptances, like certified checks, are a relatively safe form of payment for both sides of a transaction. The money owed is guaranteed to be paid on the date specified on the bill.
The use of BAs is most common in international trade transactions. A buyer with an importing business can issue a banker’s acceptance with a date after a shipment is due to be delivered, and the seller with an exporting business will have the payment instrument in hand before finalizing the shipment.
The person who is paid with a banker’s acceptance may hold onto it until its maturity date in order to receive its full value or can sell it immediately at a discount to face value.
Banker’s acceptances are a relatively safe form of payment for both sides of a transaction.
Unlike a regular check, a banker’s acceptance relies on the creditworthiness of the banking institution rather than the individual or business that issues it. The bank requires that the issuer meet its credit eligibility requirements, typically including a deposit sufficient to cover the banker’s acceptance.
Banker’s Acceptance as Investments
Banks and institutional investors trade banker’s acceptances on the secondary market before they reach maturity. The strategy is similar to that used in trading zero-coupon bonds. The BA is sold below face value, at a discount determined by the length of time before the maturity date.
Banker’s acceptances are considered to be relatively safe investments because the bank and the borrower are liable for the amount that is due when the instrument matures.
Advantages and Disadvantages of a Banker’s Acceptance
One of the key advantages of a banker’s acceptances is it’s backed by a financial institution (i.e., protected against default). This gives the seller assurances related to payment. Meanwhile, buyers are afforded the ability to make purchases in a timely manner and not worry about having to make payments in advance.
Now, the key risk is that the financial institution will have to make good on the promised payment. This is the key risk for the bank. To help hedge against this, the bank may require the buyer to post collateral.Pros
- It provides the seller assurances against default.
- The buyer doesn’t have to prepay or pay in advance for goods .
- It provides the ability to purchase and sell goods in a timely manner.
- It has a relatively low cost compared to the hedge or benefit provided.
- The bank may require the buyer to post collateral before issuing the banker’s acceptance.
- The buyer may default, forcing the financial institution to make the payment.
Banker’s Acceptance FAQs
How Does a Banker’s Acceptance Work?
For a banker’s acceptance, the importer will seek to make a purchase from an exporter (generally in another country). The exporter wants assurance of payment, but the importer also wants assurance that the seller can deliver. Banker’s acceptance is a form of payment backed by a bank that eliminates transaction-related risks for the importer and exporter.
Is a Banker’s Acceptance a Money Market Instrument?
Banker’s acceptances are money market instruments and, like most money markets, are relatively safe and liquid, particularly when the paying bank enjoys a strong credit rating.
What Is a Banker’s Acceptance Rate?
Banker’s acceptances are assumed to be safe investments as they’re backed by the bank, which means they often trade at a discount to face value. The banker’s acceptance rate is the market rate at which these instruments trade. It’s the return an investor would receive if they purchased today and held until the payment date.
What Is the Difference Between Banker’s Acceptance and Commercial Paper?
Commercial paper is a promissory note that pays a fixed rate. It’s unsecured and can be for a few days or years. Commercial paper is generally used to cover short-term obligations (such as the cost for a new project) or short-term receivables. BAs are also short-term promissory notes, although they have the unconditional guarantee of a bank and are often used for trade.
The Bottom Line
From an investment perspective, banker’s acceptances are relatively safe investments being money market investments and inline with T-bills from a risk-return perspective. For importers and exporters, BAs help boost trade by reducing transaction-related risks.