When a domestic bank needs to handle foreign transactions, they can establish a nostro account with a foreign or correspondent bank, which holds the funds and makes transactions on behalf of the domestic bank. Nostro comes from the Latin, meaning “ours.”
Having a nostro account enables the bank to process transactions for their customers in other countries without having to set up a base of operations abroad. The correspondent bank in the other country handles deposits and other transactions, which are denominated in the local currency, minus any foreign transaction fees.
Since nostro accounts are bank-to-bank accounts, not personal ones, it’s unlikely you’ll encounter one of these. But it’s useful to know how financial matters work between countries, in case you’re thinking about what to do with leftover foreign currency, or other financial dealings while traveling or doing business.
What Is a Nostro Account?
A nostro account is set up by a bank in one country, let’s call it the domestic bank, and the funds are held and partly managed by a bank in another country (the foreign bank).
The foreign bank holds all the funds needed for the domestic bank’s transactions in that country, denominated in the local currency, within the nostro account.
When customers of the domestic bank have relocated, or are traveling or doing business abroad, they can use the foreign bank to make deposits and withdrawals, and so on. The foreign bank works with the domestic bank to ensure that the currency exchange for all transactions is accurate.
A nostro account is the bank’s bank account in another country. Individuals do not have nostro accounts. This system operates behind the scenes, and isn’t something you need to think about if you’re wondering how to invest in a foreign currency, although nostro and vostro accounts do help with foreign currency trading.
How Does a Nostro Account Work?
When opening a nostro account, you open an account with another bank in a foreign country. The foreign bank is also sometimes called the facilitator bank or correspondent bank.
Financial institutions and large corporations that are involved in international trade will typically set up nostro accounts. This gives the organization the ability to hold funds in a foreign currency (via the facilitator bank), without the need to convert its own currency into a foreign currency.
Interestingly, for accounting purposes, the foreign bank calls this account a vostro account, meaning “yours.” It is the same as the nostro account, but each bank uses a separate term for their accounting purposes.
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Example of a Payment Using a Nostro Account
What is a nostro account and how, exactly, does it work in real life?
Say that a small domestic bank located in Colombia has a number of customers who are traveling, living, and working in the U.S. temporarily. The Colombian bank might establish a nostro account with a bank in the U.S. to offer services to those customers.
The U.S. bank would be the facilitator bank in this arrangement. As such, the U.S. bank could accept deposits on behalf of the domestic Colombian bank into its nostro account. Those deposits would be denominated in U.S. dollars (which is also considered the world’s reserve currency).
Funds, such as deposits to the U.S. bank, could then be forwarded to the domestic bank in Colombia through the SWIFT system. SWIFT is the Society for Worldwide Interbank Financial Telecommunications, a cooperative that offers safe and secure financial communications to facilitate cross-border transactions.
The Colombian bank could then convert the deposits to its local currency, and credit customers’ accounts with the corresponding amount of money, minus any fees charged.
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Nostro Account vs. Vostro Account
The terns nostro and vostro both describe the same bank account, but from each bank’s perspective. That’s because the domestic bank looks at the funds in the other bank as “ours” — nostro.
Meanwhile, the bank in the other country that holds the account considers it a “vostro” account (vostro means “yours). The money in the account is held in a foreign currency (i.e., the currency of the correspondent bank), then converted to local currency once the funds are transferred to the domestic bank.
Essentially, the terms vostro and nostro simply help to distinguish between the two sets of records that must be kept and reconciled by the two banks.
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Advantages of a Nostro Account
• There are several advantages to having a nostro account.
• Ease of transactions in conducting international currency exchanges.
• Nostro accounts allow you to pay money in your currency without having to incur foreign exchange risk.
• Nostro accounts allow holders to keep funds in a foreign currency.
Disadvantages of a Nostro Account
• There are also some disadvantages that come along with maintaining a nostro account.
• There may be some added expenses associated with money transfers using nostro accounts.
• Since you are working with financial institutions outside of the U.S., there are rules and regulations you have to comply with.
The Takeaway
Nostro accounts are an important behind-the-scenes system that banks and large corporations rely on to make international and foreign exchange transactions seamless. This specialized system helps settle international trades and payments without one bank having to physically set up operations in a new country.
Nostro is Latin for “ours,” which is the term used by the domestic or originating bank. Vostro means “yours” and is the term used by the correspondent or facilitating bank that holds the funds on behalf of the other institution. The two terms refer to the exact same account, just from different perspectives for accounting reasons.
Despite the convenience, nostro accounts come with certain fees and expenses, along with regulations that must be adhered to when executing these transactions.
Fortunately, most individuals don’t have to consider vostro or nostro systems when opening up their personal bank accounts. For example, if you open an all-in-one bank account with SoFi, you’ll just enjoy the convenience of banking easily and securely from your phone or computer, no matter what is happening across borders. If you set up direct deposit, you can earn a competitive interest rate. Also, SoFi members pay no account or overdraft fees, and can access complimentary financial advice from professionals as needed.
FAQ
What is a nostro account and why is it used?
A nostro account is a bank account a bank holds at a foreign bank denominated in a foreign currency where the account is held, and facilitates foreign exchange transactions with ease.
How do I open a nostro account?
Individuals don’t open nostro accounts. If you are part of a large bank or corporation, you would establish a nostro account with a bank overseas.
Does a nostro account earn interest?
A nostro account may earn interest, so it’s likely that deposits made with the foreign bank would offer competitive rates to customers relative to that location.
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