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The Bank Bill Swap Rate, commonly known as BBSW, is simply the short term swap rate. In Australia, BBSW is the term used for interest rate swaps of six months or less, anything dated longer than six months is simply referred to as a swap rate.

While BBSW has many uses, for fixed income investors its main relevance is as a benchmark upon which we can evaluate floating rate bonds or investments.

An interest rate swap is a financial instrument where one entity swaps a stream of floating interest payments for another entity’s fixed interest payments. In practice, they do not make two payments. Rather, a single net payment is made.

BBSW

As of 1 January 2017, AFMA handed over responsibility for calculating BBSW to the Australian Stock Exchange. The process has been evolving and in May 2018 was confirmed in a paper ASX BBSW Trade and Trade Reporting Guidelines.

In an ASIC media release dated Monday 21 May 2018, they commented:

The bank bill swap rate (BBSW) rate is a major interest rate benchmark for the Australian dollar and is widely referenced in many financial contracts. Previously, BBSW was calculated from the best executable bids and offers for Prime Bank securities. A major concern over recent years has been the low trading volumes during the rate-set window, the period over which the BBSW is measured. The new BBSW methodology calculates the benchmark directly from market transactions during a longer rate-set window and involves a larger number of participants. This means that the benchmark is anchored to real transactions at traded prices. ASX, the administrator of BBSW, has consulted market participants on this new methodology. In addition, the ASX has recently conducted a successful parallel run of the new methodology against the existing method.

BA Deputy Governor Guy Debelle said,

‘The new methodology strengthens BBSW by anchoring the benchmark to a greater number of transactions. This should help to ensure that BBSW remains robust.’

Bank Bill Rate means, for an Interest Period for each advance comprising part of the same Borrowing, an interest rate per annum equal to (a) the rate percent per annum determined by the Australian Sub-Agent being the average bid rate for Bills (rounded up to 4 decimal places) quoted on page “BBSY” (or any page that replaces that page) on the Reuters Monitor System at or about 10:30 a.m. (Sydney time) on the first day of such Interest Period for a period equal to, or most closely approximating, such Interest Period; or (b) if the Bank Bill Rate cannot be determined in accordance with clause (a) of this definition, the rate percent per annum determined by the Australian Sub-Agent as the average of the rates quoted to the Australian Sub-Agent by each Australian Reference Bank for the purchase of Bills accepted by such Australian Reference Bank which have a tenor equal to such Interest Period and a face value equal to the amount of the applicable advance (it being understood that the Australian Sub-Agent shall not be required to disclose to any party hereto any information regarding any Australian Reference Bank or any rate provided by such Australian Reference Bank in accordance with this definition, including, without limitation, whether an Australian Reference Bank has provided a rate or the rate provided by any individual Australian Reference Bank, and shall not make any such determination of the Bank Bill Rate if fewer than two Australian Reference Banks provide quotes as provided in this clause (b)); provided that, if the Bank Bill Rate would otherwise be less than zero, such Bank Bill Rate shall instead be deemed for all purposes of this Agreement to be zero. Toyota - 364 Day Credit Agreement

For the company that issues it, a banker's acceptance is a way to pay for a purchase without borrowing to do so. For the company that receives it, the bill is a guaranteed form of payment. A banker's acceptance requires the bank to pay the holder a set amount of money on a set date.

BAs are most commonly issued 90 days before the date of maturity but can mature at any later date from one to 180 days. They are typically issued in multiples of $100,000.

BAs are issued at a discount to their face value. Thus, like a bond, they earn a return. They also can be traded like bonds in the secondary money market. There is no penalty for cashing them in early, except for the lost interest that would have been earned had they been held until their maturity dates.

History of Banker’s Acceptance

Banker’s acceptances have been around since the 12th century. Just like now, BAs were used as a method of facilitating trade. In the 18th and 19th centuries, BAs started to become an actively traded market in London.

The U.S. launched the Federal Reserve in the early 1900s to help create banker’s acceptances that compete with London’s. The Fed’s goal was to boost U.S. trade and it was given the authority to purchase certain BAs. While the Fed still buys government bonds, it no longer buys BAs.

If you are looking to obtain a BA, go to a bank that you have a good working relationship with. (Note that not all banks offer BAs.)

Banker’s Acceptance as Checks

Banker's acceptances, like certified checks, are a relatively safe form of payment for both sides of a transaction. The money owed is guaranteed to be paid on the date specified on the bill.

The use of BAs is most common in international trade transactions. A buyer with an importing business can issue a banker’s acceptance with a date after a shipment is due to be delivered, and the seller with an exporting business will have the payment instrument in hand before finalizing the shipment.

The person who is paid with a banker's acceptance may hold onto it until its maturity date in order to receive its full value or can sell it immediately at a discount to face value.

Banker's acceptances are a relatively safe form of payment for both sides of a transaction.

Unlike a regular check, a banker’s acceptance relies on the creditworthiness of the banking institution rather than the individual or business that issues it. The bank requires that the issuer meet its credit eligibility requirements, typically including a deposit sufficient to cover the banker’s acceptance.

Banker’s Acceptance as Investments

Banks and institutional investors trade banker's acceptances on the secondary market before they reach maturity. The strategy is similar to that used in trading zero-coupon bonds. The BA is sold below face value, at a discount determined by the length of time before the maturity date.

Banker's acceptances are considered to be relatively safe investments because the bank and the borrower are liable for the amount that is due when the instrument matures.

Advantages and Disadvantages of a Banker’s Acceptance

One of the key advantages of a banker’s acceptances is it’s backed by a financial institution (i.e., protected against default). This gives the seller assurances related to payment. Meanwhile, buyers are afforded the ability to make purchases in a timely manner and not worry about having to make payments in advance.

Now, the key risk is that the financial institution will have to make good on the promised payment. This is the key risk for the bank. To help hedge against this, the bank may require the buyer to post collateral.

Pros

• It provides the seller assurances against default.
• The buyer doesn’t have to prepay or pay in advance for goods .
• It provides the ability to purchase and sell goods in a timely manner.
• It has a relatively low cost compared to the hedge or benefit provided.

Cons

• The bank may require the buyer to post collateral before issuing the banker’s acceptance.
• The buyer may default, forcing the financial institution to make the payment.

Banker’s Acceptance FAQs

How Does a Banker's Acceptance Work?

For a banker’s acceptance, the importer will seek to make a purchase from an exporter (generally in another country). The exporter wants assurance of payment, but the importer also wants assurance that the seller can deliver. Banker’s acceptance is a form of payment backed by a bank that eliminates transaction-related risks for the importer and exporter.

Is a Banker's Acceptance a Money Market Instrument?

Banker's acceptances are money market instruments and, like most money markets, are relatively safe and liquid, particularly when the paying bank enjoys a strong credit rating.

What Is a Banker's Acceptance Rate?

Banker’s acceptances are assumed to be safe investments as they’re backed by the bank, which means they often trade at a discount to face value. The banker’s acceptance rate is the market rate at which these instruments trade. It’s the return an investor would receive if they purchased today and held until the payment date.

What Is the Difference Between Banker’s Acceptance and Commercial Paper?

Commercial paper is a promissory note that pays a fixed rate. It’s unsecured and can be for a few days or years. Commercial paper is generally used to cover short-term obligations (such as the cost for a new project) or short-term receivables. BAs are also short-term promissory notes, although they have the unconditional guarantee of a bank and are often used for trade.

The Bottom Line

From an investment perspective, banker’s acceptances are relatively safe investments being money market investments and inline with T-bills from a risk-return perspective. For importers and exporters, BAs help boost trade by reducing transaction-related risks.