What Is Correspondent Banking and How Does It Work?

So what is correspondent banking?

A correspondent bank is a financial institution that offers services to another financial institution, usually in a different nation. It operates as a middleman or agent for another bank, arranging wire transfers, performing business transactions, receiving deposits, and gathering documentation.

Domestic banks will most likely use correspondent banks to service transactions that originate or are completed in other countries. In addition, domestic banks use correspondent banks to access international financial markets and serve international clients without having to operate branches abroad.

What Is a Correspondent Bank?

A correspondent bank is a bank in one nation permitted to provide services to a bank or financial institution in another country. Currency exchange, processing business transactions and trade documentation, and money transfers are the most frequent services provided by a correspondent bank.

How Does a Correspondent Bank Operate?

Correspondent banking is based on a deal between a foreign and a domestic bank to open a correspondent account, also known as a Vostro or Nostro account, at one bank to benefit the other. Correspondent banking generally includes the concept of reciprocal accounts that link two banks. These accounts are set up so that a domestic bank can make payments or money transfers on behalf of a foreign bank.

These correspondent accounts allow banks to manage international financial transactions for their customers that involve foreign currency exchange, such as those that often occur between an exporting business in one country and an importer in another.

What does the process look like?

A bank customer in one country must pay for goods from another country’s suppliers. The customer’s domestic bank determines the necessary foreign currency exchange transaction to permit suitable payment in the seller’s currency.

It deducts the necessary amount from the customer’s account. Then, it notifies its correspondent bank in the supplier’s nation to pay the matching amount to the supplier from the domestic bank’s correspondent account with the foreign bank in the supplier’s currency.

Third-party banks are referred to as correspondent banks. They bridge the gap between various financial institutions. As a result, they provide Treasury services between sending and receiving banks, particularly those located in different countries—for example,

  • exchange of currencies
  • make sure everything is in order
  • settlement
  • transfer of funds by wire
  • transfer of money

When clients travel abroad, correspondent banks may act as agents to handle local transactions for them. For example, correspondent banks can receive deposits, process documents, and act as money transfer agents locally.

What are Nostro and Vostro Accounts?

Nostro and Vostro accounts are the accounts held between correspondent banks and the banks for which they offer services. The holding bank refers to an account held for another bank as a Nostro account. The counterparty bank refers to the same account as a Vostro account, which means “your account on our records.” Generally, both banks in a correspondent relationship maintain accounts for each other to track debits and credits between them.

Correspondent banks are an essential aspect of the financial industry since they allow domestic banks to continue to operate when they can’t create branches in another country. For example, a small local bank with clients in many countries can form a partnership with a correspondent bank to suit its clients’ foreign needs. They have access to the international financial market as a result of this. As a result, the correspondent bank will charge a fee for this service, usually passed on to the customer by the local bank.

Nostro vs. Vostro Account

The terms “Nostro” and “Vostro” refer to the same bank account. The phrases are used when one bank has money on deposit with another bank, usually in the context of international trade or other financial operations.

Both banks in the partnership must keep track of the amount of money held by one on behalf of the other. The phrases Nostro and Vostro are used to distinguish between each bank’s two sets of accounting records.

The Latin words Nostro and Vostro are variations on the words “ours” and “yours,” respectively. The origins of modern retail banking may be traced back to the 13th and 14th centuries in Italy, where depositors and retail banks kept track of their account balances. The depositing customer held the Nostro ledger, while the bank kept the Vostro ledger.

Account Nostro

A Nostro account is a term used by Bank A to refer to Bank B’s “our” account. Nostro is a colloquial expression for “our money on deposit at your bank.”

The Nostro account records a bank’s money on deposit with another bank. These accounts are frequently used to streamline commerce and foreign exchange settlements. In contrast to regular demand deposit bank accounts, Nostro accounts are usually held by financial institutions and are denominated in foreign currencies.

Account Vostro

Bank B refers to the money on deposit at Bank A as “vostro.” The word “vostro” means “your money” and refers to “your money on deposit at our bank.” A Vostro account is similar to any other bank account. The account is a record of money due to or kept by a third party, most commonly another bank, although it can also be a firm or an individual.

