What is a Banker's Acceptance?
A banker’s acceptance, also known simply as a BA, is a negotiable instrument that is sometimes used by traders, particularly in international trade situations. Functioning as a time draft, the drawer of the acceptance creates an order for his or her bank to pay a specific amount of money to the bearer of the instrument on or after the date noted on the document. This procedure allows traders to make use of the credit standing of their banks, rather than rely solely on their own credit rating.
The use of a banker’s acceptance usually depends a great deal on the reputation of the bank within the financial community. Assuming that the bank is well known for being a highly ethical institution, many creditors are more than happy to accept a banker’s acceptance as payment for goods and services rendered. Since the acceptance is a short-term negotiable instrument, it can also be traded in much the same way that other documents can be traded as a money market instrument.
In order to be able to make use of a banker’s acceptance, the buyer must be able to meet the requirements set forth by the bank itself. Some of these requirements are connected with regulations issued by national banking systems, while others may have to do with specific criteria set by the individual bank. Essentially, the buyer is asking the bank for financing, with an understanding that the bank will create a time draft equal to slightly less than the face value of the acceptance. The buyer is then free to draw against the amount in the time draft account to make purchases, then repay the bank on or before the date the banker’s acceptance comes due. In turn, the bank can honor the acceptance when it is presented by the bearer.
There are number of benefits associated with the use of a banker’s acceptance. While functioning in a manner that is somewhat like that of a postdated check, this type of financial instrument does not run the risk that the payer will empty the bank account before the date on the check arrives, leaving the creditor with what is essentially a worthless document. The seller receives the acceptance up front, so there are no worries about payment at all. Since banks do not issue acceptances without ample reason to expect that the instrument will be honored by the buyer, the buyer is able to purchase goods now, resell them for a profit, and settle the terms of the acceptance within the time frame required.
When traded as an asset, a banker’s acceptance is usually sold at a slight discount from the face value of the document. This allows the new owner of the acceptance to make a modest profit when the instrument is presented for payment on the appointed date. Banks sometimes sell their own acceptances as a way of recouping the money invested in the time draft immediately, and in anticipation of the acceptance being settled in full on or before the maturity date.
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