Definition
A correspondent bank is a financial institution that provides services on behalf of another bank, usually in a different country. These services typically involve the facilitation of transactions and deposits, international fund transfers, and foreign currency exchange for the bank’s customers. The relationship between the two banks is built through reciprocal agreements and ensures that a bank’s customers can access financial services in international regions where the bank does not have a physical presence.
Examples
Example 1: International Fund Transfers
A U.S.-based bank has a customer who needs to transfer money to a supplier in Italy. The U.S. bank uses a correspondent bank in Italy to complete this transaction, leveraging the foreign bank’s network and facilities to ensure the money reaches the supplier’s account efficiently.
Example 2: Multi-Currency Account Management
A European bank maintains accounts in multiple currencies through its correspondent banking relationships with banks in the United States, Japan, and Australia. This allows the European bank to provide multi-currency services to its customers, such as foreign currency transactions and overseas investments.
Example 3: Trade Finance
A company in Canada imports goods from Japan. The Canadian company’s bank partners with a correspondent bank in Japan to manage the import documentation, payment processing, and letter of credit arrangements, facilitating smooth international trade.
Frequently Asked Questions (FAQs)
What are the main services provided by correspondent banks?
Correspondent banks typically provide services such as international fund transfers, foreign exchange transactions, cheque clearing, trade finance services, and multi-currency account management.
How do correspondent banks make money?
Correspondent banks earn fees for the services they provide, including transaction fees, processing fees, and currency exchange fees.
Do all banks have correspondent banks?
Not all banks have correspondent banks; typically, larger or internationally-active banks establish multiple correspondent banking relationships to facilitate international transactions for their customers.
What is the difference between a correspondent bank and a subsidiary?
A correspondent bank is an independent financial institution entering into an agreement to provide services, while a subsidiary is a branch or a unit of a parent bank located in a different country.
Are correspondent banking relationships regulated?
Yes, correspondent banking relationships are subject to regulatory oversight to ensure compliance with anti-money laundering (AML) and counter-terrorist financing (CTF) regulations.
Related Terms
Nostro Account
A bank account that a bank holds in a foreign currency in another bank. This is used to facilitate international transactions and manage foreign currency exchange.
Vostro Account
An account that a domestic bank holds for a foreign bank in the domestic bank’s currency. This serves a similar purpose to a nostro account but from the perspective of the domestic bank.
Anti-Money Laundering (AML)
Laws, regulations, and procedures that are designed to prevent the illegal practice of generating income through processed criminal activities.
SWIFT (Society for Worldwide Interbank Financial Telecommunication)
A network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized, and reliable environment.
Online Resources
- Investopedia on Correspondent Banks
- Federal Financial Institutions Examination Council (FFIEC)
- SWIFT (Society for Worldwide Interbank Financial Telecommunication)
Suggested Books for Further Studies
- “International Banking: Text and Cases” by Jane Elizabeth Hughes and Scott B. MacDonald
- “The Essentials of Risk Management” by Michel Crouhy, Dan Galai, and Robert Mark
- “Money Laundering: A Guide for Criminal Investigators” by John Madinger
Accounting Basics: “Correspondent Bank” Fundamentals Quiz
Thank you for exploring the concept of correspondent banking and testing your understanding with our informative quiz. Keep deepening your financial knowledge!
