Correspondent Banking and Interbank Accounts

1. Correspondent Banking and Interbank Accounts • To discuss the reasons for international banking • To define correspondent banking relationship • To define Nostro and Vostro accounts • To explain the operations of Nostro and Vostro accounts • To explore the future development in international banking

2. International Banking International banking is the cross-border extension of a bank’s services. There are several reasons for international banking : • Growth – Foreign markets offer opportunities to growth not found domestically. • Diversification – There will be greater stability of earnings due to risk reduction. • Low marginal costs – Managerial and marketing knowledge developed at home can be used abroad with low marginal costs.

3. International Banking • Knowledge advantage – The foreign subsidiary can draw on the parent bank’s knowledge of personal contacts and credit investigations for use in the foreign market. • Regulatory advantage – Multinational banks are often not subject to the same regulations as domestic banks. • Prestige – Large multinational banks have high perceived prestige to attract new clients.

4. International Banking • Wholesale strategy – Banks follow their multinational customers abroad to avoid losing their business at home and abroad. • Retail strategy – Multinational banks compete for retail banking services such as traveller’s cheques, remittance and foreign exchange.

5. Types of international banking presence • Correspondent banks • Representative offices • Foreign branches • Subsidiary and affiliate banks

6. Correspondent Banking Relationship A correspondent banking relationship is established through a bilateral contract with a foreign bank to cooperate in such banking services as money transfer, foreign exchange and trade finance. Banks use correspondent banking relationship to deliver services to customers in markets where the bank has no physical presence. A correspondent bank provides services to a respondent bank. Both banks maintain correspondent balances in each other’s interbank account.

7. Nostro and Vostro Accounts Nostro Account means our account with you. It is also called Due from Bank account. It is an account held by a bank with another bank in a foreign country, usually in the currency of that foreign country. For example, Hang Seng Bank Hong Kong maintains a sterling pound account with Midland Bank London.

8. Nostro and Vostro Accounts Vostro Account means your account with us. It is also called Due to Bank Account. It is an account maintained by a bank for a foreign bank in domestic currency. For example, Midland Bank London maintains a Hong Kong dollar account with Hang Seng Bank Hong Kong.

9. Operations of Nostro and Vostro accounts • Hang Seng Bank’s sterling pound account with Midland Bank has a credit balance of £100,000. Midland Bank’s Hong Kong dollar account with Hang Seng Bank has a credit balance of $900,000.

10. Operations of Nostro and Vostro accounts Hang Seng Bank’s Ledger Due to Midland Bank Account Balance b/f $900,000 Due from Midland Bank Account Balance b/f £100,000

11. Operations of Nostro and Vostro accounts Midland Bank’s Ledger Due to Hang Seng Bank Account Balance b/f £100,000 Due from Hang Seng Bank Account Balance b/f $900,000

12. Operations of Nostro and Vostro accounts • Mr. Wong is a customer of Hang Seng Bank who maintains a sterling pound account and the balance is £50,000. Mr. Wong instructs Hang Seng Bank to remit £20,000 to his daughter Miss Wong in London who maintains a sterling pound account with Midland Bank and the balance is £800. • ABC Company is a customer of Midland Bank and instructs the bank to remit HK$300,000 to XYZ Company which is a customer of Hang Seng Bank.

13. Operations of Nostro and Vostro accounts Hang Seng Bank’s Ledger Due to Midland Bank Account XYZ Company $300,000 Balance b/f $900,000 Due from Midland Bank Account Balance b/f £100,000 Mr. Wong Account £20,000

14. Operations of Nostro and Vostro accounts Hang Seng Bank’s Ledger Mr. Wong Account Due from Midland Bank £20,000 Balance b/f £50,000 XYZ Company Account Due to Midland Bank $300,000

15. Operations of Nostro and Vostro accounts Midland Bank’s Ledger Due to Hang Seng Bank Account Miss Wong £20,000 Balance b/f £100,000 Due from Hang Seng Bank Account Balance b/f $900,000 ABC Company $300,000

16. Operations of Nostro and Vostro accounts Midland Bank’s Ledger Miss Wong Account Balance b/f £800 Due to Hang Seng Bank £20,000 ABC Company Account Due from Hang Seng Bank $300,000

17. Future Development of International Banking • Correspondent banking relationships satisfy the needs of customers for international banking services. Since foreign exchange transactions from the domestic currency incur high costs depending on the foreign exchange spread applied to the payment, a bank may maintain a foreign currency account for its customer and effect payments via its correspondent banking network, While maintaining a foreign currency account for a customer may eliminate much of the foreign exchange cost, it does not necessarily allow for the timely information of reporting both payments from and receipts to the account.

18. Future Development of International Banking • To solve the problems, and as corporate customers have become more internationally astute, a local bank can develop a strategic alliance with a multinational bank to obtain the international cash management (ICM) services. Firstly, the bank can establish a main account in each foreign currency with various sub-accounts. Secondly, receipts and payments are segregated for high volume corporate customers to facilitate reconciliation. Then the bank’s treasury department can also benefit from increased foreign currency deposits.

19. Future Development of International Banking • The prerequisite for this solution is the development of an electronic banking system with multi-currency capabilities. The bank must also be able to map SWIFT messages to and from customer accounts so that the customers can receive real-time account reporting subject to the bank’s cut-off times for different currencies.

20. Future Development of International Banking ICM is an innovative way of looking at correspondent banking. The advantages of ICM are : • There are global expansion opportunities with controlled costs. • It provides a competitive and cost conscious solution to the problems of traditional correspondent banking. • It eliminates the costs of establishing a large branch network in foreign markets.