Correspondent banking explained

Almost every cross-border payment passes through correspondent banks. A bank in one country that wants to pay or receive US dollars, euros or any other foreign currency needs an account with a bank that can settle in that currency. For a new bank, obtaining those accounts is often harder than obtaining the licence itself.

Correspondents and respondents

The CPMI’s 2016 report on correspondent banking cites a standard definition: an arrangement under which one bank, the correspondent, “holds deposits owned by other banks (respondents) and provides payment and other services to those respondent banks”. At its most basic, it requires respondents to open accounts in the correspondent’s books and the two banks to exchange messages to settle transactions by debiting and crediting those accounts.

The correspondent provides access. The respondent uses it on behalf of itself and its customers. Services typically include international transfers, cash management, cheque clearing, loans, letters of credit and foreign exchange.

The CPMI notes that relationships are often reciprocal, each bank serving the other in a different currency. Correspondent banking matters most for cross-border payments, because domestic payments now usually settle through payment systems.

Nostro and vostro accounts

These two terms describe the same account from opposite sides.

Term	Meaning	Whose books hold the account	Example from Bank A’s point of view
Nostro (“ours”)	Our account, held at another bank	The other bank’s books	Bank A’s US dollar account at Bank B in New York is Bank A’s nostro account
Vostro (“yours”)	Another bank’s account, held with us	Our books	Bank C’s euro account at Bank A is, for Bank A, a vostro account

So the account Bank A holds at Bank B is a nostro for Bank A and a vostro for Bank B. Each bank also keeps an internal record of its nostro balance, which it reconciles against statements from the correspondent. The CPMI report calls this internal record a mirror account, kept for accounting purposes.

The term loro (“theirs”) is sometimes used for a third party’s account held at a correspondent. In practice, most banks use nostro and vostro.

How a correspondent payment moves

The CPMI report illustrates a payment from a customer of Bank A to a customer of Bank C through Bank B.

1. Bank A debits its customer’s account.
2. Bank A sends a payment message to Bank B.
3. Bank B debits Bank A’s account on its books.
4. Bank B credits Bank C’s account on its books, or, if Bank C does not hold an account with it, pays Bank C through a payment system in which both participate.
5. Bank B sends a message to Bank C.
6. Bank C credits the receiving customer.

Intermediary banks

When the sending and receiving banks do not share a correspondent, more banks join the chain. These are often called intermediary banks.

Each one adds time, cost, a compliance check and a point of failure. Each also needs enough information in the payment message to screen it, which is the purpose of the travel rule described in the compliance article.

Payments can also be split. In a cover payment, the customer details go directly from the ordering bank to the beneficiary’s bank, while a separate bank-to-bank message moves the funds through the correspondents. The CPMI report noted that both the serial method and the cover method can be used in compliance with AML rules, provided the cover message carries the required information.

Where settlement finally happens

Correspondents settle among themselves in the currency’s payment systems. For euro, the Eurosystem’s real-time gross settlement system is T2, which the ECB says institutions can access as direct participants, as multi-addressees, or through correspondent arrangements. A respondent bank without direct access relies on its correspondent’s participation.

The role of SWIFT

SWIFT, the Society for Worldwide Interbank Financial Telecommunication, operates a messaging network. It carries standardised payment instructions between banks, but it does not hold accounts or move money. Settlement happens on the books of correspondents and in payment systems.

A SWIFT connection and a bank identifier code are therefore necessary but not sufficient. Without correspondent accounts, a bank can send messages but cannot settle foreign currency payments. Major payment systems, including T2, now use the ISO 20022 messaging standard, which carries richer structured data about the parties.

Nested relationships and payable-through accounts

The CPMI report describes two higher-risk variants.

1. Nested correspondent banking. Several banks use one correspondent relationship indirectly, through the correspondent’s direct respondent. The correspondent sees payments from banks it has never assessed.
2. Payable-through accounts. The respondent lets its own customers access the correspondent account directly to transact on their own behalf.

Both make it harder for the correspondent to know whose payments it is processing. The CPMI found that these services were being scaled back, so that traditional correspondent banking dominated the remaining relationships.

