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Nostro Account: Meaning, How it Works and Advantages Explained with Examples
8 November 2022
Banks can hold an account in a foreign bank in its own currency, as in the foreign bank’s currency. Such accounts are called nostro accounts. But what is the significance of nostro accounts in banking? Are there any significant advantages of having a nostro account?
This blog dissects how a nostro account works, its benefits and other factors. Keep scrolling.
What is a Nostro Account?
A nostro account is held by a domestic bank in a foreign bank in denominations of that country’s currency. This helps banks facilitate international transactions involving multiple currencies. The term nostro is a Latin word meaning ‘ours’.
Nostro account is just the opposite of vostro account, meaning ‘yours’. More on this later. Let us first know how a nostro account works.
How Does a Nostro Account Work?
Both nostro and vostro accounts are used to facilitate international transactions and other transactions associated with exchange rate risk. When a bank decides to open a nostro account, it chooses another bank in a foreign country with which it has a good working relationship. The foreign bank in this transaction is known as the facilitator bank.
After the bank opens one or more nostro accounts with a facilitator bank, it is the latter’s duty to help the former make transactions with its domestic currency. The facilitator bank uses its networks with its country’s central bank to execute the necessary transactions.
When banks do not have any or marginal physical presence in another country, making transactions in foreign currencies becomes extremely challenging. It is at such times that a nostro account becomes essential. With a nostro account at an established bank in a foreign country, a bank can securely perform international transactions.
The following examples will illustrate the working of Nostro accounts:
Suppose Bank A, located in the USA, needs €100,000 in funds from Bank B, located in the United Kingdom. Bank B will transfer €100,000 to the Nostro account of Bank A in the UK.
One must note that Bank A will pay dollars ($) for this transaction, i.e. Bank A in the USA will submit the requisite amount in dollars to the Nostro account of Bank B in the USA. This is how the two banks will execute this transaction.
Suppose a resident of the USA wishes to open an account in Europe. He does not need to travel there for this purpose. All he has to do is approach his home bank in the USA and request them to open a Euro account on his behalf.
The US bank would open a Nostro account with a foreign facilitator bank with which it has a good banking relationship. Note that the facilitator bank needs to have a physical presence in the European zone. Now, it is the facilitator’s responsibility to set up a euro account for the US bank.
One must note that this account is much different from regular accounts held by European residents. This account will permit the account-holder in the USA to make transactions in the European zone with euro.
Suppose State Bank of India opens an account with Bank of America in Washington DC, USA. This account is actually a Nostro account for SBI, allowing it to get funds in US dollars using Indian rupees.
Nostro Accounts vs Vostro Accounts
Let us look at the differences between a Nostro account and a Vostro account:
This is an account that a domestic bank opens at another bank in a foreign country in foreign currency.
This is an account that a foreign bank holds for the domestic bank in its home currency.
Nostro is the Latin word for ‘ours’. It roughly translates to ‘our account with you’.
Vostro is the Latin word for ‘yours’. It roughly translates to ‘your account with us’.
A Nostro ledger is the one kept by the depositing customer.
A Vostro ledger is the one maintained by the bank.
The words nostro and vostro are actually used to describe the same bank account from two different perspectives. If Bank A opens a nostro account with Bank B in a foreign country, the same account would be a vostro account for Bank B.
Advantages of Using a Nostro Account
Detailed below are advantages of maintaining a Nostro account:
It helps an entity maintain funds in foreign currency.
Operating a nostro account is convenient and easy because all it involves is transferring funds from one account to another in the same bank.
Moreover, people can pay money to a third party located in a foreign country in their home currency. A major benefit is this transaction does not involve any exchange rate risk.
Nostro accounts bring down the risk of excessive fluctuation in exchange rates. This is because the requisite amount is directly transferred to the third party without any physical presence.
Nostro accounts facilitate banking relationships with international banks.
One can use nostro accounts for several dealings. Additionally, it helps in easing international transactions.
Disadvantages of Using a Nostro Account
Given below are some limitations of Nostro accounts:
Opening a nostro account could be expensive.
One needs to abide by strict rules and regulations for operating nostro accounts.
Compared to current or savings accounts, nostro accounts have lower interest rates.
If nostro accounts fall prey to cyber-attacks, it severely affects the bank’s cash reserves.
Important Points to Know about Nostro Accounts
Listed below are some important points related to Nostro accounts:
A bank decides to open a nostro account in a facilitator bank in a foreign country when it only has a marginal presence in that country. Opening this account facilitates flexible and smooth operations.
One uses domestic banks as custodians for management of the bank’s operations with respect to foreign exchange transactions.
Considering that the purpose of a nostro account is the execution of business foreign exchange transactions, officials consider it to be a business expenditure in the financial statements.
Moreover, as this is a specialised facility that banks provide for their customers, it is quite expensive.
There are many advantages associated with a Nostro account, first and foremost being convenience and ease of maintaining funds in a foreign currency. Additionally, it also promotes working relationships with international banks.
FAQs on Nostro Account
Q1. Why is a Nostro account required?
Ans: The following are some reasons why banks require Nostro accounts: • It promotes foreign transactions and dealings. • It provides a guarantee to a foreign dealer that he will receive payments. • A Nostro account makes international transactions easy. • One can use it for settlements in foreign currencies.
Q2. How do Indian banks settle cheques denominated in foreign currencies?
Ans. Indian banks need to send foreign currency cheques to a bank in the concerned country for realisation. There are several ways in which banks can collect funds, including: • Cash Letter Arrangement (CLA) using Nostro accounts • Final Credit Services (FCS) • Direct Collection Arrangement (DCA) • Check-21 facility
Q3. What are the features of a Nostro account?
Ans: Given below are the features of Nostro accounts: • A Nostro account is an account held in foreign currency. • Only a bank can open a Nostro account. This is because no dealer can deal with foreign currencies directly. • One can use Nostro accounts for the settlement of international transactions that require conversion of different currencies
Q4. What are Nostro account charges?
Ans: Nostro account charges for carrying out international transactions may range from $15 – $30 per transaction. When people need to send money abroad, their banks process the necessary transaction via their Nostro accounts. Banks use Nostro accounts for holding foreign currencies.
Q5. Is a Nostro account an asset or liability?
Ans: Bank officials consider a Nostro account that has debit balances as cash assets. A Vostro account with a credit balance is considered a liability. Nostro and Vostro are terms used to denote the same bank account from two different perspectives.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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