Definition of Banker's Acceptance (BAs)
A banker's acceptance is used for international trade as means of ensuring payments. It is a short-term debt obligation that is secured by banks. Under these obligations, the bank promises to pay the creditor a specified amount on a specified date if a borrower defaults. The term of bankers acceptance is typically 90 days from the date of issue but can range from 1 to 180 days.
According to L.J. Gitman, "Bankers acceptance arise from a sort term credit arrangement used by business to finance transaction, especially, those involving firms in foreign countries with unknown credit capacities."
Definition 2
Banker's acceptance is a Bill of Exchange accepted by a bank, usually for the purpose of financing a sale of goods to or by the bank's customer. The bill may be drawn by an exporter on the importer's bank and be sold on the open market at a discount.
More Thorough Understanding of the Term
A banker's acceptance is a type of financial instrument used in international trade finance to facilitate the exchange of products or services between parties from different nations. It is a time draft, which is a written order from the exporter (drawer) to the importer (drawee) to pay a specified amount of money at a future period, usually between 30 to 180 days.
One of the essential characteristics of a banker's acceptance is that it is seen as a relatively safe investment because the creditworthiness of the accepting bank supports it. The reputation and credit rating of the accepting bank is critical in influencing the marketability and value of a banker's acceptance in the secondary market.
Bankers' acceptances are used by banks as a short-term investment tool in addition to providing trade finance. Banks can earn a return on their investment by buying and selling banker's acceptances in the secondary market, as the market price of a banker's acceptance may fluctuate from its face value due to fluctuations in interest rates and perceived credit risk.
Significance of Banker's Acceptance
Bankers' acceptances are frequently used to finance international trade transactions because they provide exporters with a low-risk form of financing and a dependable payment channel for importers. They are typically employed in large-amount transactions or when parties are unfamiliar with each other's creditworthiness.
Bankers' acceptances are critical financial instruments in enabling international trade by offering financing choices for exporters, payment guarantees for importers, risk management, and secondary market liquidity. They help improve the efficiency and efficacy of global trade operations while adhering to existing regulations to ensure financial stability.
Practical Example
Suppose company XYZ, based in the USA, exports $100,000 worth of materials to company ABC, located in China. The Chinese company issues bankers' acceptance to USA company with payment terms of 90 days through Bank "ZZZ."
Upon delivering the materials to the Chinese company ABC, the USA company ABC presents the evidence of delivery to bank "ZZZ" and receives the banker's acceptance.
With Bank ZZZ's acceptance, the BAs become a negotiable instrument that can be exchanged on the secondary market. Company XYZ can hold the banker's acceptance until maturity and receive payment from Company ABC or sell the banker's acceptance in the secondary market to another investor for immediate cash.