Banker's Acceptances

A banker's acceptance is a short-term IOU used mainly in international trade, where a bank steps in to guarantee that payment will be made. A company that needs to pay a supplier, often overseas, arranges for its bank to promise payment on a specific future date, usually somewhere between one and six months out. The bank "accepts" the underlying draft or bill, stamping it with its own credit, which is why the instrument carries the bank's name rather than the borrowing company's.

Once a bank accepts the draft, it becomes a tradable piece of paper. The exporter who was waiting to be paid doesn't have to wait for the maturity date; they can sell the acceptance in the money market at a discount to its face value and get cash right away. Whoever buys it then collects the full face value when it matures, with the difference being their return. Because the bank's credit stands behind the payment, not the original company's, these instruments have historically traded almost like short-term bank debt.

The part that trips people up is the word "banker's" — it does not mean the bank is lending its own money outright the way a loan does. The bank is guaranteeing someone else's payment obligation for a fee, and it's that guarantee, plus the bank's ability to resell the paper before maturity, that makes the instrument liquid and low-risk relative to trade credit with no guarantee at all.

Banker's acceptances used to be a much larger part of the U.S. money market than they are today; trade financing has increasingly moved toward other instruments and mechanisms, so the size and even the availability of the banker's acceptance market has shifted over time.