Classification: Restricted

Correspondent banking = provision of banking services – by one bank

(correspondent) to another bank (respondent) in order for the respondent
bank to conduct transactions either for itself or for its customers in
jurisdictions where it does not have the license to operate (provide
financial services) or lacks a physical presence.

Usage/importance of correspondent banking for banks:

Facilitation of international trade

Global liquidity management: to manage liquidity across diff currencies

and regions. Banks maintain nostro accounts with correspondent banks to
keep foreign exchange currency balance available for international
transactions.

Correspondent banking is also known as foreign correspondent banking.

Significance of nostro accs:

1. CBTs: nostro accounts provide a platform for two banks domiciled in

two diff countries to exchange pmts. For example, Pakistani banks
need to pay to a bank in Saudi, can make payments in following
ways etc.
2. Liquidity management: Pakistani banks hold customer deposits in
foreign currencies known as (fe-25) kept in overseas nostro
accounts – utilize to invest, make overnight returns, and utilize for
day to day operations. Banks also maintain nostro acs in foreign
currencies where they have regular transaction flow and manage
liquidity in these acs to meet operational requirements.
3. VAS: nostro accs – b2b arrangements, highly customizable. Global
correspondent banking provides VAS (additional features) 1. Cross
currency payments: the option to pay/receive in multiple currencies
from an account maintained in single base currency. 2. Intraday and
overdraft facility: option can make payments from ac acc despite
insufficient funds. Overdraft arrangements are pre-agreed b/w
customer and provider.
4. VAM (virtual acc management): option to maintain various sub
accounts under one main physical account used to streamline
separate lines of business for a customer – helps in reconciliation

PAYMENT SETTLEMENT MECHANISM:

1. Book transfer – more efficient, real time, less costly, offer greater
control over visibility of transaction
2. Clearing house – sender and receiver maintain accs in same
jurisdictions but diff banks, settle pmt through clearing house.
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Additional time, costly (additional housing fee), liquidity cost, less

flexibility as more actors is involved in the payment chain.

INTERNATIONAL PAYMENT SYSTEMS:

1. RTGS – immediate settlement: transactions are processed in real

time. Owned and operated by a central bank. RTGS costly in terms
of fees, need to maintain higher liquidity levels to settle
transactions. Example: PRISM (PK) and Fedwire (US)
2. Net Settlement Systems: consolidates all pending payments into
fewer single transactions. For ex: bank a needs to pay bank b 1.2
million and bank b needs to pay bank a 800k, net settlement system
aggregates this into a single payment of 400k from bank a to bank
b. usually, privately owned by participating banks. Pros: netting
engines are cost effective in terms of charges and liquidity required.

SWIFT – not a pmt system, a messaging network, allows banks to

communicate w each other, using standardized messaging formats.
Member owned (cooperative) est 1973 belgium, 25 directors on board of
SWIFT, representing most active banks on network. Irrevocable unless
receiving bank declines to act on the message. Message types are
different from initiation, amendment, or cancellation of a transaction.

SWIFT CODE – BIC business identification code: 8 letter identifiers for each
bank to ensure accurate routing of messages. Branch code (optional)
helps bank in internally routing messaging across branches and
departments

RMA -relation management application: swift permission based,

authorized to receive from one bank to the other. Banks can restrict RMA
by not issuing authorization or by issuing rma with restricted message
types

MT1xx series: customer payment and collections

MT103 – single credit transfer bw customers – commercial payments /

serial

MT2xx series: financial institutions transfer

MT200 – financial institutions transfer for its own account: request for
movement of sender’s funds to its account at another financial institution
 Classification: Restricted

MT202 – general financial institution transfer – request for movement of

funds bw financial institutions except if transfer is related to underlying
customer credit transfer use MT 202 COV. Used for Liquidity transfers,
forex, internal treasury.

