This blog a very quick & short blog but very important blog for the students and for the professionals who likely to work in foreign exchange. Nostro, Vostro & Loro Accounts are very important to settle down the foreign exchange transaction. In this blog we are discussing about the Nostro, Vostro & Loro accounts. To know better about Nostro, Vostro & Loro accounts we have to understand about the need of these accounts. So stay with the blog to enhanced the knowledge, we are discussing here in details about the Nostro, Vostro and Loro accounts.
Nastro, Vastro & Loro account is created for easy settlement of the incoming funds (value of export goods) and track on out going funds (import goods) and keep smooth control on Foreign Exchange. I know the above statement is little complexed and not understandable for a common person. to make it easy we have to understand the concept from the beginning like what is foreign exchange ? what is need of the Nostro, Vostro and Loro accounts. So let’s begin.
Table of Contents
What is Foreign Exchange
Foreign Exchange is also known as forex. The forex is a method of the conversion of one country’s currency into another country’s currency.
In the simple words, the forex is the criteria to measure the one country’s currency value to another country’s currency value.
Exchange of the currency takes place at the authorized centers of the RBI.
For example – Any tourist of America come to India for the purpose of explore India and he/she carries US Dollars with him. Now in Indian he/she has to have INR. If we are taking the example of India, the currency of any other country is not used and acceptable in India. Than he/she has to contact the authorized money exchanger or any authorized bank to convert from USD to INR.
The money exchanger or the bank is authorized to exchange the currency by using the exchange rate.
Suppose the tourist want to exchange 100 USD into INR. The money exchanger or bank must be go through the that day’s exchange rate of USD to INR. Like 01 USD = 70 INR so 100 USD = 7000 INR and the tourist will get 7000 INR.
What is Exchange Rate
Exchange rate is the value of one country’s currency in terms of another country’s currency.
Exchange rates may be either fixed or floating.
- Fixed exchange rate are rates which has been decided by the central banks of that country.
- Floating exchange rate are the rates which have been decided by the mechanism of market demand and supply.
Which type of exchange rate system adopted by India?
India has decided to adopt the floating exchange rate system.
Quotation of Exchange Rates
The exchange rates can be quoted in two ways
01) Direct Quotation
02) Indirect Quotation
Direct quotation is where the cost of one unit of foreign currency is given in units of local currency, for example 1 USD = 70 INR . Indirect quotation is where the cost of one unit of local currency is given in units of foreign currency. for example 100 INR = 1.4285 USD
In India we are adopting the direct exchange rate system where the foreign currency is fixed and INR is variable.
Need of Foreign Exchange
The need of foreign exchange for a country is to maintain and increase their foreign exchange reserves. The countries need the foreign exchange reserves for the following purposes.
01) to maintain a fixed rate value in the country,
02) to maintain and encourage export at competitive price,
03) in the situation of financial crisis maintain liquidity in the country,
04) provides confidence for the investors.
05) to pay the external debts,
06) allocate funds to the different sectors for the growth of the country’s economy.
07) gains profit from diversified portfolios in the international market.
Mechanism of International Trade
Before we are want to understand the meaning, the need and the importance of a Nostro, Vostro or Loro accounts. we have to know about the functioning of the international trade.
International trade means a trade where the buyer and the sellers are from different countries with different currencies. In these types of trades the payment is become a big risk. The seller is always in a warry that his payment will be received or not. The banks realized that by this fearness the international trade can not grow so the concept of Letter of Credit come into existence in the banking system.
Before we are going to learn about the mechanism of Letter of Credit we have to know about what is lawful export and what are the punishable Import.
The lawful export and the Punishable Import
Every country have certain rule to check the export and imports. The Importer or Exporter are bound to follow these rules otherwise it be come a punishable offence and come into the category of smuggling. The custom department of that country looks after the each and every goods which comes in and goes out from the country.
In India FEMA (Foreign Exchange Management Act) is the act which formed to regulate the Foreign trade. RBI is the authority to regulate the act and keep their eyes on each and every foreign dealings which also helps to calculate the foreign exchange reserves in the country.
Letter of credit
The letter of credit is also known as a documentary credit or letter of undertaking. Letter of Credit provide an economic guarantee from a bank to an exporter or we can say that Letter of Credit is a payment mechanism used in international trade.
