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A banker's acceptance is a commitment by a bank to make a requested future payment. The request will typically specify the payee, the amount, and the date on which it is eligible for payment. After acceptance, the request becomes an unconditional liability of the bank. Banker's acceptances are distinguished from ordinary time drafts in that ownership is transferable prior to maturity, allowing them to be traded in the secondary market. A banker's acceptance starts with a deposit in the amount of the future payment plus fees. A time
draft Draft, The Draft, or Draught may refer to: Watercraft dimensions * Draft (hull), the distance from waterline to keel of a vessel * Draft (sail), degree of curvature in a sail * Air draft, distance from waterline to the highest point on a vesse ...
to be drawn on the deposit is issued for the payment at a future date, analogous to a post-dated check. The bank accepts (guarantees) the obligation to pay the holder of the draft, analogous to a
cashier's check A cashier's check (or cashier's cheque, cashier's order) is a check guaranteed by a bank, drawn on the bank's own funds and signed by a cashier. Cashier's checks are treated as guaranteed funds because the bank, rather than the purchaser, is respo ...
. The draft holder may hold the acceptance until maturity and receive the
face value The face value, sometimes called nominal value, is the value of a coin, bond, stamp or paper money as printed on the coin, stamp or bill itself by the issuing authority. The face value of coins, stamps, or bill is usually its legal value. How ...
payment from the bank, or it may sell (exchange) the acceptance at a discount to another party willing to wait until maturity to receive the bank's promised payment. Banker's acceptances are advantageous in transactions between unacquainted parties by reducing
credit risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
, and are used extensively in international trade for this reason. In an agreement whereby goods will be sold at a future date, if the buyer does not have an established relationship with or otherwise cannot obtain credit from the seller, a banker's acceptance enables it to substitute the bank's creditworthiness for its own. Banker's acceptances are typically issued in multiples of , with a term to maturity between 1 and 6 months.


History

Banker's acceptances date back to the 12th century when they emerged as a means to finance uncertain trade, as banks bought
bills of exchange A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, whose payer is usually named on the document. More specifically, it is a document contemplated by or consisting of a ...
at a discount. During the 18th and 19th centuries, there was an active market for sterling banker's acceptances in London. When the United States Federal Reserve was formed in 1913, one of its purposes was to promote a domestic banker's acceptance market to rival London's to boost US trade and enhance the competitive position of US banks. National banks were authorized to accept time drafts, and the Federal Reserve was authorized to purchase certain eligible banker's acceptances, but today the US central bank no longer buys banker's acceptances (but instead buys mostly US government bonds from a
Primary dealer A primary dealer is a firm that buys government securities directly from a government, with the intention of reselling them to others, thus acting as a market maker of government securities. The government may regulate the behaviour and number of ...
). In the People's Republic of China, banker's acceptance notes have become a shadow currency with captive banks of local governments issuing BA's to hide their debt levels.


Banker's acceptance rates

Banker's acceptance rates are the market rates at which banker's acceptances trade, and are determined by current values relative to face values. They represent the
return Return may refer to: In business, economics, and finance * Return on investment (ROI), the financial gain after an expense. * Rate of return, the financial term for the profit or loss derived from an investment * Tax return, a blank document or t ...
received if an acceptance were purchased today at the market price and held until the payment date. All-in rates are banker's acceptance rates which include the bank's commission.


Comparison with other drafts

When a draft promises immediate payment to the holder of the draft, it is called a sight draft.
Cheques A cheque, or check (American English; see spelling differences) is a document that orders a bank (or credit union) to pay a specific amount of money from a person's account to the person in whose name the cheque has been issued. The per ...
written on demand deposits are examples of sight drafts. When a draft promises a deferred payment to the holder of the draft, it is called a time draft. The date on which the payment is due is called the maturity date. In a case where the payee and drawee of a time draft are distinct parties, the payee may submit the draft to the drawee for confirmation that the draft is a legitimate order and that the drawee will make payment on the specified date. Such confirmation is called an acceptance — the drawee accepts the order to pay as legitimate. The drawee stamps ACCEPTED on the draft and is thereafter obligated to make the specified payment when it is due. If the drawee is a bank, the acceptance is called a banker's acceptance. Bankers acceptances are considered eligible collateral under the Treasury Tax & Loan (TT&L) Program under 31 CFR part 203


Comparison of banker's discount with true discount (as per present value)

Often, banks were willing to buy time drafts from the party holding the acceptance, provided the issuer was credit worthy. If the party holding the acceptance sold the note before maturity, a discount value called the Banker's Discount was used to reduce the face value of the amount to be handed over to the claimant. Historically, the discount rate used by the Banks on such acceptances was FV × r × t (FV: Face Value, r: interest rate, t: time period). If this discount is applied, the value of the amount returned to the holder of the acceptance will mathematically be lower than the True Value (or Present Value) of the note. The difference is called as Banker's Gain and represents the profits earned by the Bank in exchange for accepting the risk of default.


See also

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Banker's draft A banker's draft (also called a bank cheque, bank draft in Canada or, in the US, a teller's check) is a cheque (or check) provided to a customer of a bank or acquired from a bank for remittance purposes, that is drawn by the bank, and drawn on an ...
*
Commercial paper Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of rarely more than 270 days. In layperson terms, it is like an "IOU" but can be bought and sold because its buyers and sellers have some ...
*
Forfaiting In trade finance, forfaiting is a service providing medium-term financial support for export/import of capital goods. The third party providing the support is termed the forfaiter. The forfaiter provides medium-term finance to, and will commonl ...


References

{{DEFAULTSORT:Bankers' Acceptance Corporate finance Fixed-income securities Money market instruments