Correspondent banking refers to a financial arrangement between two banks, typically in different countries, that allows one bank (the "correspondent bank") to provide services on behalf of the other bank (the "respondent bank"). This relationship facilitates international transactions such as wire transfers, currency exchanges, and trade finance, enabling banks to expand their reach and offer services in foreign markets without the need for physical branches.
In a correspondent banking relationship, the correspondent bank holds deposits for the respondent bank and may provide a range of banking services, including clearing, payments, and settlements. This setup is critical for global commerce as it allows banks to conduct cross-border transactions smoothly and efficiently. The arrangement relies heavily on trust and well-established protocols to manage risks, ensure compliance with international regulations, and prevent financial crimes such as money laundering.
Historically, correspondent banking grew out of the need to support international trade, and its importance has only increased as global economic integration has deepened. However, the complex nature of these relationships also poses challenges, particularly in terms of regulatory compliance and transparency, leading to increased scrutiny and tightening of regulations in recent years.