In this example, Bank A and Bank B hold ‘nostro’ and ‘vostro’ accounts with each other.
The message from Bank A requests Bank B to debit the US Dollar account they hold with them to pay the recipient at their bank in the USA (which may be the same or a different bank). Bank A transfers the Brazilian Real 1,000 from the payer’s account and credits Bank B’s account with them. Bank B makes the payment to the recipient’s bank account and confirms that it has been done.
If Bank A and Bank B don’t hold accounts with each other they must use an intermediary bank where they both hold accounts. This is called a correspondent bank, and banks usually have a global network.
The more correspondent banks that are involved, the slower and more expensive it will be. For currency pairs with high volumes of payments (US dollar and British pounds sterling) there will be a shorter chain. For transactions where the currencies have lower volumes, it can mean that there are more correspondent banks involved, meaning that the transaction takes longer and costs more.
This diagram below shows how a Correspondent bank is involved in the transaction. Essentially, two sets of different ‘nostro’ and ‘vostro’ accounts are used to complete the transaction.
Bank A messages the Correspondent bank, moving R1,000 from the payer’s account to the Correspondent bank’s account that they hold, instructing them to pay Bank B in Nigeria 75,000 Naira. Having confirmation that Bank A has moved funds into their account they transfer funds into Bank B’s account with them and message them to pay the recipient’s bank in Nigeria.
During normal business hours, each correspondent bank in the chain takes a fee for checking and processing the message and transaction, updating balances in accounts that move the transaction along the chain.
As a result, international payments are slower than domestic ones, cost more and are more difficult to make. Sometimes, the payment may take several days and cost ten times more than a domestic transaction. Additionally, the sender or receiver may have little or no visibility of how the transaction is proceeding.
The key frictions in cross-border payments include: