Bankers Acceptances

A bankers acceptance (BA, aka bill of exchange) is a commercial bank draft requiring the bank to pay the holder of the instrument a specified amount on a specified date, which is typically 90 days from the date of issue, but can range from 1 to 180 days. The bankers acceptance is issued at a discount, and paid in full when it becomes due — the difference between the value at maturity and the value when issued is the interest. If the bankers acceptance is presented for payment before the due date, then the amount paid is less by the amount of the interest that would have been earned if held to maturity.

A bankers acceptance is used for international trade as means of ensuring payment. For instance, if an importer wants to import a product from a foreign country, he will often get a letter of credit from his bank and send it to the exporter. The letter of credit is a document issued by a bank that guarantees the payment of the importer's draft for a specified amount and time. Thus, the exporter can rely on the bank's credit rather than the importer's. The exporter presents the shipping documents and the letter of credit to his domestic bank, which pays for the letter of credit at a discount, because the exporter's bank won't receive the money from the importer's bank until later. The exporter's domestic bank then sends a time draft to the importer's bank, which then stamps it "accepted" and, thus, converting the time draft into a bankers acceptance. This negotiable instrument is backed by the importer's promise to pay, the imported goods, and the bank's guarantee of payment.

Acceptance financing is the financing of commercial transactions, usually involving import/export businesses, by using bankers acceptances. However, it may involve trading within the same country. Sometimes, a bankers acceptance, is created to ship between countries where neither the importer nor the exporter is located, called a third-country acceptance.

Bankers acceptances have low credit risk because they are backed by the importer, the importer's bank, and the imported goods. Hence, BAs offer slightly higher yields than Treasuries of the same terms. Major investors of these money market instruments naturally include money market mutual funds, and municipalities. However, as other forms of financing have become available, the secondary market for BAs has declined considerably.

What a bank charges for a BA depends not only on its own fees and commissions for creating the BA, but is also commensurate with general market yields of other money market instruments. For BAs that are ineligible as collateral for Federal Reserve loans, the Fed imposes reserve requirements on the amount of ineligible BAs — hence, ineligible BAs are discounted more, with the result that the borrower receives less money for the initial loan, but the investor receives a higher yield.

Eligible Bankers Acceptances

United States banks sometimes borrow from the Federal Reserve, but to do so, the bank must deposit collateral in its account at the Federal Reserve Bank. A bankers acceptance can be used for collateral if it is an eligible bankers acceptance, which has certain characteristics.

The eligibility criteria include the requirements that the acceptance: (1) grow out of a trade transaction involving exporting and importing (including transactions between foreign countries), domestic or foreign storage of readily marketable staples, or domestic shipment of goods; and (2) have a maturity of 6 months or less. BAs that grow out of the storage of staples must be secured at the time of acceptance by a warehouse receipt or other document conveying or securing title. Eligible acceptances are not subject to reserve requirements under current Regulation D.

The Federal Reserve does, however, impose limits on the number of eligible BA that can be issued by a bank.