MT9xx series: cash management and customer status

MT900 debit confirmation, MT 910 credit confirmation, MT 940 provides

balance and transaction details of an acc to a financial institution on
behalf of customer, MT 950 same as others but details are provided to the
accounting

MT202 BANK TO BANK TRANSFERS – TREASURY PMTS:

Instructs movement of funds between two financial institutions, often as

part of larger chain of correspondent banking transactions – does not
involve payment for corporate or individual customers directly. Commonly
used to settle preexisting transactions and obligations bw banks in
context of correspondent banking, identified through pmt reference
numbers

TRADE PAYMENT CYCLE:

Meezan bank sends MT 202 message to its correspondent bank (our

nostro account) standard chartered. The bank debits Meezan's nostro
account and initiates next leg of payment by sending MT 202 message to
beneficiary bank's correspondent. The beneficiary's bank (JP Morgan) also
maintains nostro account at another US based correspondent bank (BNY
Mellon) The funds are credited to this after cleaning, making them
available to the beneficiary.

MT 103: used by a bank instructing transfer of funds on behalf of its

customer to a beneficiary customer of another bank. Message contains
details of beneficiary, remitter and purpose of payment. High risk
payment type. All banks involved recover their charges such as BEN, SHA,
OUR. Various methods to recover charges such as deduction, billing or
direct debit.

MT103 Serial Payment process for cross border customer to customer

international transfer of funds process:

Remitter initiates request of international payment through their local

bank (Remitter's Bank) in this case Meezan bank. Meezan does not have
direct relationship with beneficiary's bank (JP Morgan) so it routes
payment via nostro account at standard chartered (its correspondent
 Classification: Restricted

bank). Meezan sends MT 103 swift message. Payment must clear through
US Federal reserve (clearing house). The funds then move from Standard
Chartered to Beneficiary's Nostro account, BNY Mellon which sends MT
103 to JP Morgan. The funds are now credited to beneficiary's account.

CBT Challenges:

1. Time consuming: normally takes min of next day for the beneficiary
to receive the payment as banks would only process the pmt once
they’ve seen the credit in their end of day account statement.
2. Uncertainty of charges there are several banks – involved in pmt
chain – deductions and charges can not always be known – adding
uncertainty to charges while also making it costly
3. Risk of conversion: conversions don’t always happen at the
beneficiary bank’s end thus resulting in unnecessary exchange
losses. There can be double fx losses where beneficiary’s account is
in foreign currency and the beneficiary bank must reconvert the
transaction before final credit

DODD FRANK ACT 2010

Regulates international remittances sent by US consumers to foreign

recipients. Before transaction is initiated – full disclosure of cost, exchange
rate, fees and amount recipient will receive. Cancellation rights – senders
have cancellation rights within 30 mins after payment, financial institution
shall make full refund. Institutions that provide more than 100
international transactions per year – applied. Wire transfer and other
electronic transfers (Western Union). Upfront fees – charged to sender of
wire transfer. Foreign transaction fees – charged to receiving institution or
intermediary bank during transfer.

CROSS BORDER FX PAYMENT OPERATIONS

Import/export customers may need to conduct trade with non major

currencies such as SEK, banks may use their USD correspondent services
to cater to these customers or open nostro accounts in third currencies to
market this business. Benefits: control payment execution process, better
FX rates to customers since they will buy locally, expanded correspondent
network in a country. Costs: associated w maintaining and opening nostro
accounts, cost of liquidity, operations, 2-way kyc due diligence of
additional correspondent rs.

MT 202 Misuse: before MT 202 COV banks used MT 202 for settling
customer transactions without disclosing customer names, misuse=a
sanctioned individual from a high-risk country sends money. his bank
 Classification: Restricted

(remitter's bank) sends MT 103 to the beneficiary's bank, but the

settlement is sent vis MT 202 without customer names. Intermediary
banks could not screen names as MT 202 only lists sending and receiving
banks, not remitter or beneficiary. Thus, a bank like BNY Mellon could
unknowingly transfer funds on behalf of a sanctioned person.

Fintech challenge: offer lower fees, better exchange rates, instant

transfer, convenient apps, transparency of fees, secure services, global
reach.

