Key Takeaways
- A correspondent bank is a third-party institution that acts as a go-between for domestic and foreign banks that need to conduct business together.
- The SWIFT network is known as the most secure network of correspondent banks, connecting over 11,000 financial institutions in 200 countries and territories.
- For record-keeping purposes, a bank refers to the money it’s holding for another bank as a vostro account. Money that’s being held for it at another bank is called a nostro account.
- There are likely fees involved in international wire transfers that are facilitated by the correspondent bank.
Definition and Examples of Correspondent Banks
A correspondent bank is a third-party financial institution that acts as a go-between for domestic and foreign banks that need to conduct cross-border payments with each other. These correspondent banks typically have formal agreements in place with both institutions, which allow them to provide a range of services to both banks, including wire transfers, check and payment processing, treasury management, settlements, and loans.
- Alternate name: Service-providing bank
The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network is the largest network of correspondent banks in the world, connecting over 11,000 financial institutions in 200 countries and territories. Through the SWIFT network, individuals and businesses can conduct business around the world without their financial institution needing to be in two locations.
For example, let’s say you live in the U.S. and go to your local bank to wire funds to a friend in Italy. An employee at the bank simply searches the SWIFT network to find a correspondent bank that has an agreement in place with the financial institution in Italy. Then, the correspondent bank facilitates the transaction.
How Does a Correspondent Bank Work?
A financial institution will use a correspondent bank if it needs to make a payment to a foreign bank and the two banks lack a formal relationship. This correspondent bank acts as a third-party agent between the two, facilitating any type of payment service that needs to be done.
For example, say you own a pizza shop in the U.S. You source all your ingredients from Italy, so you regularly need to wire money to your supplier overseas. Your local bank doesn’t have any branches in Italy so a teller at your bank searches the SWIFT network to find a correspondent bank that has an existing relationship with your supplier’s Italian bank.
Next, the teller deducts the money from your account, along with a fee, and wires the money to the correspondent bank. The correspondent bank keeps the fee and forwards the rest of the money to the bank in Italy.
Vostro vs. Nostro Accounts: How Banks Settle Cross-Border Transactions
This constant exchange of money can get confusing, so banks use nostro and vostro accounts to keep track of it all.
Note
Nostro is Latin for “our,” as in “our money, held by other banks.” And vostro is Latin for “yours,” as in “other banks’ money, held by us.”
Any given bank will have a mix of nostro and vostro accounts on its balance sheet. For instance, if a bank in the U.S. is currently holding money for a bank in Italy, it will record those funds in a vostro account so that it knows the money isn’t theirs. Meanwhile, the bank in Italy will track those same funds in a nostro account so that it knows the money is theirs; it’s just being held at another bank.
Long story short? For every nostro account that exists, there’s a corresponding vostro account on someone else’s balance sheet.
Correspondent Bank Fees
If you’ve ever conducted an international transaction at your bank, then you’re well aware of the fees involved. But what you may not know is that part (or all) of this fee is paid to the correspondent bank—not your local bank.
Most international wire transfers generally cost between $15 and $50 apiece, though it depends on the financial institution, whether the transfer is an incoming or outgoing transaction, which currency it’s in, and whether it’s initiated online or at a local branch.
For example, at Chase, an outgoing international wire transfer in U.S. dollars that is initiated through the bank’s website or mobile app from your account will cost you $50. At Bank of America, an incoming international transfer in another currency could cost you $16—but that amount could change based on your account type or the current exchange rate. Moreover, some banks will only charge you the price they pay to the correspondent bank, while others will add their own fee to the cost.
