What role does a correspondent bank play in an international transaction?

A correspondent bank is most typically used in international buy, sell or money transfer transactions to facilitate foreign currency exchange and payments.

A correspondent bank is a bank in one country that is authorized to provide services for another bank or financial institution in a foreign country. The most common services provided by a correspondent bank are currency exchange, handling business transactions and trade documentation, and money transfers.

Correspondent banking works through an agreement between a foreign and domestic bank where a correspondent account, usually referred to as a vostro or nostro account, is established at one bank for the other. Correspondent banking typically involves the two banks establishing reciprocal accounts with each other. These accounts are established to enable the domestic bank to make payments or money transfers on behalf of the foreign bank.

Such correspondent accounts enable banks to handle international financial transactions for their customers that ordinarily require foreign currency exchange, such as those that commonly occur between an exporting business in one country to an importer in another country.

The process typically works as follows: A customer of a bank in one country needs to pay for products purchased from a supplier in another country. The customer's domestic bank determines the necessary foreign currency exchange transaction to facilitate appropriate payment in the currency of the seller. It deducts the appropriate amount from the customer's account, then instructs its correspondent bank in the supplier's country to pay out the corresponding amount to the supplier in the supplier's currency from the domestic bank's correspondent account with the foreign bank. (For related reading, see: What is the difference between a nostro and a vostro account?)