A bank in the United Kingdom or the United States holds a Vostro account on behalf of a foreign bank. The money deposition happens in the currency of the country where the Vostro account is present.

Example of Nostro vs. Vostro

Consider the following scenario. GTBank, a Nigerian bank, receives a large amount of money in the form of remittances from its customers in the United States. Because GTBank does not have a physical presence in the United States, it enters into a contract with Citibank to have a U.S. dollar account opened for it remotely. One will place money received from American clients and businesses sending money to GTBank account holders in Nigeria in GTBank’s Citibank account.

Citibank will send the funds to GTBank’s US dollar account in Nigeria via SWIFT. The Society for Worldwide Interbank Financial Telecommunications, or SWIFT, is a member-owned cooperative. It provides its members with safe and secure financial transactions. Following the completion of the transfer, GTBank receives the dollar-denominated monies, translates them to the local currency (the naira), and puts them into the receivers’ local accounts.

GTBank’s Citibank U.S. dollar account is a Nostro account in GTBank’s eyes. In addition, Citibank maintains a Vostro account for GTBank in US currency.

Cash assets are Nostro accounts with negative balances. On the other hand, Vostro accounts with a credit balance are termed liabilities. Computerized accounting makes it simple to reconcile Nostro and Vostro accounts by simply entering “+” or “-” indications in the respective accounting systems of the banks.

How do International Wire Transfers work for Correspondent banks?

International wire transfers frequently happen between banks with no prior financial relationship. A bank in San Francisco, for example, that receives instructions to wire funds to a bank in Japan cannot do so without first establishing a working relationship with the receiving bank.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network handles the majority of international wire transfers. The originating bank does not have a functioning connection with the destination bank. So, it can search the SWIFT network for a correspondent bank that does. Then, the originating bank sends the transferred funds to its Nostro account maintained at the correspondent bank after selecting one with agreements with both sides of the transfer.

Intermediary Bank vs. Correspondent Bank

Although there are some parallels between the correspondent and intermediate banks, such as the fact that they both function as third parties for other banks, there is a significant distinction between them. An intermediary bank completes transactions involving a single currency, whereas correspondent banks generally handle transactions involving numerous currencies. They’re essential for domestic banks that aren’t big enough to manage these transactions.

An Overview of Correspondent vs. Intermediary Banks

Beneficiary banks utilize correspondent and intermediate banks as third-party banks to enable international fund transfers and transaction settlements. The beneficiary bank is the receiving bank where a person or company has an account.

A person or corporation would have an account with an issuing bank in both circumstances. The procedure of transmitting funds from the issuing bank to the beneficiary bank is then completed by that bank using a correspondent or intermediary bank.

There are inconsistencies in the explanation of correspondent vs. intermediary banks. For example, correspondent banks can be separate from intermediary banks, or they can be a form of the intermediary bank that is indistinguishable from intermediary banks. It all depends on where the account holder is located in the world.

Banks as Correspondents

A correspondent bank acts as a middleman between the issuing and receiving banks, providing services on behalf of the latter. Domestic banks frequently use correspondent banks as their agent abroad to complete transactions that begin or end in another country. On behalf of the domestic bank, the correspondent bank can carry out a variety of transactions. These services include completing wire transfers, taking deposits, acting as transfer agents, and arranging papers for another bank.

Banks that act as intermediaries

The role of intermediary banks is comparable to that of correspondent banks. An intermediary bank is a link between an issuing and receiving bank, which may be located in separate countries. There is a frequent requirement for an intermediary bank when international wire transfers take place between two banks. This is especially when both banks are in different countries with no prior financial relationship.

Important distinctions

There is sometimes a distinction between the unique functions that intermediary and correspondent banks play in the United States and other nations.

One distinction is that correspondent banks are frequently in charge of multi-currency transactions. For example, a correspondent bank would be liable for all transactions from the US dollar to the Danish Krone. This is if the person initiating the transfer is based in the United States. Moreover, it’s applicable while he is sending money to someone in Denmark.

