What it means
In legal terms, endorsement is the signature by which the holder of a negotiable instrument transfers it or accepts liability on it. When the endorser is a bank, the market treats the paper as carrying the bank's credit rather than the drawer's, and an endorsed bill is often described as a banker's acceptance or, in continental practice, as being backed by an aval.
The value of the endorsement is that it replaces one unknown with one known quantity. A supplier in one country has no practical way to assess a mid-sized buyer in another, but it can price the risk of a named international bank in minutes.
The mechanics are straightforward once the facility is in place. The buyer's bank agrees an acceptance line, the bill is drawn and presented, the bank endorses it for a commission usually quoted as an annual percentage of face value, and the seller can then hold the bill to maturity or sell it into the discount market at a finer rate.
The benefit shows up as a lower discount rate. Because the bill now carries bank credit, discount houses and investors will buy it more cheaply than they would buy unendorsed corporate paper, and that saving often exceeds the endorsement commission itself.
It is worth separating this from the everyday sense of endorsing a cheque, which just means signing the back to deposit or transfer it. A bank endorsement is a credit commitment, and the endorsing bank will treat it exactly like any other lending exposure, taking security and using up the customer's facility limit.
In practice
Real-world examples.
Example
A machinery exporter in one country ships to a first-time buyer in another and insists the buyer's bank endorse the 90-day bill. The exporter sells the endorsed bill to its own bank the same week and is paid in full, leaving the credit risk with the endorsing bank.
Example
A commodity trader uses endorsed bills as a rolling working capital tool, drawing new paper as each cargo ships. The bank charges commission on the outstanding face value and takes a charge over the goods as security.
Example
A small components supplier is offered an unendorsed bill by a buyer it does not know and asks its own bank whether the paper is discountable. The bank declines without a bank endorsement, and the supplier renegotiates the contract to require one.
Formula
Calculation
Net proceeds to the seller = Face value - discount charge - endorsement commission, where each charge is face value x rate x (days / 360).
An importer arranges for its bank to endorse a 120-day bill with a face value of $600,000. The endorsement commission is 1.2% a year, giving $600,000 x 0.012 x 120 / 360 = $2,400. The bill is then discounted in the market at 5% a year, costing $600,000 x 0.05 x 120 / 360 = $10,000.
Net proceeds are $600,000 - $10,000 - $2,400 = $587,600. The total cost of $12,400 equals 2.07% of face value for four months, which is about 6.2% on an annual basis, and that figure is what should be compared against any other short-term funding option.Case study
Seen in the real world.
Meridian Textiles is an illustrative, fictional fabric manufacturer created solely to show how the numbers stack up. It won an $850,000 export order on 90-day terms from a buyer whose accounts it could not obtain, and its own bank was unwilling to discount the resulting bill at any sensible rate.
Meridian asked the buyer to obtain a bank endorsement, which the buyer's bank provided for a commission of 1.5% a year, costing $850,000 x 0.015 x 90 / 360 = $3,187.50. With the endorsement in place, the discount rate Meridian was quoted fell from 9% to 5.5%. That 3.5 percentage point improvement was worth $850,000 x 0.035 x 90 / 360 = $7,437.50.
The net benefit was $7,437.50 - $3,187.50 = $4,250, and Meridian also removed the buyer credit risk from its own balance sheet. In this fictional case the endorsement paid for itself more than twice over, which is a common pattern when the underlying buyer is genuinely hard to assess.
Watch out
Common mistakes.
- Assuming a bank endorsement is a formality or a rubber stamp, when it is a credit decision that consumes the customer's facility limit and requires security.
- Confusing endorsing a cheque over to someone else with a bank endorsement, which is a guarantee of payment rather than a transfer of ownership.
- Comparing the endorsement commission against nothing, instead of against the discount saving it produces, which is where the economics actually sit.
Questions
People also ask.
Who pays for a bank endorsement, the buyer or the seller?
Commercially it is negotiable, but the buyer's bank issues it and usually charges the buyer, since it is the buyer's credit standing being replaced.
What happens if the buyer fails to pay an endorsed bill at maturity?
The endorsing bank pays the holder and then pursues its own customer, which is precisely the risk transfer the seller is buying.
Is a bank endorsement the same as a letter of credit?
No, a letter of credit is a conditional undertaking given before shipment, while an endorsement attaches to a bill that already exists and makes it freely negotiable.
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