Definition
A correspondent bank is a financial institution that provides services on behalf of another bank—usually one in a different country—to enable cross-border payments, foreign currency services, and access to overseas financial markets without the domestic bank opening a branch abroad.
Why correspondent banking exists (role)
– Enables domestic banks, especially smaller ones, to serve customers who need international services (wire transfers, foreign deposits, check clearing, currency conversion).
– Acts as an agent and settlement counterparty when the sending and receiving banks do not have a direct relationship.
– Often connects banks via global messaging and settlement systems (for example, SWIFT) so funds and instructions move across borders.
Common services provided
– Outgoing and incoming international wire transfers
– Foreign currency exchange and liquidity management
– Maintenance of nostro and vostro accounts (accounts one bank keeps for another; see definition below)
– Check and payment clearing, settlement, and documentation handling
– Local cash services for customers traveling or doing business abroad
Key definitions
– Nostro account: an account a bank holds in a foreign currency at a correspondent bank; literally, “our account (on your books).” It records the sending bank’s funds held by the correspondent.
– Vostro account: the mirror entry seen by the correspondent bank—”your account (on our books)”—for funds it holds on behalf of the other bank.
– Intermediary bank: a third-party bank used within a payment chain that typically passes funds in a single currency; it is distinct from a correspondent bank in scope and currency handling.
Typical payment flow (step-by-step)
1. Customer asks Bank A (originating bank) to send funds abroad to Bank B (beneficiary bank).
2. Bank A checks whether it has a direct relationship with Bank B. If not, it searches networks (e.g., SWIFT) for a correspondent bank that has relationships with both parties.
3. Bank A sends funds to its nostro account at the correspondent bank, instructing the correspondent to forward funds to Bank B.
4. The correspondent deducts any fee, converts currency if needed, and transmits funds to Bank B or to an intermediary bank in the chain.
5. Bank B receives funds and credits the beneficiary’s account.
Small numeric example
– Customer at Bank A in San Francisco wants to send USD 10,000 to a beneficiary bank in Japan.
– Bank A does not have a direct relationship with the Japanese bank. It uses Correspondent Bank C.
– Bank A transfers USD 10,000 from the customer’s account to its nostro account at Bank C.
– Bank C charges a transfer fee of USD 25 and a currency conversion spread if converting to JPY. Suppose the conversion results in JPY equivalent of USD 9,975 after the fee.
– Bank C forwards the proceeds to Bank B (or to an intermediary), which credits the beneficiary in JPY after any local fees.
This illustrates volume movement, fee deduction at the correspondent, and the role of nostro/vostro records.
How correspondent banks add value
– Save domestic banks the cost and complexity of establishing foreign branches.
– Provide liquidity and multiple currency access.
– Offer operational capacity (clearing, settlement, documentation) and local market knowledge.
Important factors for banks choosing correspondent partners (checklist)
– Regulatory and compliance profile: sanctions screening, anti-money-laundering (AML) controls, and jurisdictional risk.
– Know Your Customer (KYC) and due diligence capabilities.
– Range of currencies and payment corridors covered.
– Fees and pricing transparency (per-transfer and foreign-exchange spreads).
– Operational reliability: settlement speed, service hours, error-resolution procedures.
– Connectivity: SWIFT/BIC codes, direct connections to target markets.
– Credit and counterparty risk: capital strength, credit ratings.
– Legal agreements: account types (nostro/vostro), indemnities, and dispute resolution.
Potential risks and challenges
– Compliance and AML exposure: correspondent banks rely on respondent banks’ KYC and controls for transactions they process, creating potential money‑laundering and sanctions risks.
– De-risking: some banks exit relationships with correspondent partners in higher-risk regions, reducing access to international banking for affected countries and clients.
– Operational risk: payment errors, delayed settlements, or failures in message routing (e.g., incorrect SWIFT/BIC).
– Credit and liquidity risk: an inability of a correspondent to fund onward payments can block transactions.
– Cost and opacity: layered fees (correspondent + intermediary + receiving bank) and FX spreads can make total costs hard to predict.
Correspondent bank vs intermediary bank (concise comparison)
– Correspondent bank: typically facilitates multi-currency flows, provides broad services (nostro/vostro accounts, FX, settlement), and maintains ongoing reciprocal accounts with respondent banks.
– Intermediary bank: generally used as a pass-through in a chain for a single currency when neither the origin nor destination has a direct relationship; narrower scope than a correspondent bank.
Practical checklist for executing an international payment (for bank operations or corporate treasury)
– Verify whether a direct relationship exists with the beneficiary bank.
– If not, identify a correspondent with the needed currency corridor and SWIFT/BIC.
– Confirm fees, expected delivery time, and FX rate treatment.
– Ensure KYC documentation is current for the customer and payment purpose.
– Use correct account details and intermediary/correspondent identifiers to reduce routing errors.
– Reconcile nostro/vostro entries after settlement.
Bottom line
Correspondent banks are intermediaries that let domestic banks offer international services without establishing foreign branches. They provide liquidity, currency access, and settlement capabilities but introduce compliance, operational, and cost complexities that both respondent banks and their clients must manage through careful due diligence and robust controls.
Reputable sources
– Investopedia — Correspondent Bank: https://www.investopedia.com/terms/c/correspondent-bank.asp
– World Bank — The Decline in Access to Correspondent Banking Services in Emerging Markets: https://documents.worldbank.org/
– Congressional Research Service — Overview of Correspondent Banking and “De‑Risking” Issues: https://crsreports.congress.gov/
– FINRA (Financial Industry Regulatory Authority) — Obligations to Your Customers: https://www.finra.org/
– SWIFT — About SWIFT and cross-border payments: https://www.swift.com/
Educational disclaimer
This explainer is for educational purposes only and does not constitute personalized financial, legal, or compliance advice. For decisions affecting transactions or regulatory obligations, consult qualified professionals.