Correspondent Bank Meaning

Key Takeaways

  • Correspondent banks’ definitions portray them as a middleman connecting unrelated financial institutions. Their functioning as a go-between assists another financial institution in performing transactions involving an unconnected entity as the receiver’s bank. The system helps the respondent banks have vast benefits like increased client base revenue and competitive advantage.Some of the services provided by these companies include international fund transfers, wire transfers, transaction settlements, collecting documents, and accepting deposits.Some of the services provided by these companies include international fund transfers, wire transfers, transaction settlements, collecting documents, and accepting deposits.

How Does Correspondent Bank Work?

Correspondent banks based on the underlying bilateral agreement connect financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more enabling domestic and cross-border money movement and related services. They provide various services to respondent banks, including a deposit account. Communication between these banks frequently entails the transmission of messages for conducting transactions.

In some instances, banks require to connect with another bank which is generally a foreign entity, due to a lack of prior relationships with them or a lack of resources. As a result, they pay third-party institutions to participate in their transactions. It benefits the correspondent entity. They generate a portion of theirrevenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more from earning correspondent bank charges for serving as an intermediary between two unconnected banks.

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The main services provided by correspondent financial institutions include:

  • Wire transfersTransaction settlementsTrade financeTrade FinanceTrade Finance is the funding of trade transactions (both domestic and international). It is conducted in the presence of both buyer and seller and can be facilitated with the help of various intermediaries like banking and financial institutions.read moreCurrency exchangeTreasury servicesCheck clearingManaging international investmentsInternational InvestmentsInternational investments are made outside of domestic markets and offer portfolio diversification as well as risk management opportunities. As a result, an investor can diversify his portfolio and extend his return horizon by making international investments.read moreCollecting documents internationally.

These institutions often transfer funds, and accounts handling the fund transfer are called NostroNostroNostro Account is the account that one country’s bank holds in the bank of another country in the foreign currency. It helps the bank, which has the account in the bank of another country, by simplifying the exchange and trading process for the foreign currencies.read more and Vostro. The respondent mentions their account with the correspondent entity as Nostro (ours), and the correspondent entity says the account for a respondent entity with them as Vostro (Yours). 

One of the major networks used to expedite this system is the SWIFTSWIFTSWIFT is Society for World Wide Inter-Bank Financial Telecommunication and is a platform that provides national financial institutions with a secured, standardized, and encrypted network in a reliable environment for the transfer of various important information from one financial institution to another.read more network. SWIFT is one of the primary services focused on international remittances globally. The SWIFT network reveals relevant correspondent bank lists apt for accomplishing the transaction. However, countries such as China, India, and Russia are currently pushing forward new alternatives to SWIFT, which may diminish SWIFT’s dominance over time.

Example

Let’s say that Roy, who runs a high-end car workshop, needs particular parts to repair one of his client’s cars. Unfortunately, the car is a Japanese model and, at the moment, he can only get the parts from Japan.

So, he decides to use a wire transfer to pay the Japanese manufacturer for the parts. He goes to the bank and deposits the money plus fees. The other company receives it in Japan and sends the parts. It seems simple enough, right? But there’s a whole process that neither Roy nor the Japanese company sees happening; only their banks do. That’s where the correspondent financial institution comes in.

To make the wire transfer, Roy’s bank, a local U. S.-based institution, sends the money using the Society for Worldwide Interbank Financial Telecommunication (SWIFT). The correspondents in the SWIFT network connect both sides for a fee using the system. It receives the money and then transfers it to the other bank, connecting each side and completing the transaction.

Correspondent Bank Relationship

A correspondent banking relationship enables the respondent to shop for services from the correspondent entity. This effective cross banking relationship allows the respondent to provide their clients with services requiring connection with a specific region where the respondent entity doesn’t have a branch or presence and accomplish the need through local correspondent banks. This banking relationship benefit comes in many ways, such as:

  • Increase in clientsIncrease in revenueGain competitive advantageCompetitive AdvantageCompetitive advantage refers to an advantage availed by a company that has remained successful in outdoing its competitors belonging to the same industry by designing and implementing effective strategies that allow the same in offering quality goods or services, quoting reasonable prices to its customers, maximizing the wealth of its stakeholders and so on and as a result of which the company can make more profits, build a positive brand reputation, make more sales, maximize return on assets, etc.read moreReduce the cost of geographical extension of the banking organization

Using the service of a correspondent financial institution is far cheaper than opening branches in foreign countries. So, unless a bank is interested in starting operations there, outsourcing international payments or other banking services is a handy way not to lose their customers when they require international operations.

Correspondent Bank vs Intermediary Bank

There’s a lot of confusion between the concepts of correspondent and intermediary. Often it is difficult to segregate the difference between them. For starters, some countries are intermediaries facilitating transactions between two or more financial institutions. In other countries, they are differentiated based on slight differences in their functionality.

In the U. S., for example, an intermediary bank is often an institution that will represent a local bank abroad. It can conduct wire transfers, accept deposits, and even obtain documents for its clients, just like a correspondent financial institution would. The main limitation of intermediaries is that they will not handle transactions in various currencies, unlike correspondents.

In conclusion, both are third-party banks assisting in completing financial transactions between banks that do not have a working relationship. The names will mean something quite similar, but specificities of the country may necessitate doing more research to understand the limitations of both sides.

This has been a guide to a correspondent Bank and its Meaning. Here we discuss how correspondent banks work along with examples and their relationship. You may learn more about our articles below on accounting –

The prime purpose is to act as an intermediary or intermediary between two banks which does not have a working relationship. Being a middleman, they predominantly accomplish domestic and cross-border payments.

The terms indicate different entities. The correspondent connects the issuing or sender’s bank to the receiving bank. They perform services on behalf of another bank, acting as a go-between for the issuing and receiving banks.

Most people use both terms interchangeably. Both are third-party entities supporting activities like international fund transfer and transaction settlements. In some countries, the evaluation of functionalities indicates them as the same concept. At the same time, there are different concepts in other countries based on slight differences. For example, an intermediary provides services in only limited currencies; conversely, correspondents usually offer several currencies.

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