Banker's Acceptance (BA)

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 (otherwise called bills of exchange) are involved by companies as a relatively safe form of payment for large transactions. BAs can likewise be short-term debt instruments, like U.S. Treasury bills, that trade at a discount to face value in the money markets.

Understanding Banker's Acceptance

For the company that issues it, a banker's acceptance is a method for paying for a purchase without borrowing to do as such. 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, similar to a bond, they earn a return. They additionally can be traded like bonds in the secondary money market. There is no penalty for cashing them in ahead of schedule, 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 utilized as a method of facilitating trade. In the 18th and 19th centuries, BAs started to turn into an actively traded market in London.

The U.S. sent off the Federal Reserve in the mid 1900s to assist with creating 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 purchases government bonds, it no longer purchases BAs.

Assuming that you are hoping to obtain a BA, go to a bank that you have a decent working relationship with. (Note that not all banks offer BAs.)

Banker's Acceptance as Checks

Banker's acceptances, as 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 determined on the bill.

The utilization 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 close by before concluding the shipment.

The person who is paid with a banker's acceptance might hold onto it until its maturity date 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.

Not at all like a customary check, a banker's acceptance depends on the creditworthiness of the banking institution rather than the individual or business that issues it. The bank expects 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 arrive at maturity. The strategy is like that utilized 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 viewed as relatively safe investments in light of the fact that the bank and the borrower are obligated 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. In the mean time, buyers are managed the cost of the ability to make purchases in a timely way and not worry about making payments in advance.

Presently, the key risk is that the financial institution should follow through with the guaranteed payment. This is the key risk for the bank. To help hedge against this, the bank might require the buyer to post collateral.

For a banker's acceptance, the importer will look to make a purchase from an exporter (generally in another country). The exporter wants assurance of payment, but the importer likewise 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, as most money markets, are relatively safe and liquid, particularly while the paying bank partakes in 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, and that 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 assuming 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 couple of days or years. Commercial paper is generally used to cover short-term obligations (like the cost for another project) or short-term receivables. BAs are likewise short-term promissory notes, although they have the unconditional guarantee of a bank and are often utilized for trade.

The Bottom Line

According to 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 assist with boosting trade by decreasing transaction-related risks.

Highlights

• Banker's acceptances are traded at a discount in the secondary money markets.
• The banker's acceptance is a form of payment that is guaranteed by a bank rather than an individual account holder.
• BAs are most frequently utilized in international trade to settle transactions with relatively little risk to either party.
• The bank guarantees payment at a later time.
• Thus, not at all like a post-dated check, BAs can be investments that are traded, generally at a discounted price (like Treasury bills).