A bankers acceptance, or BA, is a time draft
drawn on and accepted by a bank. Before acceptance, the draft is not an
obligation of the bank; it is merely an order by the drawer to the bank to pay
a specified sum of money on a specified date to a named person or to the bearer
of the draft. Upon acceptance, which occurs when an authorized bank employee
stamps the draft "accepted" and signs it, the draft becomes a primary
and unconditional liability of the bank. If the bank is well known and enjoys a
good reputation, the accepted draft may be readily sold in an active market.
Acceptances arise most often in connection
with international trade: U.S. imports and exports and trade between foreign
countries. An American importer may request acceptance financing from its bank
when, as is frequently the case in international trade, it does not have a
close relationship with and cannot obtain financing from the exporter it is
dealing with. Once the importer and bank have completed an acceptance
agreement, in which the bank agrees to accept drafts for the importer and the
importer agrees to repay any drafts the bank accepts, the importer draws a time
draft on the bank. The bank accepts the draft and discounts it; that is, it
gives the importer cash for the draft but gives it an amount less than the face
value of the draft. The importer uses the proceeds to pay the exporter.
The bank may hold the
acceptance in its portfolio or it may sell, or rediscount, it in the secondary
market. In the former case, the bank is making a loan to the importer; in the
latter case, it is in effect substituting its credit for that of the importer,
enabling the importer to borrow in the money market. On or before the maturity
date, the importer pays the bank the face value of the acceptance. If the bank
rediscounted the acceptance in the market, the bank pays the holder of the
acceptance the face value on the maturity date.
An alternative form
of acceptance financing available to the importer involves a letter of credit.
If the exporter agrees to this form of financing, the importer has its bank
issue a letter of credit on its behalf in favor of the exporter. The letter of
credit states that the bank will accept the exporter's time draft if the
exporter presents the bank with shipping documents that transfer title on the
goods to the bank. The bank notifies the exporter of the letter of credit
through a correspondent bank in the exporter's country.
When the goods have
been shipped, the seller presents its time draft and the specified documents to
the accepting bank's correspondent, which forwards them to the accepting bank.
If the documents are in order, the accepting bank takes them, accepts the
draft, and discounts it for the exporter. At this point, the transaction is
complete from the exporter's point of view; it has shipped the goods, turned
over title to them, and received payment.
Once the bank has
passed the shipping documents on to the importer, the situation is essentially
the same as it was in the case where the bank simply accepted a draft drawn by
the importer: The bank may hold the acceptance or rediscount it in the market,
and the importer is responsible for paying the bank the face value of the
acceptance on or before maturity. There is one subtle difference, however. The
drawer of an accepted draft is secondarily liable on it, which means the drawer
must pay the holder of the acceptance on maturity if the bank is unable to pay.
In the current case, the drawer is the exporter. In the first case described,
it was the importer.
An American exporter
may seek acceptance financing in a case where it knows the buyer to be
creditworthy and wants to extend it credit but needs cash in the interim.
Around the time it ships the goods and after completing an acceptance
agreement, the exporter draws a time draft on its bank, which accepts and
discounts it. Once again, the bank may either hold the acceptance or rediscount
it. On or before maturity, the exporter will have to pay the bank the face
value of the acceptance. Ideally, the tenor of the acceptance, the time from
acceptance to maturity, will coincide with the length of the credit extended by
the exporter so that the exporter will be able to pay the bank out of the
proceeds of the sale.
Foreign importers and
exporters trading with American firms may obtain acceptance financing in ways
similar to those just described. Many acceptances used to finance trade between
foreign countries, however, are of a type known as "refinancing" or
"accommodation" acceptances. A refinancing acceptance arises from a
time draft drawn by a foreign bank on an American bank to finance a customer's
transaction. Foreign banks that are not well known in the United States may
seek this type of financing because they are unable to sell their own
acceptances, or are unable to sell them at reasonable prices, in the U.S.
market.
Acceptances are also
created to finance the shipment of goods within the United States and to
finance the storage of goods in the United States and abroad.
Borrowers in the
acceptance market are mostly firms engaged in U.S. imports and exports as well
as foreign banks seeking to finance international trade not involving the
United States. Over the last decade, these borrowers relied less and less
on acceptances as a source of financing.
Acceptance, as
a source of financing for importers and exporters, has to compete with
commercial paper, Euro commercial paper, and bank loans. Commercial paper is
probably the cheapest alternative for borrowers with prime ratings.
