Nostro Account is the account which a bank of a country holds in the bank of another country in the foreign currency and it helps the bank which is having the account in bank of another country by the way of simplifying the exchange and trading process for the foreign currencies.
Nostro Account Meaning
Nostro account refers to the foreign bank account established through the domestic bank in the respective country of the currency desired. For example, Bank X in India holds an account with the bank in Y in the USA in their home currency i.e “ Dollars”. A bank generally opens a Nostro account in another bank in a foreign country where there is a large number of foreign exchange transactions on a periodic basis. Nostro accounts are not opened in countries that are on the restricted list or where there is a minimal amount of foreign exchange transactions happening. Alternatively, for other banks, it will be considered as a Vostro account i.e your account in our books of accounts.
Examples of How Nostro Account Works
Below are some of the examples of Nostro Accounting
State Bank of India opens an account with bank of America in NewYork. It will be referred to as the Nostro account for the State Bank of India.
Suppose Bank A in the USA has to buy euros 1,00,000 from Bank B in the UK. On the settlement date, bank b will transfer euros 1,00,000 to Nostro account of Bank A in the UK itself. However, a bank must pay dollars for the transactions. Hence Bank A will transfer the required amount in dollars to the Nostro account of bank b in the united states of America. Thus there is no exchange of money from one country to another however the transaction is executed smoothly without any hiccups.
Suppose an Individual Mr. A wants to remit $ 1,00,000 to another person Mr.B in the USA. In this case, Mr. A will approach his home bank and ask them to open a Nostro account in the correspondent bank in the USA. Now Mr. A will pay ~65,00,000 ( $1 = rs 65 ) to the domestic bank in the Nostro account of Mr. B and the home bank will pay the correspondent bank in the USA $1,00,000 into its Vostro account. From that account, the correspondent bank will pay $1,00,000 to Mr. B personal Account. In this way there is no movement of funds actually from once country to another, still, the transactions have been put through and both the parties are been satisfied. MrB gets his money and Mr. A pays off its obligations.
Advantages of Nostro Account
Is one who takes care of the entire financial frame word of the company or government. Below are some of the advantages :
- You can pay the money to a third party in your home currency without taking any exchange rate risk.
- Easy to operate since it is a mere transfer of funds from one account to another in the same bank.
- Enables to keep funds in foreign currency.
- Reduces the excessive fluctuation risk in exchange rates since money is directly emitted to the other party without physically been there.
Disadvantages of Nostro Account
Below are some of the disadvantages :
- A lesser rate of interest as compared to savings or current account.
- Generally more expensive since it is a facility provided by the home bank to execute foreign exchange transactions smoothly.
- Rigorous regulations and laws imposed for the operation of the Nostro account by the federal bank.
- Monitoring of the transactions from Nostro accounts is very important.
- Open to cyberattacks which can have a huge impact on the cash reserves of the bank if the same are hacked.
Important Points to note about Nostro Account
- The domestic banks are often used as custodians in order to manage the operations of the bank with regards to the foreign exchange transactions.
- A bank recognizes the Nostro balance in the account as a debit balance with other bank and hence recorded as assets of the bank on the balance sheet.
- It is opened by the bank in those countries where the physical presence of the bank is marginal and it would be difficult to communicate on a daily basis. To avoid this discomfort, a bank opens a Nostro account in another bank in a foreign country in foreign currency for flexibility and smooth operations.
- Since this is an additional and specialized facility provided by the banks to its customers it comes with a cost which is very expensive and is allowed as business expenditure in the financial statements since the same is been used for executing business foreign exchange transactions.
Nostro Account is one of the most important and key facilities provided by the banks to the customers to carry out their foreign exchange transactions smoothly without difficulty. In modern times, Nostro and Vostro Accounts are the most essential components of the financial system since they help in executing large foreign exchange transactions without having any physical presence in other countries.
It’s a specialized service brought in by the federal bank to promote international trade and financial transactions so as to drive business growth in the future with ease in settlements and payment mechanisms. These accounts come along with certain rules and regulations which needs to be adhered to and the returns need to be filed with the statutory bodies as per the due dates mentioned.
This has been a guide to what is a Nostro Account and its meaning. Here we discuss the examples of how Nostro account works along with its features, advantages, and disadvantages. You can learn more about accounting from following articles –