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Chapter 8

Key Terminologies

You Must Know……

Correspondent Banking NOSTRO and VOSTRO Accounts SWIFT CHIPS CHAPS FEDWIRE Letter of Credit and International Remittances

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Correspondent Banking

A Correspondent Banking relationship involves the provision of banking services by one financial institution (a Correspondence bank) to another financial institution (Correspondent Banking Client)

In which the financial institution carry on activities or business at or through permanent establishments in different countries

It is also possible for one bank to open a Correspondence Account with another bank that already has an existing Correspondent facility

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Contd….

The banking services provided by Correspondent Bank may involve provision of cash management services, international fund transfers, check clearing, foreign exchange services, loans and letters of credit

Correspondent banking as the banking services – mainly payments, cash management and trade services - provided by banks to customers via other banks.

How this relationship works in real life????

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NOSTRO and VOSTRO Accounts

Both NOSTRO and VOSTRO account are normally used in the context of foreign exchange transactions done by the banks or during currency settlement. Let’s look at what they both mean.

VOSTRO is an Italian word – meaning – Yours NOSTRO is an Italian word – meaning – Ours

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Contd….

VOSTRO Account – It is the account which is held by a foreign bank with a local bank, so if Bank of America maintains an account with State Bank of India it will be a VOSTRO account for State Bank of India.

Account held by a foreign bank in a domestic bank is called VOSTRO account. A VOSTRO is our account of your money, held by US. A VOSTRO account with a credit balance (i.e. a deposit) is a liability, and a VOSTRO with a debit balance (a loan) is an asset.

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Contd….

For example Bank A (Barclays Bank of  UK) opening an account in Bank B (ICICI Bank of India), this is VOSTRO account for Bank B (ICICI Bank of India).

NOSTRO Account – It is the overseas account which is held by the domestic bank in the foreign bank or with the own foreign branch of the bank. For example the account held by State Bank of India with bank of America in New York is a NOSTRO account of the State Bank of India

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Contd….

Account held by a particular domestic bank in a foreign bank is called NOSTRO account. A NOSTRO is our account of our money, held by you. A bank counts a NOSTRO account with a credit balance as a cash asset in its balance sheet.

From the above one can see that the account which is NOSTRO for one bank is VOSTRO for another so when SBI opens a NOSTRO account with Bank of America, it is a VOSTRO account for them and vice versa.

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Contd….

Here in the above example given in VOSTRO account the same account is a NOSTRO account for Bank A (Barclays Bank of UK), or if Bank B (ICICI Bank of India) opens an account in Bank A (Barclays Bank of UK) then that account is a NOSTRO account for Bank B (ICICI Bank of India). NOSTRO accounts are usually in the currency of the foreign country. This allows for easy cash management because currency doesn't need to be converted.

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What is SWIFT???

It stands for Society for the Worldwide Interbank Financial Telecommunications

Founded in Brussels in 1973, is a co-operative organization dedicated to the promotion and development of standardized global interactivity for financial transactions.

More than 10,000 financial institutions and corporations in 212 countries every day to exchange millions of standardised financial messages. This activity involves the secure exchange of proprietary data while ensuring its confidentiality and integrity.

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Contd….

SWIFT enables its customers to automate and standardise financial transactions, thereby lowering costs, reducing operational risk and eliminating inefficiencies from their operations

SWIFT is organized into three regions – the Americas, Asia Pacific, and EMEA (Europe, Middle East and Africa).

SWIFT provides a service for financial messages, such as letters of credit, payments, and securities transactions, between member banks worldwide.

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Contd….

SWIFT's essential function is to deliver these messages quickly and securely -- both of which are prime considerations for financial matters.

SWIFT Code??? Bank swift code which is also referred to as the BIC

code is a unique code that is used to recognize financial and non-financial institutions. The bank swift code comes with eight or eleven characters that throw light on details regarding the bank code, country code, location code, and the branch code.

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Contd….

The first four letters of a eleven digit bank swift code shows bank code, followed by another two digits that identifies the country code, as the next two letters help identify the location of the financial institution. The last three letters tell us more about the branch related to a financial institution, which is but an optional code of letters that come along with the other details of a financial institution.

BKTRUS33 DEUTGB2L

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Contd….

Businesses that plan to enter into transactions with clients located in other countries should take note of the bank swift code to enable smooth international transactions. As an inherent part of international transactions, bank swift code is used to transfer money between banks, particularly for telegraphic transfers and wire transfers. This code is also used by banks across the globe to exchange messages between them.

http://www.deutschebank.co.in/swift-transfer.html

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CHIPS

CHIPS stands for Clearing House Interbank Payments System

CHIPS is the largest private-sector U.S.-dollar funds-transfer system in the world. In 2012, CHIPS cleared and settled an average of $1.5 trillion in cross-border and domestic payments daily. CHIPS operates on a global business day and utilizes a sophisticated liquidity savings mechanism to provide fast, final payments while maximizing liquidity efficiency for participating banks.

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Contd….

CHIPS sets the industry standard for resiliency, reliability, and innovation in funds transfers. Leading banks worldwide, as well as their correspondents and customers, find CHIPS a trusted partner in the U.S.-dollar clearing and settlement services.

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How it Works..???

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CHAPS

CHAPS stands for Clearing House Automated Payment System

CHAPS is the only UK payment system that guarantees real-time finality, of any value, in ‘Central Bank money’ as each payment instruction settles.

CHAPS continues to be one of the largest Real-Time Gross Settlement systems (RTGS) in the world. 

As of July 2011 the total value processed since the start of CHAPS exceeded one quadrillion pounds

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Contd….

