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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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