What Is a Correspondent Bank?

Chances are that you don’t think about the banks involved when you’re giving money to a friend. That can be especially true if you’re using a service like Venmo or PayPal to transfer money. Just like you may use a service like Venmo to move money, banks have their own ways of moving money. When a bank needs to transfer money to another bank internationally, they turn to a correspondent bank to make the connection.

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What Is a Correspondent Bank?

A correspondent bank is an intermediary that provides services to banks transferring funds across borders. Correspondent banks act as third parties to facilitate payments between international and domestic banks. Transactions such as international wire transfers, global investments and currency exchanges are often aided by correspondent banks.

Because banks can’t open branches everywhere, correspondent banks play an essential role in connecting different banking systems. For instance, a local bank in Duluth, Minnesota, may not have a partner in Tokyo, Japan. By using a correspondent bank, the bank in Duluth can transfer funds to a bank in Tokyo, as well as participate in Japanese financial markets.

How Do Correspondent Banks Work?

Correspondent banks specialize in relationships. They have established relationships with domestic and international banks. Typically, a domestic bank will utilize a correspondent bank when a transfer begins or ends across borders. You can think of them as the middle person allowing these banks to process transactions.

As a middle person between domestic and international banks, a correspondent bank can help you when banking internationally. They work at the local level to help you make withdrawals/deposits, transfer funds and process documentation.

How Banks Transfer Money Across Borders

SmartAsset: What Is a Correspondent Bank?

Correspondent banks use a secure network, like SWIFT (The Society for Worldwide Interbank Financial Telecommunications), to transfer these funds. SWIFT is a global messaging network of 11,000 financial institutions which banks can use to send instructions, such as details for wire transfers.

They also keep what are called nostro and vostro accounts. “Nostro” and “Vostro” are Latin words that translate literally to “ours” and “yours.” They’re the same account but recorded differently by each bank involved in the funds transfer. “Nostro” is used by the bank sending the funds, saying, “this is our money on deposit at your bank.” “Vostro” is the inverse: “your money at our bank.”

Currency is an essential aspect of nostro and vostro accounts. With a nostro account, a correspondent bank holds a domestic bank’s money in a foreign currency. With a vostro account, the correspondent bank holds a domestic currency for a foreign bank.

Example Transaction

Let’s work through an example to further understand the correspondent bank’s role. Say you own an electronics company in Duluth, Minnesota. You establish a contract with a manufacturer in Taiwan, and you need to wire money to them. You go to your local bank to send this money, and here’s where the correspondent bank comes in.

Your bank doesn’t have a connection to any bank in Taiwan. They contact a correspondent bank to send the funds. The correspondent bank takes your U.S. dollar and works with the Taiwanese to make the funds available to the manufacturer as a New Taiwan Dollar.

Keep in mind that it’s important to understand currency risk with especially large currency exchanges.

Do Correspondent Banks Charge Fees?

You may be well aware of the fees associated with banking internationally. You may not know that most of those fees come from correspondent banks. For their services, correspondent banks charge a fee. This fee is passed on by the domestic bank to the client.

Per transaction, you can expect to see a fee ranging from $15 to $75. The difference in fees depends on where the transfer is coming from or going to, the type of currency exchange and whether it’s an online transfer. Your bank may just charge you what the correspondent bank is charging them, or they may include a fee of their own as well.

Bottom Line

Correspondent banks offer a valuable service to domestic banks, facilitating the transfer of funds internationally. Their established relationships with foreign banks allow them to complete transactions such as currency exchanges, wire transfers and more. They use the SWIFT network to make these transfers and establish nostro and vostro accounts to keep track of them.

These services don’t come free. The fees you’re charged by your bank to send money across the border are often the same fees they’re charged by the correspondent bank. Your bank may even charge an additional fee of its own.

Tips for Personal Finance

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If you do business in a specific country, opening an offshore bank account may make sense. They allow you to hold money outside your home country for various purposes. Other reasons to open an offshore bank account include if you’re paid for work in a foreign currency, hold property or investments in another country or are planning to retire abroad. Offshore bank accounts can offer a tax-advantaged way to save money for investors while keeping your money secure.