Correspondent banking refers to any financial institution (correspondent bank) providing services to other banks (respondent banks). A respondent banks can gain access to foreign financial markets by using correspondent banks, rather than setting up branches overseas.
A common example is where a domestic bank does not contain branches in a certain country. When that bank needs to perform transactions in that country it would use a correspondent bank for access.
How does correspondent banking work?
Correspondent banks act as middlemen between different unconnected financial institutions. They will hold accounts of the respondent bank and refer to them as Vostro or your account but on our books. The respondent bank will refer to the accounts as Nostro, or our account on your books.
Generally speaking, both banks in a correspondent relationship hold accounts for one another for the purpose of tracking debits and credits between the parties.
Correspondent banks generate a portion of their revenue from bank charges for serving as an intermediary between two unconnected banks.
Most international wire transfers are handled through SWIFT. If there no working relationship between the originating and beneficiary bank, the originating bank can search the SWIFT network for a correspondent bank that has a relationship with both financial institutions.
Services provided by a correspondent bank
A correspondent bank can provide the following services to respondent banks:
- funds transfer
- settlement
- check clearing
- wire transfers
- currency exchange
What are the pros and cons of correspondent banking?
Correspondent banks allow domestic banks access the global financial network without having to setup branches in countries they wish to do business in. Having a correspondent banking relationship allows domestic banks offer a range of services to its customers without having a relationship with the financial institutions at the other end.
Transactions processed through a correspondent bank can take time and can be costly. Customers usually have to bear these costs.