A letter of credit, is a letter issued by a bank taking guarantee for the buyer’s payment to a seller. the bank guarantee’s that the seller will get their correct bill amount if the seller fulfills all the requirements mention in the letter of credit. In the event where the buyer is unable to make a payment of the purchase, the bank will cover the full or remaining amount of the purchase under letter of credit.
Who many parties involved in a Letter of Credit ? The following parties are involved for the issuance of letter of credit and smooth functioning of international trade.
01) Applicant of Letter of Credit (Buyer).
02) Letter of Credit Issuing Bank.
03) Beneficiary (seller or exporter)
04) Beneficiary bank
05) Advising Bank.
06) Confirming Bank.
07) Negotiating Bank.
08) Reimbursing Bank.
Nostro Account
First all of we have to understand that from where the term come from ?
The Term Nostros, is a Latin word, the meaning of the term is “ours.” This term is frequently used to facilitate foreign exchange and trade transactions.
What Is a Nostro Account ?
A nostro account refers to an account that a domestic bank holds in a foreign currency account in another bank. It can be easily understand by the clip given below. Where SBI or PNB maintains their account with Bank of America in US Dollars is called nostro account of a domestic banks.
How the Nostro Account works ?
A nostro account helps to easy and fast disposal of export bill because the beneficiary bank can ask to the buyer’s bank to deposit the funds to its nostro account with the other bank.
It will be also beneficial to a foreign paying bank to easily credit the funds whereas if the paying bank first convert the proceeds into the domestic currency and send.
It can also easily understand by an example ,
if the buyer is from US based than the beneficiary’s bank can ask to the buyer’s bank to credit the proceeds in USD to their nostro account at Bank of America
What is the importance of a Nostro Account ?
01) easy disposal of the outstanding bills
02) best way to keep track and easy to maintain the foreign transactions
03) easy to maintain to track the record of foreign currency reserves.
Vostro Account
First all of we have to understand that from where the term come from ?
The term Vostro is a Latin word. The meaning of the term “Vostro” is “yours,”
What Is a Vostro Account?
The Vostro account is an account which is open and maintain by a foreign bank in the domestic currency.
In concern of India if The Bank of America opens and maintains their account with SBI in Indian Rupees will called Vostro account for SBI.
That account will be Nostro account for Bank of America but Vostro account for SBI.
How the Vostro Account works ?
If a foreign bank work or act as an agent in other than their parent’s country so the foreign bank have to open and maintain a Vostro account.
These services include the executing fund transfers, withdrawals, and deposits for customers in countries where any other domestic bank of the foreign bank does not have their physical presence. What is the importance of a Vostro Account ?
Foreign banks want to open Vostro accounts for a multitude of reasons, although it is expensive or sometimes make impossible to open and operate a bank branch in another country. that’s why the bank’s prefer to open a Vostro account for
01) to satisfy customers with international banking needs,
02) relationships with banks in abroad
03) to provide uninterrupted banking services to their clients.
What is difference between Nostro and Vostro account?
A Nostro account is domestic bank’s account of their money in other currency, held by the foreign bank.
A Vostro account is the account of foreign bank’s money which is held with domestic bank.
Loro Account
First all of we have to understand that from where the term come from ?
The term LORO is an Italian word which literally means ‘Their’. What is Loro account ?
A Loro Account is just like a Current Account maintained by one Domestic Bank on behalf of other domestic bank in foreign bank in foreign currency.
In other word Loro Account is a Nostro Account of one domestic bank who opened with a foreign bank and become Loro Account for other bank who take advantage to collect their funds.
How the Loro Account works ?
Loro account helps in the situation when a domestic banks use the nostro account of third party banks to settle down his foreign exchange transactions.
It can be easily understand with the clip given above where Canara Bank want to settle down their foreign transition with National Bank of Hongkong, but the Canara bank have no arrangement to collect the funds but other domestic bank Bank of Baroda is maintaining their Nostro account with National Bank of Hongkong. In this case Canara bank can request Bank of Baroda to collect the funds on their behalf. As soon as the funds will be collected by the BOB than the Bank of Baroda will advice Canara bank about the collection of the fund and make arrangement to reimburse the funds. By this act the transaction will also be reconcile accordingly.
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