The term “correspondent banking” is defined as informal arrangement whereby a smaller bank maintains deposit balances with larger banks in nearby cities and looks to them for a wide variety of services and assistance.
Another writer has described “Correspondent Banking” as an informal linkage between banks in different countries set up when banks maintain correspondent accounts with each other.
A third description of “correspondent banking” states that the home country bank will aim to provide overseas services for its own customers by using an overseas correspondent bank as agent.
As in international trade and payments world over require services of another bank in that particular country and it is not possible for a bank to have branches all over the world thus the need for correspondent banking.
Major articles in an agreement signed with a foreign correspondent would usually include:
1. Types of transactions covered; i.e. remittances, letters of credit and collections.
2. According arrangements; i.e. which account will be debited for payments and which account to be credited for receipts. e.g. for pound sterling transactions an account in that currency would be needed and for dollar transactions an account in dollars would be needed.
3. control documents; details would be specified regarding “test keys” and signature book-lets. Swift code.
4. dispatch of statement of account; there would be clear instructions regarding dispatch of statement; whether daily, weekly or monthly, by mail or by fax etc.
5. whether the remittance instruments e.g. drafts are to be followed by an advice or a tested cable for a large amount payment; also whether the drafts would be singly signed or by two persons;
6. The interest rate to be specified, whether the account will be allowed to be overdrawn; if so, to what extent and what will be the rate of interest to be charged on overdrawn balances.
7. Any service charges; per entry in the account or per page etc.
Nostro accounts mean “our account with you”. For effecting any payment or receipt of funds in another country, maintaining a nostro account is a basic requirement. Such nostro accounts are maintained in various currencies in which major transactions take place, mostly the nostro accounts are in US dollar Pound Sterling, Deutsch Mark, French France and Japanese Yen, etc.
If a transaction involves a currency for which there is no nostro account, then its payment would be effected in equivalent so many units of a currency in which the bank has a nostro account. E.g. if a bank in Pakistan wishes to make payment in Italian Lira and it does not have an account in this currency, it would buy Italian Liras and make payment in equivalent US Dollars.
However as majority of transactions are denominated in US Dollars, most banks in Pakistan maintain nostro accounts either with their own branches in USA or if they do not have a branch then with foreign correspondent a Dollar account is maintained to which debits and credits for Dollars related transactions are put through.
The SBP fixes limits for maintaining balances in Nostro accounts and SBP usually calls for daily balances held in such accounts. The limit is usually for total amount held abroad and would include balances of all accounts held in any currency. The credits to nostro accounts are treated as inward remittances and any balance exceeding the nostro limit has to be surrendered to SBP through sale in the interbank market.
Vostro account means “your account with us”.i.e. account of foreign correspondent maintained with banks in Pakistan. Usually such accounts are nonresident rupee accounts, which are exclusively fed with remittances from abroad in foreign currency converted to Pak rupees or by transfer from another nonresident rupee account. Debits to such accounts constitute inward remittances and credits constitute outward remittances. banks in Pakistan are allowed to freely open any correspondent’s nonresident rupee account and no SBP permission is required. No interest is allowed on credit balances of such accounts. However, in case of overdrawn balances, banks in Pakistan usually charge interest; the rate depending on arrangements.
For effecting of an inward rupee denominated remittance, the nonresident rupee account of a foreign correspondent will be debited.