SWIFT GPI (GLOBAL PAYMENT INNOVATION) messaging service,

revoluntizes speed, transparency, and tracking of Cross border payments.
Within mins to few hours, real time tracking of payment status, includes
transparency of fees, exchange rates applied. UETR (Unique end to end
transaction reference) provides tracking number for every GPI transaction,
both sender and recipient can track payment progress. Remittance info,
benefit for banks – improved customer service, increased operational
efficiency.

CROSS BORDER FX SOLUTIONS

1. Passive Conversion: pre agreed arrangement – automatically

converts eligible pmts in specific currency corridors to local currency
at an FX rate with pre-agreed spread. Banks use their local
knowledge, previous experience to analyse whether a payment’s
beneficiary is likely to have an account in local currency. Benefit:
provides sending bank with heightened payment control and
exchange transparency.
2. Active Conversion: wire pmt where conversion is requested by
remitting bank in order to make pmts in currencies where it does not
have nostro account. FX rate can be agreed actively (before
initiating the transaction) or passively (informed by correspondent
bank after executing transaction). Customer can either receive live
FX rates or held rates upfront (valid for pre-agreed period of time).
Provides customers the choice to and pay receive wires in multiple
currencies from one account.

CORRESPONDENT BANKING REVENUE STREAMS

1. Liquidity reserve: when a correspondent bank holds funds in a

nostro account, it earns float income on the deposited amount. Ex
overnight repo, interbank lending even if its for a few hours or
overnight
2. Charges on account services: correspondent banks charge on
maintenance, statements, online access etc
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3. Transaction fee on sending and receiving wire transfers, fees can

vary based on currency, destination and transaction amount
4. Foreign Exchange Services – correspondent banks can earn FX
revenue when they convert wire transfer into destination currency

METHODS OF RECOVERING TRANSACTION FEE

1. Beneficiary Deduction: recipient bears the cost of transaction fee,

deducted directly from the amount received. The sending bank
informs recipient’s bank about the applicable fees. Recipient banks
deduct the fees from total amount before crediting the beneficiary’s
account. Adv: for the sender, simplifies process as they pay what
they intended. Disadv: beneficiary may be surprised to receive lower
amount, potential dissatisfaction. Recipient receives 970.
2. Direct Debit: banks automatically deduct transaction fees from
sender’s account when initiating the wire transfer. Sender authorises
the bank to deduct fees from their acc when processing wire
transfer. 1030 ex for sender deducted. Adv – transaction fees
covered upfront, reducing risk of fee disputes. Disadv – requires
authorisation from the sender, which may not always be feasible in
urgent transactions.
3. Billing / Invoice Method – banks bill their clients separately after the
wire transfer has been processed. After wire transfer is completed,
bank generates invoice for transaction fees and sends it to sender.
This must be paid within a specific period. Adv – provides clarity of
transaction fees to sender, cost associated with wire transfers. Dis
adv – banks unable to pass transaction fee to underlying customers

DOWNSTREAM / NESTED CORRESPONDENT BANKING

A bank (respondent bank) uses another bank (correspondent bank)

services to access financial services indirectly. Why does it occur?
Respondent bank lacks access to certain financial networks in CBTs.

Characteristics – indirect access, layered relationships (correspondent

banks may have multiple correspondent rs), risk and compliance (this
arrangement poses increased risk related to compliance aml, due
diligence)

IMPORTANCE OF DOWNSTREAM NESTED CORRESPONDENT BANKING

1. Access to global financial services – offers small banks with

insufficient business funds or volumes to reach international
financial systems
2. Facilitating trade and remittances – where local banks may not have
required infrastructure
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3. Cost effective solutions – often provides a more economical way for

banks to offer international services without developing expensive
corresponding rs.

RISKS – additional credit liquidity risk due to reliance on third parties,

operational risk: the more parties involved the higher chances of failures,
reputation risk, regulatory risk

EXAMPLE: small bank in a country can’t access financial networks like

SWIFT, may want to send money internationally. Thus, establish rs with
bank B (larger, has international capabilities) bank B has rs w bank C, a
global bank part of SWIFT network. Bank C completes the transaction
through its global network.