What the rules require of correspondents

FATF Recommendation 13 requires correspondents, in addition to normal customer due diligence, to:

1. Gather sufficient information about a respondent to understand its business and determine, from public information, its reputation and the quality of its supervision, including any ML/TF investigation or regulatory action.
2. Assess the respondent’s AML/CFT controls.
3. Obtain senior management approval before establishing new correspondent relationships.
4. Clearly understand the responsibilities of each institution.
5. For payable-through accounts, be satisfied that the respondent has conducted CDD on customers with direct access and can provide it on request.

The FATF also prohibits correspondent relationships with shell banks and requires correspondents to ensure respondents do not let shell banks use their accounts. The FATF glossary defines a shell bank as one with no physical presence in the country in which it is incorporated and licensed, and unaffiliated with a regulated group under effective consolidated supervision. Physical presence means “meaningful mind and management located within a country”, not merely a local agent or low-level staff.

US federal regulation applies the same rule to accounts held in the United States: under 31 CFR 1010.630, a covered financial institution “shall not establish, maintain, administer, or manage a correspondent account in the United States for, or on behalf of, a foreign shell bank”, and must take reasonable steps against indirect use. Because most US dollar payments settle through US banks, this rule matters worldwide.

De-risking and the decline in relationships

De-risking means terminating or restricting relationships with whole categories of customers or countries, rather than managing risk case by case. It became a policy concern after 2011.

The CPMI and SWIFT tracked the trend. The CPMI’s 2020 commentary reported that the number of active correspondent banks worldwide fell by about 22% between 2011 and 2019, while the number of payment corridors fell by about 12%.

The volume and value of cross-border payments continued to grow over the same period, meaning more traffic passes through fewer banks. The CPMI and SWIFT published annual data until the end-2022 data set, fulfilling their commitment to the FSB.

The Financial Stability Board attributes the decline to “industry consolidation, reduced profitability from these activities, overall risk appetites of correspondent banks and various reasons related to AML/CFT or sanctions regimes”. Its four-point action plan, launched in November 2015, covered further analysis, clarification of regulatory expectations by the FATF and Basel Committee, domestic capacity building, and better due diligence tools. In 2018 the FSB also published a stocktake on remittance service providers losing access to banking.

The CPMI report found that correspondents had cut services for respondents that did not generate enough volume to cover compliance costs, were located in jurisdictions perceived as too risky, served customers about whom information was insufficient, or offered higher-risk products or customer types.

Why new banks struggle to get USD and EUR clearing

Every point above applies with extra force to a newly licensed bank.

1. No track record. The correspondent cannot review years of payment data, audit reports or supervisory history.
2. Low initial volume. Onboarding and annual review of a respondent cost the correspondent the same whatever the volume, and a new bank’s early volumes rarely cover them.
3. Jurisdiction risk. Banks licensed in jurisdictions on FATF or EU lists, or with weak recent evaluations, face more scrutiny or refusal.
4. Customer risk. Business models built on non-resident customers, fintech or payment institution clients, crypto-asset firms or high-risk sectors look like nesting to a correspondent.
5. Ownership and management. Opaque ownership or managers without banking experience fail correspondent due diligence even if they passed licensing.
6. Concentration among providers. With fewer correspondents active in each currency, a refusal from one or two can close the market.

How applicants improve their chances

1. Plan correspondent access before applying. A business plan that depends on foreign currency payments needs a credible answer on how they will settle, and supervisors will test it.
2. Start with a regional correspondent. A respondent can build a record with a regional bank before approaching global dollar or euro clearers.
3. Prepare a full due diligence pack. Ownership charts to natural persons, licences, AML policies, risk assessment, audit results, and the industry questionnaires correspondents use.
4. Keep the customer model clear. Explain whose payments will flow, and avoid offering accounts to other banks or payment firms until controls are proven.
5. Diversify early. Two correspondents per major currency reduce the risk that one termination halts the business.

The next article covers the systems behind all of this: core banking platforms, outsourcing and technology regulation.