What is a cross-border payment? And how do cross-border transactions work? These two questions can get tricky to understand sometimes. Cross-border payment is a transaction of funds sent from one entity to another to a recipient in another country. In most cases, the person who is sending and the person who is receiving do not share the same ledger. This transaction between two countries sometimes involves a series of different intermediaries to complete the transaction.
Most of the time, this transaction is done on corporate levels, and the increase in cross-border transactions can become the reason for the growth in many e-commerce retail payments. The current situation tells that this type of transaction is going to increase in the upcoming years.
Cross-Border Payments Overview
Cross-border transactions are typically settled through correspondent banking. This process involves two banks that establish joint accounts with each other. Once the account is in place, these correspondent accounts are referred to as Nostro and Vostro accounts. For instance, think of this situation as a Canadian bank that obtains related banking services from a bank located in America that holds a Nostro account on behalf of the bank located in Canada where all the funds are dominated in USD$. On the other hand, the American bank will have an account in the Canadian bank that has a joint account known as the Vostro account, in which the funds are dominated as CAD.
Correspondent Banking Cross-Border Settlement
These transactions are mostly done through banks with the help of an interconnected network, which is legal, and most jurisdictions make cross-border transactions. These cross-border transactions with corresponding banking involve multiple banks during this process. To explain this in the most basic way, the correspondents hold the deposit which other respondent banks own, and they provide services to these banks. It is also called a bilateral agreement between these banks which helps them provide reciprocal services to each other.
Correspondent Banking Payment Process
This short scenario can explain the simplest form of this cross-border transaction: Harry in Canada wants to send CAD 200 to Ron in the US. To do so, Harry will initiate the payment from Bank Z in Canada, and Bank Z has the Nostro account of Bank Z+, an American bank. Since Bank Z has a direct bilateral account relationship with Bank Z+, the settlement instruction and payment information can travel in a single message.
However, when these transactions occur, the banks do not have direct bilateral joint relationships with each other most of the time. In such cases, the involvement of many intermediaries for the fund transfer can help maintain steady and on-time transactions.
Sohail Afzal, CPA, CMA, MBA
Sohail Afzal, (CPA, CMA, MBA) is the founder & CEO of GTA Accounting Professional Corporation. He is a highly experienced Chartered Professional Accountant and businessman himself and understands the challenges that many businesses face when it comes to cash flow management. As an experienced business consultant & tax advisor, he is helping companies grow by providing the technical, financial, and contractual information necessary for strategic decision-making.