how a correspondent bank works
correspondent banks are third party banks they act as middlemen between different financial institutions as such they provide treasury services between sending and receiving banks especially those in different countries services can include correspondent banks may also act as agents to process local transactions for clients when they are traveling abroad at the local level correspondent banks may accept deposits process documentation and serve as funds transfer agents the accounts held between correspondent banks and the banks for which they provide services are referred to as nostro and vostro accounts an account held by one bank for another is referred to by the holding bank as a nostro account or our account on your books the same account is referred to as a vostro account your account but on our books by the counterparty bank generally speaking both banks in a correspondent relationship hold accounts for one another for the purpose of tracking debits and credits between the parties a correspondent bank must act as the middleman when sending and receiving banks don t have agreements in place for wire transfers correspondent banks are a pivotal part of the financial industry as they provide a way for domestic banks to operate when it isn t feasible for them to open branches in a different location especially in another country for instance a small domestic bank with clients in different countries can partner with a correspondent bank to meet the needs of its client internationally doing so also gives it access to the foreign financial market the correspondent bank will therefore charge a fee for this service which is usually passed off from the domestic bank to the customer special considerationsinternational wire transfers often occur between banks that don t have an established financial relationship for example a bank in san francisco that receives instructions to wire funds to a bank in japan can t wire funds directly without a working relationship with the receiving bank most international wire transfers are executed through the society for worldwide interbank financial telecommunication swift network knowing there isn t a working relationship with the destination bank the originating bank can search the swift network for a correspondent bank that has arrangements with both banks upon finding a correspondent bank having arrangements with both sides of the transfer the originating bank sends the transferred funds to its nostro account held at the correspondent bank 2using the example above the correspondent bank deducts its transfer fee usually between 0 and 50 and transfers the funds to the receiving bank in japan in transactions such as this the correspondent bank adds value in two ways correspondent banking poses some risk management challenges because the correspondent bank relies on its customer the respondent bank to perform know your client kyc due diligence on its customers 3reliance on a third party s compliance program rather than conducting kyc on all customers for whom the respondent bank is processing payments through the correspondent bank is why this activity is generally considered to be high risk from a money laundering perspective 4correspondent bank vs intermediary bankalthough there are some similarities between both correspondent and intermediary banks namely that they act as third parties for other banks there is a major difference between the two while correspondent banks normally handle transactions involving multiple currencies an intermediary bank completes transactions involving only a single currency they are especially key for domestic banks that may be too small in size to handle these types of transactions 