It is a sterling payments scheme that processes and settles both systemically important and time-dependent payments.  The scheme is run by CHAPS Clearing Company, which manages day-to-day operations.

Launched on 9th February 1984, the CHAPS scheme provides a guaranteed same-day service for the bank-to-bank transmission of sterling-denominated payments. 

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Contd….

Since 1996, CHAPS has used an enhanced Real-Time Gross Settlement (RTGS) system where each individual payment is settled in real-time across its Members’ settlement accounts at the Bank of England.

A CHAPS payment is an electronic bank-to-bank same-day value payment made UK sterling, generally used for high-value interbank transactions.

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Contd….

Banks themselves use CHAPS to move money around

the financial system, but it is also used regularly: For delivery of domestic and international wholesale

payments i.e. Money Market / Foreign Exchange (FX) transactions.

For business-to-business payments.  By solicitors / licensed conveyancers to transfer the

purchase price of a house between the bank accounts of those involved.

By individuals buying or selling a high-value item, such as a house or car.

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FEDWIRE

The Federal Reserve Banks operate three wholesale payment services:

The Fedwire Funds Service: which is a real-time gross settlement system to settle funds electronically between banks;

The Fedwire Securities Service: which provides issuance, settlement and transfer services for U.S. Treasury securities and other government-related securities and

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Contd….

The National Settlement Service, which is a multilateral settlement service used by clearinghouses, financial exchanges, and other clearing and settlement groups.

An electronic transfer system developed and maintained by the Federal Reserve System.

These services date back to the early 1900s when the Federal Reserve Banks began using telecommunications to transfer funds between accounts maintained in different Federal Reserve Districts. 23

Contd….

The Fedwire services play a key role in the nation’s payments mechanism and enable depository institutions, the U.S. Treasury and other government agencies to transfer funds and book-entry securities nationwide.

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Contd….

Depository institutions use Fedwire mainly to move balances to correspondent banks and to send funds to other institutions on behalf of customers. Transfers on behalf of bank customers include funds used in the purchase or sale of government securities, deposits, and other large, time-sensitive payments. The Treasury and other federal agencies use Fedwire extensively to disburse and collect funds.

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Contd….

In a typical funds transfer, an individual or a business instructs its bank to send a funds transfer. The sending bank debits the sender's account and initiates a FEDWIRE funds transfer. The Federal Reserve, in turn, debits the account of the sending bank and credits the account of the receiving bank; the Fed notifies the receiving bank about the transfer. The receiving bank credits the recipient's account and notifies the recipient of the receipt of the funds. The transfer is final when the funds are received. Funds can be used by the recipient immediately thereafter.

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Letter of Credit

Refer the Material Provided

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International Remittance

In this globalizing world, migration of people from one country to another for employment opportunities has become a common phenomenon.

Dominant migration corridors have been formed between various countries/regions.

This is primarily due to the socio-economic conditions prevailing in the migrants’ countries of origin and destination.

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Remittance is the act of transmitting money to adistant location to fulfil an obligation

Contd….

An International Remittance business may follow the conventional banking model or any of the non-banking models.

1. Conventional Banking Model

2. Non-Banking Channels

3. Emerging Non-Banking Channels

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1. Conventional Banking Model

It is end-to-end remittance transaction with the following parties:

Remitter’s Bank - the bank where the remitter has an account that is debited for transferring money to the beneficiary

Beneficiary’s Bank - the bank where the beneficiary of the remittance has an account that is credited for the remittance money received

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Contd….

Correspondent Bank (only in cases where the above-mentioned entities do not have a direct business tie-up) - an intermediary bank which has associated with various banks globally, through which remittance transactions are routed

The generic process involved in a remittance transaction based on a Nostro account model.

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Contd…(NOSTRO-based Setup)

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2. Non-Banking Channels Non-banking players play a vital role in the remittance

space and have a larger share in the Global Remittance business than conventional banks. These entities operate in various forms:

Money Transfer Operators (MTO) Exchange Houses

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Contd…

What is Money Transfer Operators??? Western Union and Money Gram have a network of

agents across the globe and serve as non-bank remittance channels.

The remitter can visit an MTO outlet and pay cash in foreign currency to send money to any part of the globe where the MTO’s agent is present.

The receiver can visit the MTO agent at his location and collect the money in local currency.

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Contd…(MTO Model)

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Contd…

What is Exchange Houses??? Exchange Houses are extensively used for

remittances from the Middle East. Unlike the banking channel, this channel is based on Vostro accounts i.e. the accounts maintained by exchange houses with various banks in the beneficiary countries. These accounts are pre-funded by the exchange houses.

Key Steps……

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Contd…

Step 1 The remitter deposits the remittance money in the overseas currency in cash at the Exchange House counter.

Step 2 The exchange rate and the transaction fee are communicated and confirmed over the counter.

Step 3 The beneficiary account details are provided by the remitter.

Step 4 The exchange house instructs the Beneficiary Bank with whom it has a tie-up for transferring the requisite amount in the beneficiary country’s local currency.

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Contd…(Exchange House Model)

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3. Emerging Non-Banking Channels

Online Channels Which provide platforms encompassing the entire

remittance process, are a recent development. They have created global networks with banks/FIs in origination and destination countries. From the comfort of his home, the remitter can initiate a remittance request by registering himself on the online entity’s website and furnishing his and the beneficiary’s bank account details.

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Contd…

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Contd…

White Label Platform Providers A White Label Platform provider is a variant of the

online platform channel, wherein a third party enables banks and FIs operating in the remittance corridors to launch remittance services by providing the following:

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Contd…

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Challenges faced….

Transaction cost Grey Market Reconciliation of the remittance transactions Revenue sharing agreement

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