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
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 the 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 do 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 Chinise bank Nostro account, 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 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.
We hope that you found this guide to be informative, and you now know why some international bank transfers cost more than others do.