A bankers' acceptance ("BA") is essentially a
negotiable financial instrument used to raise short term funds in
the money market. It is a common form of short term borrowing at a
fixed rate in Canadian credit facilities.
How A BA Works
A BA consists of a draft containing a promise to pay a sum
certain at a specified date drawn by a borrower and stamped or
accepted by a bank. By accepting the draft, the bank assumes the
primary obligation to pay the principal face amount of the BA at
The BA is rendered negotiable through an effective endorsement
by the borrower, enabling the BA to be sold at a discount by the
borrower (a) to a lender under a credit facility being provided to
the borrower or (b) if the borrower has sufficient distribution
capability (and usually only investment grade issuers have such
capability), directly to a purchaser in the secondary market. In
either case, the lender or purchaser may further negotiate the BA
or hold it until maturity. If the purchaser holds the BA to
maturity, it is entitled to present the BA to the accepting bank
for payment of the principal face amount of the BA. In this manner,
the borrower may use the superior credit rating of the accepting
bank to lower the borrower's cost of borrowing.
BAs usually have a term of 30 to 180 days. For trading
convenience, BAs are also drawn in convenient amounts, usually in
integral multiples of hundreds of thousands of dollars. BAs are
usually denominated in Canadian dollars but also may be denominated
in US dollars.
The cost to the borrower is a function of the discount applied
to the BA and an accepting fee charged by the bank. At the time of
acceptance, the bank charges an acceptance fee based upon the face
amount and the term of the BA. The fee charged in respect of any
particular instrument will reflect the bank's assessment of the
drawer's credit-worthiness. The discount reflects the
purchaser's assessment of the risk of the transaction (as
measured in relation to the bank's credit-worthiness) and the
amount charged by the purchaser for the use of its funds until the
date of maturity. BA funding is usually 50-75 basis points cheaper
than floating prime rate funding.
Common BA Terms
In practice, banks assume an active role in the trading of BAs.
It is common for loan agreements to provide that the bank, after
accepting a BA, may sell the BA.
At the date of maturity, the holder of the BA calls upon the
accepting bank to honour its obligation, the accepting bank pays
the holder and then looks to the borrower for reimbursement.
Typically, the loan agreement provides the borrower with the option
of either "rolling the BAs" (i.e. issuing new BAs and
reimbursing the accepting bank for the matured BAs with the
proceeds of such new issuance) or using some other method of
availment under the facility to reimburse the bank, such as
borrowing through a Canadian prime rate advance.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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The Canadian Office of the Superintendent of Financial Institutions ("OSFI") recently ruled that a bank cannot promote comprehensive credit insurance ("CCI") within its Canadian branches under the Insurance Business (Banks and Bank Holdings Companies) Regulations (the "Regulations").
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