What is a correspondent bank?
A correspondent bank is a third-party financial institution that enables domestic banks to conduct cross-border transactions and access foreign financial services without opening branches abroad. It performs payments, settlements, wire transfers, check clearing, currency exchanges, and other treasury services on behalf of client banks in different jurisdictions.
Key takeaways
- Correspondent banks let domestic banks serve international clients and access foreign markets without physical branches.
- They manage nostro and vostro accounts to record cross-border debits and credits.
- Most international transfers route via networks such as SWIFT, using correspondent relationships to reach destination banks.
- Correspondent banking can carry elevated compliance and money‑laundering risks because it relies on the respondent bank’s KYC controls.
- Intermediary banks typically handle single‑currency legs of a payment; correspondent banks often support multiple currencies.
How correspondent banking works
- A domestic (originating) bank that lacks a direct relationship with a foreign receiving bank identifies a correspondent bank that maintains accounts with both parties.
- The originating bank sends funds to its account (nostro) at the correspondent bank.
- The correspondent bank deducts any applicable fees and forwards the funds to the receiving bank, or instructs settlement via its accounts.
- Both banks reconcile debits and credits through their respective nostro/vostro ledgers.
Example: If a San Francisco bank needs to wire money to a bank in Japan but has no direct tie, it will use a correspondent bank that has relationships in both countries and can execute the transfer over SWIFT.
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Nostro and vostro accounts (brief)
- Nostro account — “our account on your books”: the originating bank’s account held at the correspondent bank.
- Vostro account — “your account on our books”: the correspondent bank’s record of the originating bank’s balance with it.
Both are used to track international debits, credits, and fees between correspondent partners.
Value provided by correspondent banks
- Avoids the cost and regulatory complexity of opening foreign branches.
- Saves the effort of negotiating direct bilateral arrangements with numerous foreign banks.
- Enables access to multiple currency corridors, liquidity, and local clearing systems.
Typical costs
Correspondent banks charge fees for processing and settlement. Fees vary by route and service; small transfers may incur modest fixed fees (commonly in the low tens of dollars, though amounts vary by provider and country).
Risks and compliance challenges
- Reliance on the respondent bank’s Know Your Customer (KYC) and anti‑money‑laundering (AML) controls creates heightened risk for correspondent banks.
- Monitoring and transaction screening are critical; weak controls can expose correspondents to illicit flows and regulatory penalties.
- Regulators and correspondent banks often require enhanced due diligence, transaction monitoring, and periodic reviews of respondent relationships.
Choosing a correspondent bank — key considerations
- Compliance standards and AML/KYC robustness.
- Coverage of required currencies and geographic corridors.
- Operational reliability, processing speed, and settlement risk.
- Fee structures and transparency.
- Access to payment networks (e.g., SWIFT) and local clearing systems.
Correspondent bank vs intermediary bank
- Correspondent bank — usually handles transactions across multiple currencies and provides broader treasury and clearing services.
- Intermediary bank — typically used for a single‑currency leg in a payment chain, acting as an intermediate connector rather than providing full correspondent services.
Conclusion
Correspondent banks play a crucial role in international banking by enabling cross‑border payments and foreign market access for domestic banks without the need for overseas branches. They provide operational convenience and currency reach but require careful selection and strong compliance practices to manage AML and operational risks.