6.1 Types of correspondent accounts

A correspondent account is an account that one bank (the respondent) holds with another bank (the correspondent) so that it can make and receive payments, usually in a currency or a country where it has no branch of its own. Correspondent banking is the backbone of international payments: when a Kenyan importer pays a supplier in China in US dollars, the money moves through the US dollar accounts that the banks involved hold with each other. Because these accounts can be misused to move illicit money, regulators require banks to carry out due diligence on every correspondent relationship, and the compliance department keeps these relationships under continuous review. Example: a Kenyan commercial bank's treasury in Mombasa uses its US dollar account with a correspondent bank in New York to settle a coffee exporter's incoming payment.

Nostro account

A nostro account ("ours" in Latin) is an account a bank holds in a foreign currency with a bank abroad. For a Kenyan bank, its US dollar account with a bank in the United States, or its euro account with a bank in Germany, is a nostro account. The bank uses it to make and receive foreign currency payments for its customers, and keeps an internal record (the mirror or shadow account) that it reconciles daily with the correspondent's statement.

Vostro account

A vostro account ("yours") is the same account seen from the side of the bank that holds it. When a bank in Uganda keeps a Kenya shilling account with a Kenyan bank, the Kenyan bank calls it a vostro account: it is a deposit account of another bank on its books. The Kenyan bank must apply know-your-customer and anti-money laundering checks to the respondent bank and monitor the transactions passing through it.

Loro account

A loro account ("theirs") is used when a bank refers to an account held by a third bank with another bank. For example, a Kenyan bank instructing its correspondent in London to credit the account of a Tanzanian bank held there refers to that account as a loro account.

Mirror (shadow) account

A mirror account is the bank's own internal ledger copy of its nostro account. Every payment instruction sent or received is recorded in it, and it is reconciled daily with the correspondent's statement (MT950 or camt.053 message) so that unmatched items, charges and errors are found and cleared quickly.

Settlement accounts with the Central Bank of Kenya

Every commercial bank holds a settlement account with the Central Bank of Kenya. Interbank payments in Kenya shillings are settled across these accounts through the Kenya Electronic Payment and Settlement System (KEPSS), the country's real time gross settlement system, and the net results of the automated clearing house are settled across them. These accounts also hold the bank's cash reserve ratio balances.

Other types and arrangements

• Payable-through accounts: A correspondent account that the respondent bank's own customers can use directly to make payments; regulators treat these as high risk and many banks do not offer them.
• Nested (downstream) correspondent relationships: A respondent bank allows other banks to use its correspondent account; the correspondent must know about and assess these banks.
• Regional settlement accounts: Accounts used for regional payment systems, such as the East African Payment System (EAPS) for payments among East African Community central banks and the COMESA Regional Payment and Settlement System (REPSS).
• Local currency correspondent accounts: Accounts that smaller or foreign banks hold with larger local banks to access local clearing.
• Collateral or margin accounts: Accounts held with a correspondent to support trade finance lines, such as confirmed letters of credit.

Due diligence on correspondent relationships

Before opening or maintaining a correspondent account, the bank's compliance department assesses the respondent bank under the Proceeds of Crime and Anti-Money Laundering Act and the CBK prudential guideline on anti-money laundering:

• Ownership and management: Who owns and runs the respondent bank.
• Licensing and supervision: Whether it is licensed and effectively supervised in its home country.
• AML and sanctions controls: The quality of its anti-money laundering, counter-terrorist financing and sanctions screening controls, often gathered through a standard due diligence questionnaire.
• No shell banks: A bank must not open correspondent accounts for a shell bank, which has no physical presence where it is licensed.
• Senior management approval: New correspondent relationships are approved at senior level and reviewed periodically.