A Correspondent Bank is a financial institution that offers services to a customer on behalf of any other bank or financial institution, usually in a foreign country. The correspondent bank performs several services for the other banks, such as accepting deposits, collecting documents and more. Such a network of banks, collectively called Correspondent banking plays a crucial role in supporting international trade.
The definition of correspondent banking is an arrangement where one bank (correspondent) hold deposits on behalf of the other bank (respondent bank), and offer payment and other services to the respondent banks. It is basically a bilateral agreement between the two banks to provide payment services to the respondent bank’s customers who are there in the correspondent bank jurisdiction.
Table of Contents
Features of Correspondent Banking
- A correspondent bank act as an agent of the respondent bank.
- Correspondent banks offer the following services, such as Treasury, clearance of cheques, drawing of demand drafts, process documentation, foreign exchange, financing, managing international investments, and more.
- The correspondent bank charges a specific fee for its services to the respondent bank.
- Services of a correspondent bank are usually needed for international financial transactions that require foreign currency exchange.
What’s the Need?
In the present world, international trade holds immense importance. Almost every company and individual plans to take their business to a global level. However, without banking services, this is not possible. On the other hand, it is not possible for every bank to have a branch everywhere.
This is where correspondent banking helps. Such a banking facility is essential for providing banking services in foreign countries where the respondent bank doesn’t have a physical presence. A foreign bank use correspondent banks when it is financially not feasible for the former to open a branch in that country. Thus, using the services of correspondent banks helps the respondent bank to retain the clients along with keeping costs down.
How Correspondent Banking Works?
The accounts (or customers) that a correspondent banks serves is called Vostro. It means “your account on our books.” Similarly, the respondent bank calls such an account as Nostro or “our account on your books.” For example, if you are in the US and ask your bank to open a Rupee account for you. Your bank will open a Nostro account with its correspondent bank in India.
Now, if the respondent bank needs to transfer a sum of money to a foreign bank with which it does have an agreement, it would use the services of a correspondent bank. The international transfers are done using SWIFT network (Society for Worldwide Interbank Financial Telecommunication).
Thus, the respondent bank will search for a SWIFT code of the correspondent bank, which has contact with the foreign bank. The respondent bank will transfer the amount to the correspondent bank, who after deducting its fee, transfers the amount to the foreign bank account.
Let’s understand this with the help of an example. Customer A from the US wants to import smartphone from supplier B in China. Customer A approaches his bank XYZ to transfer an amount to supplier B’s account in ABC bank in China. XYZ, however, does not have an agreement with ABC bank.
In such a case, XYZ will contact its correspondent bank in China who has an agreement with ABC bank. XYZ will transfer the amount (plus correspondent banks’ charges) to the correspondent bank, who then forwards it to ABC bank.
To ensure the effectiveness of correspondent banking, it is crucial that both banks gather details about the other banks, such as its goodwill, performance, clients and more. For instance, both banks should have information about the name, address, primary business line, names of directors, recent annual report or audited financial statement, copy of a few legal documents and more.
Further, it is important to define the roles and responsibilities of the banks clearly. Moreover, the respondent bank should share the identification data of the customer for which it is using the services of the correspondent bank.1–3