Intermediary bank: Meaning, Criticisms & Real-World Uses

What Is an Intermediary Bank?

An intermediary bank, also known as a correspondent bank, is a financial institution that acts as a middleman in facilitating funds transfers between two other banks that do not have a direct relationship with each other. This is particularly common in cross-border payments where the sender's bank and the recipient's bank operate in different countries or do not have established direct accounts with one another. Intermediary banks are a crucial component of the global financial system, falling under the broader category of banking operations and playing a vital role in enabling international trade and remittances. Their involvement ensures the secure and efficient movement of funds, particularly complex financial transactions across various jurisdictions, despite adding layers to the payment processing chain.

History and Origin

The concept of banks acting as intermediaries for cross-border transactions dates back centuries, evolving from early forms of trade finance and the need to settle accounts between distant merchants. However, the modern system of intermediary banks gained prominence with the rise of standardized global financial messaging. A pivotal development was the creation of the Society for Worldwide Interbank Financial Telecommunication (SWIFT) in 1973. Established by 239 banks from 15 countries, SWIFT was designed to standardize international funds transfers and enhance security, replacing the slower and more error-prone telegraphic transfer systems prevalent at the time.¹⁹,¹⁸, SWIFT's messaging network, which went live in 1977, provided a common language and secure platform for financial institutions to exchange payment instructions, thus formalizing and streamlining the role of intermediary banks in international wire transfer processes.¹⁷,¹⁶

Key Takeaways

An intermediary bank facilitates international fund transfers between banks that do not have direct relationships.
They are essential for cross-border payments, enabling global trade and remittances.
The SWIFT network revolutionized the efficiency and security of communication among intermediary banks.
Their role can add to the cost, speed, and complexity of international transactions.
Intermediary banks face stringent regulatory requirements, particularly concerning anti-money laundering (AML) and counter-terrorist financing (CFT).

Interpreting the Intermediary Bank

An intermediary bank acts as a pivotal node in the global financial network. When a customer initiates an international payment, their bank (the originating bank) might not have a direct account relationship with the recipient's bank (the beneficiary bank). In such cases, the originating bank sends the funds and payment instructions to an intermediary bank with which it has a relationship. This intermediary bank then forwards the payment to another intermediary bank, or directly to the beneficiary bank, until the funds reach their final destination. This multi-bank chain is particularly common for transactions involving different currencies or less frequently transacted routes. The efficiency of this process relies heavily on established correspondent banking networks and robust clearing and settlement procedures.

Hypothetical Example

Consider an individual, Alice, in New York who wants to send €5,000 to her cousin, Bob, in Berlin. Alice's bank in New York is "US Bank A," and Bob's bank in Berlin is "EU Bank Z." If US Bank A and EU Bank Z do not have a direct account relationship, the transfer will likely involve an intermediary bank.

Alice initiates the wire transfer from her account at US Bank A, specifying Bob's account details at EU Bank Z.
US Bank A, recognizing no direct link with EU Bank Z, sends the payment instructions and funds (or their equivalent in U.S. dollars) to an intermediary bank, perhaps "Global Bank X," which has a presence or established relationship in both the U.S. and Europe.
Global Bank X receives the instructions and funds. It then debits US Bank A's account (or its own U.S. dollar holdings) and credits EU Bank Z's account (or its euro holdings) held with Global Bank X, or passes the instruction to another intermediary in the euro zone.
Finally, EU Bank Z receives the funds from Global Bank X and credits Bob's account with €5,000, after any applicable foreign exchange conversion and fees.

This multi-stage process, facilitated by the intermediary bank, ensures the cross-border movement of funds.

Practical Applications

Intermediary banks are fundamental to many aspects of the global economy. Their most prominent applications include:

International Trade Finance: They facilitate payments for imports and exports, enabling businesses to conduct transactions across borders with different currencies. This includes handling Letters of Credit and other trade instruments.
Remittances: Intermediary banks are crucial for individuals sending money to family and friends in other countries. These remittances are a vital source of income for many developing economies.
Interbank Settlements: They enable banks to settle balances with each other for various transactions, including securities trading and derivative contracts, where direct relationships are not always feasible.
Capital Markets Transactions: When large institutions trade securities across international exchanges, intermediary banks ensure the efficient transfer of funds between different national financial institutions.

