NOSTRO Account: What It Is and How It Works

When money moves across borders, it passes through a network of correspondent banks, currencies, time zones, and regulatory checks. Nostro accounts sit at the heart of this network, allowing banks to hold foreign currency in overseas financial institutions and ensure smooth, mostly real-time, clearing of transactions.

So, what is Nostro account and why should you care? While you won’t be opening one yourself, understanding how it works will help you see why some payment routes are faster, cheaper, and more reliable than others. We’ll explain some key concepts surrounding the Nostro account in this article.

• Nostro account is a foreign currency account that a domestic bank holds with a foreign bank, which is used for cross border payments when a bank has no branch abroad. Only banks and authorized financial institutions can operate Nostro accounts. Individuals and businesses don’t have Nostro accounts and can benefit from them only indirectly. 
• Nostro accounts help domestic banks in settling foreign exchange deals by reducing dependence on currency conversion for each transaction and ensuring smooth execution of forex trades. They also help minimize the impact of volatile exchange rates, lower the risks associated with foreign exchange transactions, and foster positive relationships with corresponding banks. 
• In India, only RBI-authorized AD Category-I banks can open and manage Nostro accounts, which include various public and private sector banks, and some foreign banks with their operations in India.

A Nostro account is a bank account held by one bank (the "home bank") in another bank (the "correspondent bank") in a foreign currency. Essentially, it's "our account" (hence the name, derived from the Latin "nostro" meaning "our") held by a bank in another country, facilitating international transactions and foreign exchange operations.

A Nostro account acts as a financial bridge between two banks across borders. By using a Nostro account, the domestic bank avoids setting up its own infrastructure in the foreign country. Instead, it leverages the established local network of the foreign bank. 

Take a look at this step-by-step rundown of how Nostro account actually works:

1. Account setup with a foreign bank

A domestic bank (e.g. an Indian bank) opens their Nostro account with a foreign bank (e.g. a US-based bank). Now this account is held in the foreign bank’s currency (in this case, US Dollars).

• From the Indian bank’s perspective, it’s a Nostro account.
• From the US bank’s perspective, it’s a Vostro account.

This setup allows the Indian bank to transact in a currency it does not issue, without needing a physical presence in the foreign country.

2. Role of the facilitator bank

The foreign bank that holds the Nostro account is referred to as the facilitator bank. The facilitator bank executes payments through its own local clearing networks. 

In our case, the US-based bank enables the Indian bank to conduct financial transactions in US Dollars, such as paying its international vendors or settling foreign exchange trades. 

3. Use of clearing networks

The US Bank uses their own payment clearing system with its own central bank, i.e. the Federal Reserve System, to get the payment across.

But, if the US bank is not a primary clearing member having access to the central bank’s clearing system, it routes the payment via another local bank that does have access. This process ensures smooth settlement of cross-border payments.

Nostro accounts are used by banks and financial institutions. These accounts are used when a bank in one country needs to hold money in the currency of a foreign country. Since the bank might not have a branch there, it opens a Nostro account with a local bank in that foreign country.

For example: If an Indian bank wants to hold US dollars, it can open a Nostro account with a US bank. This helps the Indian bank easily manage international payments, such as sending or receiving money in dollars for its customers.

Businesses and individuals don’t open Nostro accounts themselves. However, they do benefit indirectly when their bank uses one to handle foreign transactions.

In a nutshell, Nostro accounts are used to facilitate international trade, settle cross-border payments, and hold the currency of a foreign country, where the domestic bank does not have a branch.

Since the Nostro account is a bank account that a domestic financial institution holds in the currency of another country, it primarily enables foreign currency transactions. Its main features are holding funds in a foreign currency, enabling international transactions, relying on a facilitator bank, and being commonly used by banks in countries with freely convertible currencies. We'll look at each of these in detail below:

• Held in freely convertible currency: Nostro accounts are mostly opened in countries where currencies are freely convertible (currencies that can be exchanged without restrictions in the global market). 
• Additional charges: Nostro account is a banking service in addition to the primary services. So, most facilitator banks usually charge maintenance or service fees, which can be high depending on usage.
• Easy access to foreign currency: Banks can easily access the foreign currency balances. Hence, they don't need to worry about any delays in payment obligations. It relieves the stress of last-minute currency exchanges.
• Exposure to forex and political risk: Funds in Nostro accounts are subject to the fluctuations of exchange rates and specific political risks in a country. Elements such as sanctions, regulatory changes, or capital controls can impact access to these funds.
• Banking agreements: A bank can’t just open a Nostro account whenever it feels like. It requires a formal agreement between banks. This process involves due diligence, compliance checks, and operational protocols.

As an exporter or businessman, you won’t open a Nostro account yourself. But you should still be aware of the advantages that banks get when they use Nostro accounts. Following are the main advantages of using a Nostro account:

• Maintain funds abroad in the local currency: A Nostro account allows a domestic bank to hold foreign currency in a bank located in that foreign country. This facilitates easier access to local currency for transactions in that market.
• Lower forex risk: There is no need to get currency converted at the time of payment transmission. The funds are in the foreign currency already, thereby eliminating the risk of unwarranted forex changes during transactions.
• Reduces exposure to exchange rate volatility: By holding a Nostro account, banks can better manage and limit the financial effect of exchange rate movements on cross-border fund transfers
• Strengthens ties with foreign banks: Needless to say, opening and maintaining a Nostro account with a foreign bank is fruitful to building a connection with such correspondent banks. Consequently, it improves coordination and operational efficiency in international dealings.
• Useful for international trade: Nostro accounts support a wide range of global financial activities. They aid in timely and efficient fund transfers, crucial for sending/receiving remittances and handling other international financial obligations.

Nostro accounts are tightly regulated by RBI and play an important role in ensuring compliant, traceable, and legitimate cross-border payments. Here are some of the frameworks and compliances associated with these accounts:

1. RBI-authorized access only: In India, only RBI-authorised banks, primarily Authorised Dealer (AD) Category-I banks, can open and operate Nostro accounts. This restriction ensures that all international transactions are managed by institutions regulated under the RBI and FEMA guidelines. Let’s have a detailed account at who can open and operate Nostro account in India:

• Authorized Dealer (AD) Banks

These are Indian banks licensed by the Reserve Bank of India (RBI) to deal in foreign exchange. Examples: State Bank of India (SBI), ICICI Bank, HDFC Bank, Bank of Baroda, Axis Bank, and Punjab National Bank.

• Foreign banks operating in India

They may use their global network to facilitate international transactions via Nostro accounts. Examples: HSBC India, Citibank India, Standard Chartered Bank India.

• Other authorized financial institutions

Other RBI-authorized entities like large NBFCs and institutions, that may facilitate international trade payments via Indian AD banks' Nostro arrangements. This is less common. 

1. Mandated for export payments: As per RBI guidelines, export remittances collected through online payment channels must be routed through an AD bank’s Nostro account. This mandatory step ensures that the earnings are traceable and legitimate. 

1. Essential for official documentation: Payments received via Nostro accounts make it easier to obtain key documents like FIRA (Foreign Inward Remittance Advice) or e-BRC (Electronic Bank Realisation Certificate). These are important for: 

• Tax filings
• Claiming export incentives
• Requesting GST refunds
• Proving legitimate foreign income

Nostro accounts are key to managing compliant, low-risk international payments by routing funds through regulated banking channels. Indian businesses indirectly benefit from banks' Nostro accounts, which ensure transparency and speed in international transfers.

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