What it means
The problem correspondent banking solves is straightforward. A mid-sized bank in one country cannot hold accounts at every central bank in the world, so it keeps accounts with larger banks that can.
When a customer sends money abroad, the sending bank instructs its correspondent to pay the beneficiary's bank at the other end. Two pieces of jargon come up constantly.
A nostro account is the account your bank holds with a foreign bank in that foreign currency, literally your money held by them; a vostro account is the mirror image, their money held by you. Both sides reconcile these balances daily, and unexplained differences are chased hard.
Costs pile up because a payment may pass through several hands. The sending bank charges a fee, each intermediary may deduct its own, and the currency conversion carries a spread that is usually larger than the visible fees.
This is why a $50,000 transfer can arrive several hundred dollars lighter than the sender expected. Compliance is now the dominant issue in this business.
Correspondent banks must understand not only their client bank but something about that bank's own customers, because they are the gateway through which sanctioned or laundered money could enter the system. Enforcement failures have produced very large fines, which is why many global banks have exited relationships in higher-risk markets, a trend known as de-risking.
For a finance team the practical implications are timing and traceability. Payments routed through several correspondents take longer, can be held for compliance checks, and are harder to trace when they go astray.
Newer settlement networks and regional payment schemes are shortening these chains, but for most currency pairs the correspondent model still does the work.
In practice
Real-world examples.
Example
A community bank with 14 branches and no overseas offices maintains euro and sterling nostro accounts with two large international banks. When a customer pays a supplier in Germany, the community bank debits the customer, instructs its euro correspondent to make the payment, and reconciles the nostro balance the next morning.
Example
An importer complains that a $120,000 payment arrived $310 short. Tracing the transaction shows one intermediary correspondent deducted a $35 handling charge and the beneficiary bank took a $25 receiving fee, with the balance explained by the exchange rate applied, and the importer renegotiates so that all charges are borne by the sender.
Example
A global bank reviews its correspondent relationships in a region where sanctions exposure has risen and closes accounts for four smaller client banks. Those banks must find a replacement or route payments through a regional clearing scheme, and their customers face longer settlement times in the meantime.
Formula
Calculation
Formula: Total cost of a cross-border payment = Sending bank fee + Intermediary fees + (Amount x FX spread)
Worked example. Delaney Foods sends $50,000 to an overseas supplier. Its own bank charges a $25 outward payment fee, one intermediary correspondent deducts $15, and the exchange rate offered is 0.8% worse than the mid-market rate.
Visible fees: $25 + $15 = $40.
Foreign exchange cost: $50,000 x 0.008 = $400.
Total cost: $400 + $40 = $440, which is $440 / $50,000 = 0.88% of the payment.
Only $40 of that appears on a statement as a fee. The remaining $400 is taken inside the exchange rate, because the $49,960 left after fees is converted at a rate 0.8% below the mid-market benchmark, giving the supplier about $400 less local currency than a mid-market conversion would have provided.
Twelve payments of this size a year cost $440 x 12 = $5,280, which is usually enough to justify negotiating a fixed spread with the bank or opening a foreign currency account.Case study
Seen in the real world.
The following is a fictional and illustrative example. Ashford Textiles, an invented importer, paid roughly 60 suppliers across three countries and made about 200 international payments a year, averaging $18,000 each. Its bank quoted a $20 fee per payment, which the finance director considered reasonable, and the company had never examined the exchange rates applied.
In this illustrative review, the finance team compared each conversion against the mid-market rate published on the payment date and found an average spread of 1.1%. On $3,600,000 of annual payments that came to $39,600 of hidden cost, against $4,000 of visible fees, so the true annual cost was $43,600 rather than the $4,000 that appeared in the bank charges account.
Ashford negotiated a tiered spread of 0.35% on payments above $10,000 and opened a single foreign currency account so that receipts in one currency could fund payments in the same currency without conversion. The invented company estimated the combined saving at about $27,000 a year, achieved with no change to suppliers, systems or payment timing.
Watch out
Common mistakes.
- Believing the transfer fee is the whole cost. The exchange rate spread is normally several times larger than the stated fee and does not appear as a separate charge anywhere.
- Assuming a payment travels directly between the two banks named on the instruction. Most cross-border payments pass through one or more intermediaries, each of which can deduct a charge and add a day.
- Confusing a correspondent bank with a branch. A correspondent is an independent bank acting under an agreement, not part of the same group, which is why its compliance checks can hold up your payment.
Questions
People also ask.
What are nostro and vostro accounts?
Nostro is the account your bank holds with a foreign bank in foreign currency, and vostro is the account a foreign bank holds with you in your currency; they are two views of the same relationship.
Why do some international payments take three days?
Time zones, cut-off times and compliance screening at each institution in the chain add delay, and a payment routed through two intermediaries has three sets of checks to pass.
How can a business reduce correspondent banking costs?
Consolidate payments into fewer, larger transfers, negotiate the exchange rate spread explicitly, hold accounts in the currencies you trade in, and specify clearly who bears the charges.
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