Despite their necessity, the system involving multiple intermediary banks can lead to challenges in cross-border payments, including higher costs, slower processing times, and reduced transparency., Th¹⁵e¹⁴ International Monetary Fund (IMF) has highlighted these issues, noting that moving money across borders can still be slow, expensive, and inconvenient, even with technological advancements. ht[^13^](https://www.moderntreasury.com/learn/what-are-swift-payments)tps://www.imf.org/en/Publications/fandd/issues/2022/03/cross-border-payments-imf-favas-etal

Limitations and Criticisms

While essential, the intermediary bank system faces several limitations and criticisms:

Increased Costs: Each intermediary bank involved in a transaction typically charges a fee, which can accumulate and make cross-border payments more expensive for the end user. These fees can be a significant burden, especially for smaller transactions or remittances.,
¹² ¹¹ Slower Processing Times: The involvement of multiple parties and different operating hours across time zones can lead to delays, meaning international transfers can take several business days to complete.,
¹⁰ ⁹ Lack of Transparency: Tracing the exact path of a payment through multiple intermediary banks can be difficult, leading to a lack of visibility on the payment status and potential points of delay or error.,
⁸ ⁷ Regulatory Burden and "De-risking": Intermediary banks, especially correspondent banks, are subject to stringent anti-money laundering (AML) and counter-terrorist financing (CFT) regulations, including Know Your Customer (KYC) and due diligence requirements. The Financial Action Task Force (FATF) provides guidance on these expectations., Th⁶e⁵ increasing complexity and cost of compliance have led some large international banks to terminate or restrict correspondent banking relationships with smaller banks, particularly in perceived "high-risk" regions. This practice, known as "de-risking," can hinder financial inclusion and push legitimate transactions into less regulated channels.,, T⁴h³e² World Bank defines de-risking as financial institutions terminating or restricting business relationships to avoid rather than manage risk, in line with the FATF’s risk-based approach. http[^1^](https://documents1.worldbank.org/curated/en/397411476868450473/pdf/109337-WP-StakeholderDialogueonDerisking-PUBLIC-ABSTRACT-SENT.pdf)s://www.worldbank.org/en/topic/financialsector/brief/de-risking-and-correspondent-banking This poses a significant challenge for global risk management and financial stability.

Intermediary Bank vs. Correspondent Bank

The terms "intermediary bank" and "correspondent bank" are often used interchangeably, as a correspondent bank inherently acts as an intermediary in cross-border transactions. However, "correspondent bank" specifically refers to a bank that provides services on behalf of another bank (the "respondent bank") in a different jurisdiction, holding an account for the respondent bank and facilitating payments, clearing and settlement, and other financial services. An "intermediary bank" is a broader term that simply denotes any bank in the middle of a payment chain between the originating and beneficiary banks, which may or may not have a standing correspondent relationship with both. All correspondent banks act as intermediaries, but not all intermediaries are necessarily formal correspondent banks with direct account relationships with all parties in a given transaction. The core function remains the same: to bridge the gap in international payment processing.

FAQs

Why are intermediary banks needed for international transfers?

Intermediary banks are necessary because not all banks globally have direct account relationships with each other. They act as bridges, facilitating the movement of funds and payment instructions between financial institutions that operate in different countries or financial systems.

Does an intermediary bank always charge a fee?

Yes, typically an intermediary bank will charge a fee for its role in processing a financial transaction. These fees can be deducted from the transferred amount, paid by the sender, or paid by the recipient, depending on the fee structure chosen for the wire transfer.

How long does a transfer through an intermediary bank take?

The duration of a transfer involving an intermediary bank can vary, usually ranging from 1 to 5 business days. Factors influencing the speed include the number of intermediary banks involved, the countries and currencies of the transaction, and the operating hours and clearing and settlement procedures of each bank in the chain.

Are intermediary banks secure?

Yes, transfers through intermediary banks are generally secure. They operate within a regulated framework and often utilize secure messaging networks like SWIFT to transmit payment instructions. However, the multi-party nature means adherence to stringent due diligence and compliance measures is critical to mitigate risks like fraud and money laundering.