A correspondent bank is a foreign bank that provides banking services on behalf of a local bank, in a foreign country. That allows local banks to offer foreign banking services to their customers, without opening branches in a foreign country.
The banking services correspondent banks provide include wire transfers, processing banking documents, performing due diligence before executing transactions, and conducting transactions.
- How Correspondent Banks Operate
- How Banks Settle a Foreign Transaction with Correspondent Banking
- Correspondent Banking Fees
- How a Banks Finds an Intermediary Bank
- Intermediary Bank – Frequently Asked Questions
- International Payments
How Correspondent Banks Operate
When two banks agree to establish a banking correspondence, they usually open a correspondent bank account from their ends. Local banks use these correspondent bank accounts, to settle international transactions with correspondent banks.
What are Nostro and Vostro Accounts?
A local bank refers to the bank account it opens for a correspondent bank as a nostro account. That same account is referred to as a vostro account, by the correspondent bank on whose behalf it was opened.
The number of correspondent bank accounts a local bank has, is determined by the number of correspondent banking relationships it has. In most cases, the higher the number of foreign transactions a bank handles, the more correspondent banking relationships it has.
How Banks Settle a Foreign Transaction with Correspondent Banking
A buyer with a bank account in the US may want to pay a supplier in China, who does not have a bank account in the US. The buyer will have to rely on their US bank to use its correspondent bank in China to complete the transaction.
First, the buyer authorizes a deposit to the supplier in China, by giving his bank the banking details of the supplier and the amount to be paid. The buyer’s US bank debits the buyer’s account, then contacts its correspondent bank in China, and authorizes them to credit the supplier’s bank account.
The bank in China verifies the details and credits the supplier’s bank account. The US bank credits the same amount to its Nostro account in the Chinese bank, and the bank in China can see the US bank has credited its US Vostro. Both banks deduct their transfer fees from the buyer’s funds.
Correspondent Banking Fees
In that regard, the buyer has to send the supplier enough funds to cover the transfer fees. Moreover, if the US bank does not have a correspondent banking relationship with the supplier’s bank, then it has to use an intermediary bank.
The intermediary bank must have a correspondent banking relationship with the supplier’s bank, and the buyer’s bank. Often, that can raise the fees needed to process the transaction.
How a Banks Finds an Intermediary Bank
When a bank does not have a correspondent banking relationship with a receiver’s bank, it uses the Society of Worldwide Interbank Financial Telecommunication (SWIFT) network, to find an intermediary bank.
The intermediary bank is simply a bank that has a correspondent banking relationship with the two banks that want to transact but is not correspondents.
A majority of international bank transfers happen through the SWIFT network. That saves banks from the costly process of setting up multiple correspondent bank accounts or opening branches worldwide.
Intermediary Bank – Frequently Asked Questions
What is the difference between a correspondent bank and an intermediary bank?
Correspondent banks are often two banks that process each other’s transactions. In the early days of banking, most correspondent banks were within the same country. Today, most correspondent banks have their headquarters in different countries.
The two currencies the correspondent banks use are often domestic, but in some cases, they can be foreign currencies. In such cases, the banks have to convert their currencies to complete a transaction.
Intermediary banks send cash to complete a foreign transaction. They are used by banks that don’t have a local correspondent bank. Banks also use intermediary banks to route money through national banking systems.
Respondent banks often do so, if they don’t have a correspondent bank that are members of such a banking system. Using an intermediary bank is often more costly, than using a correspondent bank.
Some correspondent banks do business with each other often. And because of that, they may have arrangements to lower transaction costs for their clients.
What are the risks of correspondent banking?
Correspondent banks can expose respondent banks to financial or criminal risks. This can happen if the correspondent bank does not follow a strict Know Your Client (KYC) policy.
That can lead to the respondent banks enabling criminal activities, which the correspondent bank’s clients are conducting. Fortunately, most governments today are enforcing a strict KYC policy for their banks.
The rise of international terrorism, and an increasing need to monitor tax evaders, has seen more governments introduce strict KYC guidelines. Therefore, few countries lack some form of KYC guidelines for their banks.
In that regard, authorities such as the US’s Federal Reserve, often have lists of countries, which US banks can use as guidelines. If the Federal Reserve blacklists a country, then a US bank cannot do any business with a bank in that country.
What is a correspondent bank fee?
A correspondent bank fee is a money a correspondent bank charges a respondent bank’s clients. It deducts this fee from the sender’s amount. Therefore, a sender has to include such fees when sending money.
Why is correspondent banking high risk?
Correspondent banking is often high risk because the respondent banks have no direct control of the recipient’s bank account. Once the transaction is complete, it isn’t possible to reverse the money.
We hope that you found this guide to be informative, and you now know why some international bank transfers cost more than others do.