Banker's Acceptance: a Worked Example

A bill of exchange is an unconditional written order from one party, the drawer, telling another, the drawee, to pay a sum on demand or at a fixed or determinable future date. Until the drawee agrees, the drawee is not bound by it; the drawer, and anyone who has indorsed the bill, are. Acceptance is that agreement, written on the bill and signed by the drawee. The three markets share one code for it, the UK's Bills of Exchange Act 1882, followed closely by New Zealand's Bills of Exchange Act 1908 and Australia's Bills of Exchange Act 1909. Each defines acceptance and makes the acceptor liable to pay the bill on the terms it accepted.

When the drawee is a bank, the bill carries the bank's credit, and that is the purpose. A buyer the exporter barely knows has been replaced by a bank the market can price. The bank holds a claim for the face value at maturity on whoever it accepted for, the importer or the issuing bank that nominated it, and books that as an exposure from the day it signs, because it must pay the holder whether or not that party pays it.

In trade, the acceptance usually comes out of a usance letter of credit made available by acceptance. The exporter ships and presents its documents with a draft drawn at, say, 120 days after sight. The ICC's rules for documentary credits, UCP 600, do not allow a credit to be made available by a draft drawn on the applicant, so the drawee is a bank. If the documents comply, the nominated bank accepts (if it declines, the issuing bank must honour instead), and the rules authorise a nominated bank that has accepted a draft to prepay or buy it.

Two prices sit in those lines. The acceptance commission is the bank's fee for lending its name. The discount is the buyer of the bill's return for waiting. Because both are taken off the face value rather than added to the cash, the effective rate on the money received is a little higher than the quoted rates. The day basis follows the currency's money-market convention; the example uses 360 days, the usual basis for US-dollar paper.

A wine exporter, constructed for this page like every figure in it, sells US$800,000 of wine to an importer under a credit available by acceptance of a draft at 120 days after sight, with the exporter's own bank nominated. The documents comply. The nominated bank accepts the draft and offers to discount it at 5.4% a year, with an acceptance commission of 0.75% a year. Both rates belong to the example and are not a market norm.

The exporter has cash at shipment and no foreign debtor to chase. On day 120 the issuing bank reimburses the nominated bank and debits the importer under its facility. The nominated bank, having bought its own acceptance, has carried the issuing bank's risk for four months and been paid for it.

Change one fact. The credit is available by deferred payment instead: the bank promises to pay on day 120, but no bill is drawn. The exporter can still be paid early, since UCP 600 lets a nominated bank prepay its own deferred payment undertaking, but the paper changes. There is no negotiable instrument. A third party can still buy the right to be paid, but by assignment, which passes the claim subject to defences, and bill-of-exchange law, with its protection for a holder in due course, has nothing to attach to.

The nearest neighbour is a bill accepted by the buyer itself, the trade acceptance that documents against acceptance produces under a documentary collection. The paper looks the same and the same Act governs it. The difference is the signature. A trade acceptance is worth what the importer is worth, and an exporter that discounts one is borrowing against its buyer's credit, usually with recourse to itself if the buyer does not pay. A banker's acceptance moves that credit to a bank.

Recourse does not vanish. Unless the drawer stipulates otherwise on the bill, it stays liable if the acceptor does not pay at maturity, provided it is given due notice of dishonour, so an exporter that sells an accepted bill to a third party has not wholly left the chain. A bank that discounts its own acceptance carries the risk of its reimbursing bank itself.

In Australia the instrument had a second life as domestic funding. Under a bill facility the borrower, not a trading partner, drew bills that its bank accepted and discounted, and banks lent to businesses that way for a long time. The habit survives in names. Australian business loans are commonly priced off BBSY, the bid rate set five basis points above BBSW, and BBSW is calculated from trading in prime banks' short-term paper, now mostly certificates of deposit with bank-accepted bills the balance. New Zealand's equivalent is BKBM, the bank bill benchmark rate, set each business morning from the market in bank bills.

DEFINED IN ONE PARAGRAPH → · PRODUCT FILE: LC DISCOUNTING → · THE BANK BILL RATE →

For the exporter's banker, an accepted bill turns a receivable owed from abroad into a claim on a bank, which changes what can be lent against it and at what price. A credit paper that relies on discounting should say who the acceptor is, whether the credit is available by acceptance or by deferred payment, and what recourse the discounting bank keeps against the exporter.

For the importer's banker, the acceptance is a promise to the market that does not wait for the customer. The limit is used from acceptance to maturity, the goods have usually been released against the documents long before, and the bank's protection for those four months is whatever its facility, its security and any trust receipt give it. The credit decision is about the importer's cash in four months' time, not about the wine.

HOW BANKS READ EXPORTERS → · PRODUCT FILE: TRADE LOAN →