Trade knowledge / Losing a Banker´s Acceptance: A $400,000 Piece of Paper
Date: 2017-12-02
Losing a Banker´s Acceptance: A $400,000 Piece of Paper
Would you misplace an original painting valued at $400,000? You probably would keep an alert and watchful eye on anything of such value.
Would you also keep equal vigilance over a piece of paper called a Banker’s Acceptance? Losing it could cost you just as much!
As I've discussed in a previous article, a banker's acceptance (B/A) was created by the Federal Reserve Bank to help U.S. banks complete with London banks in providing international trade finance. A B/A must meet certain criteria including:
1.the tenor cannot exceed 180 days,
2.it must finance a trade related transaction (a few exceptions exist to this rule), and
3.it must meet limitations as to amount by customer and bank.
Most often, the B/A arises out of a time draft related to a letter of credit.
Each B/A must be tied to a specific self-liquidating transaction. This type of financing (authorized by the Federal Reserve Bank) carries the commitment of the accepting bank and makes it an attractive investment vehicle by allowing a bank to sell it to an eager investor. Because B/As have gained a good reputation and acceptance in the secondary market, the Federal Reserve Bank no longer finds it necessary to add their guarantee.
Once a bank has created a B/A, it can be discounted and sold into the secondary market. As a negotiable instrument, the purchaser can sell it to another investor until the maturity date. On the maturity date, the bank owes the face amount of the B/A to the holder of the document. Since the bank does not know who holds the B/A at maturity, it will expect the holder to present the B/A to the bank on its maturity.
A Misplaced Banker's Acceptance
In this particular story, a bank created a B/A valued at $400,000 and sold it into the market. At maturity, the bank collected the $400,000 owed by the customer, but no one presented the matured B/A to the bank. Sixty days later the B/A finally arrived. Apparently someone found the overlooked B/A and presented it for redemption. The bank had no obligation to pay any interest to the holder for the 60-day period after maturity.
This story has an interesting side note. Early during the 60-day period, the bank’s internal auditing staff audited the international department’s policies and records. When they came across this past-due item in the records, they wrote the department up as an audit exception and reported it to the bank’s board of directors. It took some educating to convince the auditors and the board of directors that the department had done nothing improper.
Although the bank had no obligation to try to find the holder of the B/A, they did make a few preliminary phone calls after which the trail turned cold. Although prepared to pay the holder, the bank could not know whom to pay. Therefore, the bank had use of the $400,000 interest free during the period. The bank's auditors would have better served their purpose by writing up the party who lost the use of the money during the 60-day period because they did a poor job of guarding their investment.
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