Due From Banks

Due from Foreign Banks—Demand (Nostro Accounts)

Due from foreign banks—demand or “nostro” accounts are handled in the same manner as due from domestic bank accounts, except that the balances due are denominated in foreign currency.

A bank must be prepared to make and receive payments in foreign currencies to meet the needs of its international customers. This can be accomplished by maintaining accounts (nostro balances) with banks in foreign countries in whose currencies receipts and payments are made.

Nostro balances may be compared to an inventory of goods and must be supervised in the same manner. For example, payment for the importation to the United States of goods manufactured in France can be made through a U.S. bank’s French franc account with another bank in France. Upon payment in France, the U.S. bank will credit its nostro account with the French bank and charge its U.S. customer’s dollar account for the appropriate amount in dollars. Conversely, the exportation of U.S. goods to France results in a debit to the U.S. bank’s French correspondent account.

The first transaction results in an outflow of the U.S. bank’s “inventory” of French francs, while the second transaction results in an inflow of French francs. The U.S. bank must maintain adequate balances in its nostro accounts to meet unexpected needs and to avoid overdrawing those accounts for which interest must be paid. However, the bank must not lose income by maintaining excessive idle nostro balances that do not earn interest.

The U.S. bank also runs risks by being either long or short in a particular foreign currency or by maintaining undue gaps. Losses could result if that currency appreciates or depreciates significantly or if the bank must purchase or borrow the currency at a higher rate. Excessive nostro overages and shortages should be avoided by entering into spot and forward exchange contracts to buy or sell such nostro “inventories.” Those contracts are discussed in the “Foreign Exchange” section. However, it is important to remember that all foreign currency transactions, except over-the-counter cash trades, are settled through nostro accounts. Therefore, the volume of activity in those accounts may be substantial, and the accounts must be properly controlled.

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