Correspondent banks are often located in the nations where the two currencies are local. However, a bank may be based in a separate country occasionally.

Intermediary banks transfer cash to complete international transactions, but only for one currency. A domestic bank is usually too small to handle international payments in this situation. Therefore, it turns into an intermediary bank.

Particular Points to Consider

All banks accept wire transfers, an electronic method of delivering money to another person or entity. However, international wire transfers are more expensive and complicated to complete.

Intermediary banks deal in foreign transactions in particular parts of the world, such as Australia or EU member countries. There is no distinction whatsoever between the correspondent and intermediate banks.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network handles the majority of international wire transfers. Suppose the issuing and receiving banks do not have a working relationship. In that case, the originating bank can use the SWIFT network. It will help them to find a correspondent or intermediary bank that has agreements with both financial institutions.

Contact Capitalixe for correspondent banking solutions

At Capitalixe, we specialise in helping small, offshore, and emerging market banks obtain payment and banking solutions.

Our job is to match your company with the most appropriate and beneficial financial solution from our extensive network of over 100+ reputable payment and banking providers we work with worldwide.

By understanding your business goals, payment requirements, and market positioning, we take the time-consuming pain away of going to market and provide you with the solutions that are best suited to your needs.

The best part of all is our services are free of charge.

Feel free to reach out to us for a complimentary consultation. We will be more than happy to help you.

 

By Lissele Pratt

COO & Co-founder of Capitalixe

The Future of Cross-Border Payments: What Will it Look Like?

The cross-border payments landscape is constantly evolving. New technologies and approaches are always emerging, making it difficult to predict what the future will hold. However, some clear trends suggest where the industry is headed.

So, what are these trends? And how will they shape the future of cross-border payments? We’ve created a complete guide to answer these questions.

In this guide, you’ll learn about:

  • What are cross-border payments?
  • How cross-border payments work today
  • The benefits of cross-border payments
  • The future of cross-border payments
  • What is SWIFT and how can it help?

Read on to find out everything you need to know about the future of cross-border payments.

What are cross-border payments?

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Cross-border payments are electronic money transfers between two countries. The majority of these payments consist of a sender and receiver who do not share a common ledger, and the transactions between the two countries will involve a series of intermediary transactions.

They can be used for a variety of purposes, including:

  • Paying suppliers in other countries
  • Receiving payments from customers in other countries
  • Transferring money to friends and family members in other countries
  • Making investments in foreign companies or securities

Let’s say you’re a CFD broker. You have clients in the UK, Europe, and the US. To settle trades with these clients, you need to be able to send and receive payments in all three currencies. 

Types of Cross-Border Payments 

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SWIFT

The society for Worldwide Interbank Financial Telecommunication (SWIFT) is a system that allows for cross-border payments to be made in any currency via a swift code. It’s used by businesses all over the world and is considered to be extremely secure. 

SEPA

The single Euro payments Area (SEPA) is a system that allows for cross-border payments to be made in Euros. It’s used by businesses in the European Union (EU) and European Economic Area (EEA).

Credit card payments

These are cross-border wire transfers made with a credit or debit card. 

Alternative methods of payments

E-wallets, apps, and cryptocurrencies. These are all new methods of making cross-border payments that are becoming more popular.

How cross-border payments work today

Cross-border payment options are typically made through banks or other financial institutions. The sender will initiate a transfer through their bank, and the recipient’s bank will receive the payment and credit it to their account.

In most cases, cross-border payments take several days to complete. This is because the banks involved need to convert the currency, process the payment, and then send it through the international banking network.

The process can be further complicated by things like different time zones, holidays, and weekends. All of these factors can delay payment and add to the overall cost.

The benefits of cross-border payments

Despite the challenges, there are a number of reasons why you might need to make cross-border payments. In many cases, they offer a number of advantages over traditional payment services. Some of the benefits include:

Achieve a greater ROI

With cross-border payments, businesses can save on operational costs and improve their bottom line. That’s because they can take advantage of better foreign exchange rates and avoid costly bank fees.

Businesses can also save on costs associated with having a local presence in another country such as rent, salaries, and other overhead costs. Outsourcing services from emerging markets can also be a cost-effective way to get the same quality of work without having to pay high prices.

