A money-market instrument which constitutes a time draft drawn on and accepted by a bank. A banker’s acceptance (BA) provides a source of financing for traders in international markets, as it helps effect payment for merchandise sold in import-export transactions.

Acceptances are typically used to finance an international transaction where a merchandise seller doesn’t offer his goods or services on credit. To overcome this problem, an initial banker’s acceptance (actually a draft) is issued by the buyer instructing the bank to pay the seller of goods a specified sum of money at a preset date. Once the bank accepts this order, it becomes liable to pay the seller on behalf of the buyer. As such, a banker’s acceptance allows a bank customer to take advantage of the bank’s reputation to finance cross-border trade transactions.

Basically, the draft is an order by the drawer (usually a commercial company or a trader) to the bank (drawee) to pay a certain amount of money on a specific date to a designated person or the bearer. Acceptance by the bank makes this draft an actual obligation, i.e. an unconditional liability, on that bank. If the acceptor (bank) has a good credit-worthiness and reputation, the accepted draft can be traded in an active secondary market. However, the buyer (importer) must agree to repay any drafts the bank accepts. The bank doesn’t give its customer the face value of the accepted draft, it rather discounts it; that is, it pays the customer a cash amount less than the face value of the draft. The customer (importer) uses the proceeds to pay the seller (exporter).

At the end of the credit term, the bank redeems the full face value of the draft, with the difference between the face value and the actual cash amount being the bank’s compensation. Meanwhile, the bank may hold the acceptance till maturity, or sell or rediscount it in the secondary market. Therefore, if the bank re-discounted the acceptance in the market, the customer will have to pay the holder of the acceptance, not the bank, the face value on the maturity date.