What is a correspondent bank?
A correspondent bank is a bank that provides services on behalf of another financial institution, equal or unequal. It can facilitate wire transfers, conduct business transactions, accept deposits and collect documents on behalf of another financial institution. Correspondent banks are most likely to be used by domestic banks to manage transactions that originate or are concluded in foreign countries, acting as an agent of a domestic bank abroad.
In general, the reasons why domestic banks employ correspondent banks are limited access to foreign financial markets and the inability to manage customer accounts without opening branches abroad.
Operation of a correspondent bank
Correspondent banks can act as intermediaries between banks in different countries or as an agent to process customers’ local transactions when traveling abroad. At the local level, correspondent banks can accept deposits, process documentation, and act as a money transfer agent. The ability to perform these services frees domestic banks from the need to establish a physical presence in foreign countries.
The accounts held between the correspondent banks and the banks to which they provide services are called Nostro and Vostro accounts. An account held by one bank for another is designated by the holding bank as a Nostro account. The same account is called a Vostro account by the counterpart bank. Generally, the two banks in correspondent relationship keep accounts with each other in order to monitor debits and credits between the parties.
Example of funds transfer via a correspondent bank
International wire transfers often take place between banks that do not have an established financial relationship. For example, a bank in San Francisco that has received instructions to transfer funds to a bank in Japan cannot transfer funds directly without an employment relationship with the receiving bank.
When agreements are not in place between the sending bank and the receiving bank, a correspondent bank must act as an intermediary.
Most international electronic transfers are made through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network. Knowing that there is no working relationship with the destination bank, the origin bank can search the SWIFT network for a corresponding bank with agreements with the two banks. After having found a correspondent bank having arrangements with both sides of the transfer, the originating bank sends the funds transferred to its Nostro account held at the corresponding bank.
The correspondent bank deducts its transfer fees, usually $ 25 to $ 75, and transfers the funds to the receiving bank in Japan. In such transactions, the correspondent bank adds value in two ways. It reduces the need for the national bank to establish a physical presence abroad and avoids setting up direct agreements with other financial institutions around the world.
Key points to remember
- A correspondent bank is a financial institution authorized to provide services on behalf of another financial institution.
- The accounts held between the correspondent banks and the banks to which they provide services are called Nostro and Vostro accounts.
- National banks employ correspondent banks, including limited access to foreign financial markets and the inability to manage customer accounts without opening branches abroad.