Concept
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A banker’s acceptance is a short-term debt instrument traded in the money market and is a variation of commercial paper. With a banker’s acceptance, a commercial entity still issues a note (i.e. they borrow an amount of money) that entitles the holder to a future payment of its par value. However, in the case of a banker’s acceptance, even if the issuing entity fails to make its promised payment the guaranteeing bank agrees to make the payment on the issuer’s behalf. This guarantee significantly mitigates the default risk of this type of instrument. A party may wish to lend money by purchasing a commercially issued note but may be unsure of the borrower’s ability to pay the par value upon maturity. Therefore, the guarantee provided by the bank can enable the loan to be made, as it is typically a larger and more stable entity than the issuer.