Risk Management
08:10
Risks Associated with Bankers’ Acceptances
Risks Associated with Bankers’ Acceptances
For purposes of the OCC’s discussion of risk, the OCC can be said to assess banking risk relative to its impact on capital and earnings. From a supervisoryperspective, risk is the potential that events, expected or unexpected, may have an adverse impact on a bank’s earnings or capital. The OCC has defined ninecategories of risk for bank supervision purposes. These risks are credit,interest rate, liquidity, price, foreign currency translation, transaction, compliance, strategic, and reputation.
The risks associated with bankers’ acceptances are transaction, compliance,credit, liquidity, foreign currency translation, and reputation. These risks are discussed more fully in the following paragraphs. (Once an examiner determines whether the bankers’ acceptances are held as a loan or investment,they should refer to the appropriate booklet in the Comptroller’s Handbook for further guidance.)
Transaction Risk
Transaction risk is the current and prospective risk to earnings and capital arising from fraud, error, and the inability to deliver products or services,maintain a competitive position, and manage information. Risk is inherent in efforts to gain strategic advantage, and in the failure to keep pace with changesin the financial services marketplace. Transaction risk is evident in each product and service offered. Transaction risk encompasses product development and delivery, transaction processing, systems development,computing systems, complexity of products and services, and the internal
control environment.
Banks should work closely with borrowers seeking bankers’ acceptance financing to ensure that the borrower fully understands the supporting documentation and timely processing requirements related to this type of financing. The basic documentation for a bankers’ acceptance consists of
A bankers’ acceptance credit agreement which contains the borrower’s promise to repay the bank when the acceptance
matures.
• A “purpose statement” or letter from the borrower that describes the underlying trade transaction being financed, certifies that no other
financing is outstanding, and specifies that the transaction has not been refinanced.
• A draft.
Compliance Risk
Compliance risk is the current and prospective risk to earnings or capital arising from violation of, or nonconformance with, laws, rules, regulations,prescribed practices, internal policies and procedures, or ethical standards. Compliance risk also arises in situations where the laws or rules governing certain bank products or activities of the bank’s clients may be ambiguous or untested. This risk exposes the institution to fines, civil money penalties,payment of damages, and the voiding of contracts. Compliance risk can lead to diminished reputation, reduced franchise value, limited business opportunities,reduced expansion potential, and lack of contract enforceability.
The major compliance risk associated with bankers’ acceptance financing relates to creating ineligible bankers’ acceptances but treating them as if they were eligible for Federal Reserve discount. If this occurs, the Federal Reserve will generally impose a retroactive reserve requirement on the accepting bank.
If the bank has created a bankers’ acceptance based upon accurate information provided by the borrower in the purpose statement, only to learn later that it erroneously considered the transaction eligible, the bank will not be able to collect compensation from the customer to cover the reserves.
Compliance with the legal lending limit must be considered. When a bank discounts or holds its own bankers’ acceptances, they are converted to a loan and included in the legal lending limit. Purchased bankers’ acceptances are exempt
Credit Risk
Credit risk is the current and prospective risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract with the bank or
otherwise to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance. It arises
any time bank funds are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether reflected on or off
the balance sheet.
Bankers’ acceptances contain credit risk not only for the bank creating the acceptance, but also for the exporter, for banks purchasing another bank’s acceptances, and for other investors (such as money market mutual funds, trust departments, state and local governments, insurance companies, pension funds, corporations, and commercial banks) who buy bankers’ acceptances.
The principal credit risk of this instrument is that the importer will be unable to make payment at maturity of the bankers’ acceptance — leaving the accepting bank responsible to make payment. For acceptances purchased in the market, credit risk is somewhat mitigated because bankers’ acceptances
are considered to be “two-name paper,” which means that the importer is secondarily liable on the instrument. In addition, the instrument is a contingent obligation of the drawer (exporter). In other words, the exporter (drawer) is contingently liable if the importer does not pay. The acceptance is also an obligation of any other institutions that have endorsed it. That is,“holders in due course” that have bought and sold the acceptance in the market.
Liquidity Risk
Liquidity risk is the current and prospective risk to earnings or capital arising from a bank’s inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value.
Partly because the maturities of most bankers’ acceptances are short, the market generally views acceptances as safe and liquid. The fact that “name”
banks dominate acceptance financing also limits liquidity risk. Liquidity risk will be greater if the accepting bank is lower rated, is not a “name” or “prime”
institution, or if the instrument is not eligible for Federal Reserve discount.
Source:Original Man
