What is a ‘Nostro Account’
Nostro account refers to an account that a bank holds in a foreign currency in another bank. Nostros, a term derived from the Latin word for “ours,” are frequently used to facilitate foreign exchange and trade transactions. The opposite term vostro accounts, derived from the Latin word for “yours,” is how a bank refers to the accounts that other banks have on its books in its home currency.
BREAKING DOWN ‘Nostro Account’
Nostro account and vostro account refer to the same thing from a different perspective. For example, Bank X has an account with Bank Y in Bank Y’s home currency. To Bank X, that is a nostro, meaning “our account on your books,” while to Bank Y, it is a vostro, meaning “your account on our books.” These accounts are used to facilitate international transactions and to settle transactions that hedge exchange rate risk.
Locations of Nostro Accounts
Most large commercial banks worldwide hold nostro accounts in every country with a convertible currency. Major examples of convertible currencies are the U.S. dollar, Canadian dollar, British pound, the European euro and the Japanese yen. Prior to the advent of the euro as a currency for financial settlements on January 1, 1999, banks needed to hold nostro accounts in all of the countries that now use the euro. Since that date, one nostro for the entire euro zone has been sufficient. If a country were to leave the eurozone, either voluntarily or involuntarily, banks would need to re-establish nostros in that country in its new currency in order to continue making payments. The most commonly discussed potential exit from the euro zone has been Greece, which received multiple bailout packages since the beginning of the 2008 financial market crisis.
The central banks of many developing countries limit the buying and selling of their currencies, which is usually to control imports and exports and to control the exchange rate. Banks generally do not hold nostro accounts in those countries, as there is little or no foreign exchange business.
When a bank needs to make a payment in a country where it does not hold a nostro account, it can use a bank with which it has a correspondent relationship to make the payment on its behalf.
Example of a Payment Using a Nostro Account
The following example illustrates the process of making a payment using a nostro account. Bank A in the United States enters into a spot foreign exchange contract to buy British pounds from Bank B, which is in Sweden. On the settlement date, Bank B must deliver pounds from its nostro account in the United Kingdom to the nostro account of Bank A, also in the United Kingdom. On the same day, Bank A must pay dollars in the United States to the nostro account of Bank B.