Every financial institution in the world cannot have direct contact with every other financial institution. Global trade would grind to a standstill if only direct relationships were required to perform financial transactions across borders.
As a result, the global financial system needed a solution that allowed banks in various countries to conduct business even when they had no prior relationship. A "correspondent bank" is the term for this arrangement.
What is a "Correspondent Bank?"
Third-party financial institutions that operate as go-betweens for local and foreign banks are known as "correspondent banks." To conduct business with a local bank, correspondent banks serve as an agent for a foreign banks. Treasury services, foreign wire transfers, worldwide investments, and trade finance are just some of the services they may give to both sides.
The correspondent bank charges the foreign bank a fee for its services. Since correspondent banks have direct financial links with local and international banks, they can serve as a go-between. As a result, they can do both banks. Domestic banks often handle transactions that begin or end in a foreign nation via correspondent banks.
A Correspondent Bank: How Do They Operate?
Correspondent banks act as a go-between for two different financial institutions since they are third-party entities. If they don't have a formal connection, the local and international banks can't complete the transaction. Instructions and needed cash are delivered to the correspondent bank for it to complete a transaction, such as a money transfer, settlement etc. The transaction is constructed due to the bank sending such information to the other bank.
Correspondent banks are the most regularly utilized method when transferring money to another nation. An interbank financial telecommunications network called SWIFT serves this purpose. SWIFT is the world's most extensive network of bank correspondents. One thousand and one hundred and twenty financial institutions worldwide are a part of it.
What You Need to Know About Vostro and Nostro Banking
It is common for them to have many Nostro and Vostro accounts. Correspondent banking uses the Latin phrase "nostro," which means "your account, on our records." Your performance on our books is called "Vostro," which means "yours."
Using these accounts, you can keep track of your international debit and credit card purchases. As a result, when a local bank wants to send money overseas, it will deposit the cash into the correspondent bank's Nostro account. A correspondent sends funds to the recipient's Vostro account after the correspondent bank deducts the transaction charge.
A Correspondent Banking Transaction Example
Jim needs a piece of machinery from Japan for his firm. A JPY-denominated account must be used to transfer funds to the vendor. Due to the lack of a direct connection between his US bank and the Japanese bank of his supplier, the transaction must be routed through the SWIFT network for processing. Using the SWIFT network, the banker at bank will select a correspondent bank linked with both Jim's institution.
After finding the correspondent, Jim's bank will transfer the monies to the correspondent's Nostro account, which will deduct a charge before depositing the funds into the receiving bank's Vostro account. This process is repeated until all funds have been transferred.
Is There a Fee for Using a Correspondent Bank?
To use the services of a correspondent bank, you'll have to pay a fee. Several variables can affect this. Costs for international wire transfers can range from $25 to $75 per transaction. As a result, banks educate their consumers about these charges. Some may charge consumers what the bank charges them, while others may add a markup to the actual cost to the final customer.
Correspondent Banks: Pros and Cons
Correspondent banks' most significant benefit is that they allow domestic financial institutions access to the global financial system without the need to open international branches. Banks would undoubtedly incur substantial costs and regulatory risks due to such an undertaking. A local bank can offer worldwide money transfers, check clearing, and other relevant services to its clients by simply cooperating with a correspondent bank.
Everything is taken care of by the correspondent bank. For clients, one drawback of using correspondent banks is the extra time it takes to complete their transactions. The processing time for a wire transfer is typically a couple of days. It seems excessively slow in this day and age, where money is supposed to move in milliseconds.
Conclusion
International trade relies heavily on correspondent banks. Their lack of availability would severely restrict multinational enterprises' ability to conduct business with domestic banks. Direct relationships between banks and the opening of branches in every city worldwide are both unachievable for any one bank to achieve. They can only access the global financial system for their clients through the correspondent banking network.
