Introduction to Correspondent Banking (2024)

Contents

What is an example of Correspondent Banking?

An example of correspondent banking is when a bank in one country provides banking services to a bank in another country.

For instance, if a bank in the UK has a correspondent banking relationship with a bank in Japan, the UK bank can use the services of the Japanese bank to process transactions in yen, such as payments to Japanese beneficiaries or to execute trades denominated in yen.

The Japanese bank, in turn, can use its correspondent banking relationships with banks in other countries to process transactions in foreign currencies, such as euros or dollars, on behalf of its customers.

Given that more than50% of international trade transactions worldwide are invoiced in US dollars– even when US firms are not involved in the transaction – correspondent banking is a critical tool for the functioning of the global trading system.

Another example of correspondent banking in action is when a bank in a developing country does not have the resources or expertise to provide a specific service, such as trade finance.

In this instance, it may establish a correspondent banking relationship with a larger bank in a developed country with the necessary resources and expertise to provide the necessary service.

This allows the developing country bank to offer its customers access to trade finance services, without the bank developing the capabilities in-house.

Why is Correspondent Banking needed?

Correspondent banking is needed for several reasons:

• Access to foreign markets: Through correspondent banking, banks can access services offered in other countries, facilitating cross-border transactions. This is a critical function given that most international trade transactions – regardless of the nations involved – are conducted in the United States Dollar.
• Payment processing: Correspondent banking facilitates creates a more efficient international trades and investments by allowing banks to process payments and settle transactions in foreign currencies.
• Risk mitigation: Foreign exchange fluctuation, compliance with local regulations, and settlement risks can all be mitigated through correspondent banking.
• Liquidity management: By providing access to foreign currency funding and credit lines, correspondent banking can assist banks in managing liquidity.
• Supplemental services: Correspondent banking enables smaller and regional banks – who may lack the resources or expertise in specific areas – to offer a broader range of services to their customers

How does Correspondent Banking work?

Correspondent banking involves a relationship between a correspondent bank and a respondent bank.

The respondent bank typically has a customer that needs to send or receive funds in a foreign currency or execute a trade in a foreign market. The correspondent bank has a presence or relationship in that market, which allows it to facilitate the transaction on behalf of the respondent bank.

Correspondent banking transactions generally follow a similar set of steps:

1. A respondent bank receives a request from a customer to execute a transaction in a foreign currency or foreign market.
2. The respondent bank does not have a presence or relationship in that market, so it contacts a correspondent bank that does.
3. The correspondent bank agrees to facilitate the transaction on behalf of the respondent bank and provides the necessary services, such as processing the payment or executing the trade.
4. The correspondent bank charges a fee for its services, usually paid by the respondent bank or passed on to the customer.
5. Once the transaction is completed, the correspondent bank informs the respondent bank of the outcome, and the funds are settled between the two banks.

Correspondent banking relationships are often subject to extensive regulatory oversight to mitigate risks such as money laundering or terrorist financing. The regulatory requirements may include conducting due diligence on each other, monitoring transactions for suspicious activity, and complying with local regulations.

What are the examples of Correspondent Banks?

There are countless examples of correspondent banks around the world. Among the most well-known and largest correspondent banks are:

Through there are correspondent banking relationships with other banks worldwide, these banks are able to provide a range of banking services to their customers worldwide.

There are other banks that operate as correspondent banks, such as Asian, Middle Eastern, and Latin American regional banks that serve their local markets and provide correspondent banking services to banks elsewhere.

While some transactions may have both a correspondent and a respondent bank, in others these functions can both be filled by the same institution

When do you need to use a Correspondent Bank?

There are many different situations in which a correspondent bank needs to be used. These situations include:

• International payments: If you need to make a payment in a foreign currency, and your bank does not offer that currency or does not have a presence in the beneficiary’s country, a correspondent bank will be needed to facilitate the payment.
• Trade finance: If you are involved in international trade, a correspondent bank may need to provide trade finance services, such as issuingletters of creditor providingguarantees.
• Foreign currency transactions: If you need to convert funds to another currency and your bank does not offer that currency, a correspondent bank may be needed to provide the foreign currency.
• Clearing services: The process of settling financial transactions between two or more banks, typically involving the verification of the transaction and the transfer of funds.
• Access to foreign markets: A correspondent bank may be necessary if you want to expand your business in a foreign market.
• Risk mitigation: If you want to mitigate risks associated with international transactions, such as compliance with local regulations or managing settlement risks, a correspondent bank with a presence in that market may be required.

In summary, a correspondent bank is often required when your bank does not offer the necessary services or has a limited presence in a foreign market. Through the process of correspondent banking, your business may be able to gain access to a range of banking services in different markets that your bank alone may not be able to provide.

When expanded to the global scale, it is clear how correspondent banking is an integral part of international banking.

The evolution of Correspondent Banking: Building a more inclusive network to connect the world

At the 2023 BAFT Global Annual Meeting, industry experts gathered to discuss the changes they’ve noticed in the correspondent banking industry, the challenges they face, and what practices should be adopted moving forward. Read the full articlehere.

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