Borrowers with less than prime ratings can take out bank loans, issue Euro
commercial paper, issue commercial paper with credit enhancements, or issue
asset-backed commercial paper. Borrowers of the latter type may find acceptance
financing an attractive alternative. Apparently, borrowers increasingly
do not find acceptance financing as such an attractive alternative. From
1983, when asset-backed commercial paper and Euro commercial paper were
introduced, until 1991, outstandings rose to between $50 billion and $70
billion for asset-backed commercial paper and to $75 billion for Euro
commercial paper. Over the same period, commercial and industrial loans made to
U.S. businesses by onshore and offshore banks rose from $467 billion to $777
billion (McCauley and Seth 1992, p. 54). The volume outstanding
acceptances based on U.S. imports and exports fell over this period, from
$31 billion to $24 billion. The percentage of U.S. foreign trade
financed by acceptances fell from 25 percent to 10 percent.
Foreign banks with no
presence in the United States may finance their own acceptances by drawing
refinancing acceptances on American banks or by issuing Eurodollar liabilities.
Jensen and Parkinson (1986, pp. 9-10) cite the narrowing of the spread between
the rates on Eurodollar deposits and bankers acceptances, from nearly 100 basis
points in the early 1980s to about 25 basis points in 1985, as a factor in the
decline of refinancing acceptances in the first half of the 1980s. Since then,
the spread has narrowed even more to under 10 basis points, and the decline in
refinancing acceptances has continued, both in terms of volumes outstanding and
in terms of the percentage of world trade financed.
Almost all acceptances are created by money
center banks, large banks in seaboard states and in the principal grain trading
cities, and U.S. branches and agencies of foreign banks. Over the last
decade or so, branches and agencies of foreign banks have gained an increasing
share of the market. Their share has risen from about one quarter of all
acceptances outstanding in the early 1980s to over 60 percent in 1990 and 1991.
The secondary market
for acceptances is tiered, this means that the acceptances of banks with high
credit ratings trade at lower rates of discount than the acceptances of banks
with lower ratings. Traditionally, the acceptances of money center banks traded
at lower rates of discount than those of regional banks and foreign banks, but
during the 1980's this changed. In the late 1987 the spread between the rates
of discount on the acceptances of regional banks and those of money center
banks, which averaged around 10 basis points in the early 1980s,
disappeared. The spread between the rates of discount on the
acceptances of foreign banks and those of money center banks, which was over
100 basis points when foreign banks were first entering the market, was around
5 basis points in 1990; indeed, the acceptances of some foreign banks traded at
lower discounts than those of American money center banks (The First Boston
Corporation 1990, p. 154).
The number of
principal dealers in bankers acceptances has been cut with approximately 50%in
the last few years. Today, there are about a dozen, all of which are also
primary dealers in government securities. Dealers in acceptances act as dealers
in other money market instruments do, buying and selling acceptances and
profiting from the spread between the prices at which they buy and sell. To
facilitate their trading, a number of acceptances are in their own
portfolios; a small number of these are kept until maturity. During 1991,
dealers' daily positions in acceptances averaged a little over $1.5 billion.
As bankers acceptances are generally created
in amounts over $100,000, institutional investors dominated the
market. Commercial banks held, on average in 1991, 21 percent of the
acceptances outstanding; most of these were their own. Money market mutual
funds held 13 percent, dealers held 3 percent, and the Federal Reserve's
foreign correspondents held 3 percent. The remaining 60 percent were held by a
variety of investors, of which, if relative holdings were like those in
previous years, some of the largest were state and local governments, pension
funds, and insurance companies (Jensen and Parkinson 1986, p. 4).
Investors consider
acceptances to be safe investments because acceptances are "two-name"
paper; this means, two parties, the accepting bank and the drawer, are
obligated to pay the holder on maturity. Investors are willing to accept a
slightly lower return on acceptances than on "one-name" paper
such as commercial paper and certificates of deposit.
Over the last decade or
so the attractiveness of bankers acceptances to both banks and borrowers, have
been diminished by a number of developments. Asset-backed commercial
paper and Euro commercial paper have been introduced, spreads between rates on
Eurodollar deposits and rates on acceptances have fallen, and acceptances have
thereby lost their favorable reserve-requirement status. As these developments
appear to be permanent, the rebound of the acceptance market is most unlikely
and may even continue to decline in importance.
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