How are foreign exchange transactions among international banks settled?
The interbank market is network of correspondent banking relationships, along with large commercial banks maintaining demand deposit accounts along with one another, known as correspondent bank accounts. The correspondent bank account network let for the efficient functioning of the foreign exchange market. As an instance of how the network of correspondent bank accounts facilities international foreign exchange transactions, let U.S. importer wishing to purchase merchandise invoiced in guilders from a Dutch exporter. The U.S. importer will contact his bank and inquire regarding the exchange rate. If the U.S. importer accepts the offered exchange rate, the bank will debit the U.S. importer's account for purchase of the Dutch guilders. The bank will instruct its correspondent bank in the Netherlands to debit its correspondent bank account the appropriate amount of guilders and to credit the Dutch exporter's bank account. Then the importer's bank will debit its books to offset the debit of U.S. importer's account, reflecting the reduction in its correspondent bank account balance.