Banker’s acceptance is one of those complicated word combination which make people rack their brain trying to understand what it is and how it works. In this post, we will try to find out what it is in the simplest possible terms and discover why it can be both bad and good to you.
Terms from the sphere of banking, finance, or economics can be extremely hard to understand for common people. That is why when it comes to acceptances, futures options or bonds, the matters start to seem very confusing to most people. Money businesses normally are complicated, but you need to understand them to protect your finance and always stay in profit.
What is banker’s acceptance? Trying to make things clear
In simple cases, this is a positive reply of a person who is offered something. That is if you are a supplier and you are offered a financial operation in the course of which something will be bought from you, and you will receive money, you give a positive answer and the offer is considered accepted.
READ ALSO: Sponsorship letter format and samples
In banking matters, this term is frequently met. For instance, a client comes to a bank and leaves an application for a loan. It is called an offer. Then, the bank renders the asked funds, and this fact proves that the offer was accepted. As a result, the client can either open an account or receive an amount of money.
In other cases, banks make an offer of cooperation with certain conditions. For instance, it offers loans at a certain satisfying interest rate. Clients appreciate the offer, and when they turn to the bank willing to receive the offered loan and complete the mentioned conditions, the offer is also considered accepted.
In more serious matters than just taking a small loan, this is a financial tool that is used to handle big financial operations or commercial transactions. Two companies agree to purchase something or pay for something. One of them is backed by a bank in this situation. What does it mean? The bank undertakes guarantees of this company’s financial ability and potential.
What are the main characteristics of banker’s acceptance?
There are three main characteristic features that determine this financial instrument:
- Credit quality
What do they mean? Let’s try to figure out.
Credit quality is one of the chief financial criteria that are used when it’s necessary to evaluate the investment quality of a bond or its diverse forms. Credit quality is a notion that gives investors an idea of the worthiness or default risks they will have to face when investing in a bond. When we speak about a banker’s acceptance, we mean the profit or the risks the bank will have to face in case it accepts the offer and steps in an agreement or a contract as the third side.
Marketability means that this financial instrument can be sold. Since it’s a negotiable document with a short-term validity, it can be sold to third persons just as any other instrument of the financial market. In case a bank has a brilliant reputation and is known for its flawless ethic practice, many lenders will be happy to accept the offer.
Liquidity is the ability of assets to be sold at a good price. Some assets possess high liquidity, and others are lower on the ranking. The faster and easier the asset can be converted into money considering its full value, the higher its liquidity is.
How does banker’s acceptance work?
As a rule, big, especially international contracts are signed in such a way that there’s a certain time, within which everything should be paid. The bank, which agrees to guarantee one’s side’s finance, makes a kind of research of this side’s financial movement. In simpler words, the bank watches how the company’s finance is moving in and out of its accounts. It is called a preliminary estimation of the client’s capacity to pay.
In case the bank discovers whatever suits it in the financial matters of the client company, it agrees to issue a sort of document. It will be the mentioned banker’s acceptance. This document will guarantee that in case the client has no or not enough funds on the account by the due date, the bank will pay the needed amount out of its own funds.
It is possible to receive such a favor from the bank only after it evaluates the client’s capacity to pay and the future possibility of returning the debt. The bank will also need all the purchase and transportation documents and demands confirmation that all the needed payments are made.
So, to recapitulate all the facts mentioned above, it’s possible to say that such an agreement between a bank and a company, which participates in a financial operation, is a means of making the other side of the operation sure that the goods or services will be paid for on a due date. It helps reduce risks for both sides of the financial operation and also optimize the flow of documentation. As well, the one who pays can use the reputation of the bank to provide guarantees of payment, and it can play a big role.
Are there any pros and cons of banker’s acceptance?
Like any other financial instrument, this one has its own positive and negative sides. If you need to use this tool for some purpose, you should know them and be aware of the potential negative effects it can bring.
Positive sides of the acceptance from a bank include:
- Smaller financial risks. The reputation of a bank plays a huge role when a seller is reluctant to sell something to a buyer who still has no big positive reputation. In such a case, a guarantee from a bank ensures the seller that everything will be paid and that the buyer is worth trust.
- Bigger possibilities. Again, it’s the matter of a reputation because a buyer who is backed by a known and respected bank can attract more from sellers and a business with a guarantee from a bank can receive better investments.
- A very low cost. The guarantees from a bank are worth something. However, the interest rate is usually very low, and it’s well worth the opportunities you receive in return. The cost will hardly influence your profits a lot, but you will receive a new partner, a whole bank!
- No payments in advance. If you are backed by a bank, nobody will demand advance payment. You will be too reliable for all this stuff. On the other hand, you will have a chance to use the funds as due before you need to pay.
Negative sides of such a choice
- Financial analysis. The bank you’ve chosen will never make any deal with you until they check you through and through. They will take all your skeletons out of chests, and thus you need to be absolutely clear before you turn to them with such an offer.
- Suitability. Banks tend to be very picky when it comes to offers like this. They are reluctant to make any agreements of this type when they see a business with a very low-income margin — nothing to say if you are loss-making.
- Collaterals. Many banks prefer to reinforce their own security with the help of collateral. The fees you pay may be not enough, and the bank will want your movable assets. It can sometimes be a huge blow on a company that’s already unsteady or too fragile.
As you can see, a banker’s acceptance is something that has both negative and positive sides. If you are thinking about this financial tool, evaluate everything properly and determine what weighs more to you: the advantages or the risks. Sometimes, financial professionals can help make a good choice.
READ ALSO: Where to invest money in Nigeria in 2019