Suppose you’re an online gaming company that makes most of its revenue in US dollars. However, you have servers and other operational costs in Euros. With a cross-border payment solution, you can get the best exchange rate for your transactions and save money on every transaction. This can add up to significant savings over time and improve your bottom line.

Increase the number of buyers and affiliates

With cross-border payments, your high-risk business can expand its customer base and tap into new markets. That’s because you’ll be able to accept payments from buyers in other countries.

For example, let’s say you run an e-commerce store that sells products to customers in the United States. With a cross-border payment solution, you could start selling to customers in Europe and Asia as well. This would open up a whole new revenue stream for your business.

Comply with international tax and regulations

Cross-border payments can also help businesses stay compliant with international tax and regulatory requirements. This is because they provide a paper trail of all transactions. This can be helpful in the event of an audit or investigation.

For high-risk businesses, cross-border payments can also offer a number of other benefits. For example, they can help businesses avoid chargebacks and fraud.

The future of cross-border payments 

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Despite the benefits, there are still a number of challenges with cross-border payments. 

But the good news is that things are changing. With the advent of new technologies like blockchain, the future of cross-border payments looks promising.

Here are some of the ways that cross-border payments are expected to change in the future:

Cross-Border Payment methods will continue to evolve

There’s no doubt that payment methods will continue to evolve and in turn enhance cross border payments. In the past, cross-border payments were typically made through banks or other financial institutions. But this is changing. SWIFT GPI, SEPA Instant, and other innovations are making it possible to make cross-border payments in real-time.

Cross-Border Payments will be instant

One of the biggest changes to cross-border payments is that they will become instant. This is possible with the use of blockchain technology. With blockchain, payments can be processed in real-time, without the need for intermediaries.

Suppose you’re a high-risk business. In the past, you may have had to wait days or even weeks for your payments to clear. But with blockchain, your payments will be processed immediately, giving you the working capital you need to keep your business running smoothly.

Cross-Border Payments will offer differentiating features

Another way that cross-border payments are expected to change is that they will offer differentiating features. This is because the market is becoming increasingly competitive. As a result, businesses are looking for ways to stand out from the crowd.

One way that businesses are doing this is by offering unique features that appeal to specific niches. For example, some cross-border payment solutions are designed for businesses that need to send large amounts of money. Others are designed for businesses that need to make frequent payments. 

Each of these solutions offers differentiating features that appeal to a specific group of customers. This is expected to continue in the future as more and more businesses enter the market.

Cross-Border Payments will be more transparent

In the past, there’s been a lack of transparency with these payments. However, cross-border payments are evolving and APIs are playing a big role in this.

With APIs, businesses will be able to connect to a network of central bank and financial institutions. This will allow businesses to compare prices and find the best deals. It will also allow businesses to track their payments and receive notifications when the funds have been received. This increased transparency will help businesses to avoid hidden fees and charges.

Cross-Border Payments will meet every business’s needs

In the past, cross-border payments were often seen as a niche product. But this is changing. As the world becomes more connected, there is a growing need for this solution. 

This is because businesses are increasingly doing business with partners in different countries. By tracking international payments with a single, ubiquitous standard, businesses can streamline their operations and save money. Plus, transparency on fees, remittance and FX information will help businesses to avoid hidden charges and improve the customer experience.

Final Thoughts

The future of cross-border payments looks promising. With the advent of new technologies, the process is becoming more efficient and transparent. This means that businesses will be able to save money and conduct transactions more quickly and easily.

SWIFT payments Can Help Your Medium or High-Risk Business:

One of the most popular methods for making cross-border payments is SWIFT. 

SWIFT is a global network that connects banks and financial institutions. It allows businesses to send and receive money quickly and securely.

SWIFT is an ideal solution for businesses that need to make large or frequent cross-border payments.

At Capitalixe, we offer SWIFT-enabled cross-border payment solutions that can help your medium to high-risk business save time and money. It’s designed for businesses of all sizes and can be customised to meet your needs.

Interested in learning more about our solutions? Contact us today!