A correspondent bank is a financial institution that acts on behalf of another bank or financial institution, normally in another country, to provide services to a customer. Accepting deposits, gathering records, and other services are provided by the correspondent bank to the other banks. Correspondent banking is a network of banks that plays a critical role in promoting international trade.
Correspondent banking is described as a relationship in which one bank (correspondent) holds deposits for another bank (respondent bank) and provides payment and other services to the respondent banks. It's essentially a bilateral arrangement between the two banks to offer payment facilities to the respondent bank's customers in the correspondent bank's jurisdiction.
What is the purpose of Correspondent bank?
International trade is extremely important in today's world. Almost every organisation and entity intend to expand their operations internationally. This is not possible, however, without banking facilities. On the other hand, a bank cannot have a branch in every location.
Here's where correspondent banking comes in handy. This type of banking facility is needed to provide banking services in countries where the respondent bank does not have a physical presence. When it is not financially viable for a foreign bank to open a branch in a given country, it turns to correspondent banks. As a result, using the services of correspondent banks assists the respondent bank in retaining clients while also lowering costs.
What is the Mechanism of Correspondent Banking?
Vostro refers to the accounts (or customers) that a correspondent bank represents. It literally translates to "your account on our books." The respondent bank refers to such an account as Nostro, which means "our account on your accounts." For instance, if you live in the UAE and request that your bank open a Rupee account for you. Your bank will establish a Nostro account with its Indian correspondent bank.
As a result, the respondent bank will look for the correspondent bank's SWIFT code, which is in touch with the foreign bank. The balance will be transferred from the respondent bank to the correspondent bank, which will then transfer it to the international bank account after deducting its charge.
Let's look at an example to help us understand. Customer A from the UAE needs to import a smartphone from China's supplier B. Customer A asks his bank, XYZ, to move money to supplier B's account in China's ABC bank. XYZ, on the other hand, has no arrangement with ABC bank.
In this situation, XYZ will contact its Chinese correspondent bank, which has a contract with ABC bank. XYZ will send the funds (plus correspondent bank fees) to the correspondent bank, which will then send them to ABC bank.
It is critical that both banks gather information about the other bank, such as its goodwill, efficiency, customers, and more, in order to ensure the effectiveness of correspondent banking. Both banks, for example, should have details such as the company's name, address, primary business line, directors' names, a recent annual report or audited financial statement, a copy of a few legal documents, and so on.
Furthermore, the banks' functions and obligations must be clearly defined. Furthermore, the respondent bank should share the customer's identity data with the correspondent bank for which it is using the correspondent bank's services.