Banker's Acceptance (BA): Definition, Meaning, and Types

What Is a Banker's Acceptance (BA)?

A banker's acceptance (BA) is a negotiable piece of paper that functions like a post-dated check. A bank rather than an account holder guarantees the payment. Banker's acceptances are also known as bills of exchange. They're used by companies as a relatively safe form of payment for large transactions.

BAs can also be short-term debt instruments, similar to U.S. Treasury bills, that trade at a discount to face value in the money markets.

Understanding Banker's Acceptance

A banker's acceptance is a way for the company that issues it to pay for a purchase without borrowing to do so. The bill is a guaranteed form of payment for the company that receives it. A banker's acceptance requires that the bank pay the holder a set amount of money on a set date.

BAs are most commonly issued 30 days before the date of maturity but they can mature at any later date from one to 180 days.

BAs are issued at a discount to their face value. They earn a return like a bond does. They also can be traded like bonds in the secondary money market. There's no penalty for cashing them in early except for the lost interest that would have been earned had they been held until their maturity dates.

History of Banker’s Acceptance

Banker’s acceptances have been around since the 12th century. They were used as a method of facilitating trade. BAs started to become an actively traded market in London in the 18th and 19th centuries.

The U.S. launched the Federal Reserve in the early 1900s to help create banker’s acceptances that would compete with London’s. The Fed’s goal was to boost U.S. trade and it was given the authority to purchase certain BAs. The Fed still buys government bonds but it no longer buys BAs.

Banker’s Acceptance As Checks

Banker's acceptances are a relatively safe form of payment for both sides of a transaction, just like certified checks. The money owed is guaranteed to be paid on the date specified on the bill.

The use of BAs is most common in international trade transactions. A buyer with an importing business can issue a banker’s acceptance with a date after a shipment is due to be delivered and the seller with an exporting business will have the payment instrument in hand before finalizing the shipment.

An individual who's paid with a banker's acceptance can hold onto it until its maturity date to receive its full value or they can sell it immediately at a discount to face value.

A banker’s acceptance relies on the creditworthiness of the banking institution rather than the individual or business that issues it, unlike a regular check. The bank requires that the issuer meet its credit eligibility requirements, typically including a deposit sufficient to cover the banker’s acceptance.

Banker’s Acceptance As Investments

Banks and institutional investors trade banker's acceptances on the secondary market before they reach maturity. The strategy is similar to that used in trading zero-coupon bonds. The BA is sold below face value at a discount that's determined by the length of time remaining before the maturity date.

Banker's acceptances are considered to be relatively safe investments because the bank and the borrower are liable for the amount that's due when the instrument matures.

Advantages and Disadvantages of a Banker’s Acceptance

One of the key advantages of a banker’s acceptance is that it’s backed by a financial institution and therefore protected against default. This gives the seller assurances related to payment. Buyers are afforded the ability to make purchases in a timely manner and not worry about having to make payments in advance. 

The key risk for the bank is that the financial institution will have to make good on the promised payment if the buyer defaults. The bank may require the buyer to post collateral to help hedge against this.

The Bottom Line

Banker’s acceptances are relatively safe investments from an investment perspective because they're money market investments and they're in line with T-bills from a risk-return perspective. BAs help boost trade by reducing transaction-related risks for importers and exporters.