Correspondent Bank – Definition & How it Works?

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A correspondent bank helps two financial institutions in two parts of the world process a transaction. They are an important component of the international economy, powering financial transactions worldwide, and they use a Vostro and Nostro account system to manage balances.  Today we will learn about correspondent banks. We’ll look at how they work, how much they charge, and how they help the world economy function.

A correspondent bank is a banking institution that offers services to other banking institutions, usually in a different nation. It operates as a middleman or agent for another bank, arranging wire transfers, performing commercial transactions, receiving deposits, and gathering documentation. Local banks will most often employ correspondent banks to process orders that begin or are closed in other countries. Correspondent banks are used by commercial banks to obtain access to international currency institutions and serve global customers without requiring them to operate branches overseas.

On the authority of the foreign bank, correspondent banks can also provide Treasury operations, manage Forex, manage overseas investments, and assist global trade and financing.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network connects over 11,000 banking institutions in 200 countries and regions and is the world’s most significant infrastructure for correspondent banks. Firms and individuals can do business internationally mainly owing to the SWIFT network, which eliminates the need for their organization to be in multiple locations.

Correspondent banks can conduct Treasury operations, manage Forex, manage overseas investments, and help global trade and financing under the jurisdiction of the foreign bank.

Nostro and Vostro accounts are used by banks to maintain track of the funds needed to settle cross-border payments. Banks and financial institutions typically have multiple Nostro and Vostro accounts.

Nostro is Latin for “our,” and it signifies “our account, on your books” in correspondent banking. Vostro is a Latin word that means “yours,” and it refers to “your account, on our books.” These accounts are what allow cross-border money deposits and payments to be tracked.

When a regional bank has to transfer money abroad, it will deposit the amount in the correspondent bank’s Nostro account. The transaction fee is subtracted, and the remaining funds are sent to the recipient bank’s Vostro account by the correspondent bank.

Overseas wire transfers are frequently made between banks with no prior business link. A bank in California, for instance, that receives directions to transfer funds to a bank in Tokyo cannot do so without first establishing a working partnership with the receiving bank.

In the case above, the correspondent bank charges a transfer charge of $0 to $50 before transferring the money to the recipient bank in Japan. The correspondent bank contributes value to this type of transaction in two ways. It eliminates the requirement for the home bank to have a physical presence in another country and minimizes the time and effort of establishing direct relationships with other banking institutions throughout the world.

Let’s assume there’s a manufacturing plant owner named Phil, and he runs a small manufacturing plant in the United States, which deals with complex, artistic designs. There are a few small companies in East Asia that manufacture the machinery needed to produce such designs. Phil comes across a small Japanese firm that perfectly suits his needs.

Phil gets in touch with the factory owner in Japan and strikes a deal. He assumes that he can transfer money from his bank to his seller’s bank in Japan. But that’s not how it will work. Instead, the banker at Phil’s end (USA) will connect to Phil’s seller’s end (Japan) using the SWIFT network. When Phil’s bank locates the correspondent, the money will be sent to the correspondent’s Nostro account. The correspondent bank will deduct a charge and transfer the cash into the recipient bank’s Vostro account.

This is a simplified example of what a correspondent bank’s operations look like.

If you’ve ever used your bank to make an overseas transaction, you would be fully aware of the costs involved. However, you may not be aware that a portion (or all) of this fee is given to the correspondent bank, rather than your local bank.

Most overseas money transfers charge between $15 and $50, depending on the banking institution, if the transaction is an inbound or outbound transaction, the currency used, or if the transaction is made online or at a bank branch.

At Chase, making an international wire transfer in US dollars started from your account via the bank’s site or app costs $50. An inbound international transfer in some other currency could charge you $16 at Bank of America, but the cost depends on your bank account and the current conversion rate. Furthermore, some banks only charge you the sum they transfer to the correspondent bank, while others might levy an additional fee.

The most significant benefit of correspondent banks is that they allow local banks to enter the international banking system, without actually having to open branches in other countries.

Customers face one drawback: transactions processed via correspondent banks take a while, frequently longer than they anticipate. The processing time for a wire transfer is normally a couple of days. Nowadays money is supposed to flow in seconds, it sounds like an unreasonable delay.

Another downside is the additional cost. Customers are normally responsible for these fees because correspondent banks demand a fee for their services. This can dramatically increase their transaction expenses, especially if their bank charges a premium.

While there are some parallels between correspondent and intermediary banks, such as the fact that they both function as third parties for several other banks, there is a significant difference. A correspondent bank normally handles transactions involving multiple currencies, whereas an intermediary bank completes transactions involving just one currency.

Correspondent banks are frequently in charge of multi-currency deals. A correspondent bank would be liable for all transfers from the US dollar to the Japanese Yen if the person initiating the transfer were based in the United States and sending money to someone in Japan. The funds would be collected for the beneficiary by a correspondent bank in Japan that deals in foreign currencies.

Correspondent banks are often situated in the nations where the two currencies are local, however, a bank may be based in a separate country on rare occasions.

Transferring assets has become a lot easier and faster due to the Internet and the advancement in technology. Not only that, but we have multiple channels for transferring those funds, including wire transfers, money orders, demand drafts, checks, and cash.

While traditional techniques allow you to send money worldwide, they can be slow and unsafe, especially when dealing with significant sums. Furthermore, in rare cases, cash or checks may not be accepted in some countries. An international wire transfer allows you to send thousands of dollars in seconds while also translating the cash into a foreign currency of your choice, making it the best option for those who travel internationally, work overseas, or do business in foreign countries.

To facilitate global wire transfers, third-party institutions collaborate with recipient banks. These financial institutions might be correspondent or intermediary banks. The differences between them are not always consistent and are frequently dependent on location.

Correspondent banks play a central role in facilitating global financial transactions, acting as intermediaries between banks in different countries. They utilize Nostro and Vostro accounts to manage cross-border payments and commonly charge a fee for the provision of their services.

Is a correspondent bank the same as a receiving bank?

No, a correspondent bank is only an intermediary between the sending and receiving banks.

What is the correspondent bank in Swift?

The SWIFT network is the largest and most secure network of correspondent banks. It connects over 200 countries.

What is the meaning of a correspondent account?

The term “correspondent account” refers to an account set up to accept payments from, make payments on behalf of, or manage other monetary transactions with an overseas banking institution.

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