Borrowed Time, Borrowed Money: How Correspondent Banks Use Credit to Move Liquidity

Every cross-border payment is briefly a loan.

Imagine that you need to send $3 million to suppliers abroad, so you call up your payment provider, they give you a quote, execute your trade, and promise to deliver the converted currency later that day (or maybe tomorrow, or in a few days, “subject to cut-off.”)

If your money is moving along traditional rails, it will likely pass through one or more correspondents, banks whose job it is to route transactions. At some point between wire and delivery, especially in lower liquidity corridors, it is highly plausible that one of these banks will need to execute the transaction before they have liquidity on hand to cover it.

There are lots of ways to solve this problem. Credit is one.

How Elastic is Your Trust?

It might surprise you to learn that the terms “credit” and “debt” don’t come from finance. The idea is much older and only starts mixing with the monetary system with the ancient notion of *Wergild—*blood prices to compensate for the murder or accidental loss of a relative. The same concept is encoded in the German Schuld, which marries the idea of debt and guilt. The idea of credit then has always been somewhat metaphysical, involving compensation, responsibility, and most importantly trust.

Credit itself comes from the Latin term “credere,” to trust in. For our purposes, credit is trust priced against time. If you are a bank taking out an intra-day loan, your creditors are putting faith in the idea that you’ll make good for your side of the bargain. If you’re a treasurer giving your $3 million to a payment provider, you are demonstrating an act of trust, trust that they will find a way to get your money to where it needs to go.

Back to our correspondent bank.

They need to move $3 million of your dollars, but their pre-funded balance is tied up in a number of other conversions. The money you’re sending to cover the transactions hasn’t arrived. They don’t expect enough offsetting transactions to come in to cover the trade. Their liquidity in this corridor is thin, because trade volume is usually low, so they are left with a problem.

This isn’t an uncommon situation, particularly during heavy trading days. Using Swedish central bank data, SWIFT found that banks’ intraday peaks often ran well beyond their opening and closing balances. Banks often need to access more money for a variety of reasons than they have on-hand.

The bank can source this money from either another bank it has a relationship with, or from the central bank itself.

The liquidity provider you’re using faces a similar question further upstream: how much currency will the bank agree to deliver before receiving payment? That willingness to extend credit is governed by what is often called a delivery limit.

In both cases, the time it takes for money to move from place to place requires market participants to extend trust to one another in the form of credit.

The Nitty-Gritty: How Correspondent Banks Interact with Cross-Border FX

How does intraday credit work, and what is it?

As stated earlier, an intraday loan is money taken out by the bank to support a transaction or transactions. Money cannot travel through the financial system instantly, but counterparties expect it to travel very, very fast. To increase settlement speed and market efficiency, the correspondent bank might take out a loan to cover the disjunction, with the expectation it will pay that money back by the end of the day.

For dollars, a major lender is the Federal Reserve, which allows banks to overdraw reserve accounts up to certain credit limits.

Intraday bank loans are what allow the correspondent to support the payment provider’s promise to move money for their client, and thus allow them to get that money where it needs to go.

Seen all together, you’ve got a stack:

• The central bank.

• The correspondent bank.

• The payment provider.

• Their client.

Trust at every level determines how much money can actually move through the stack.

That’s how liquidity often works. Liquidity equals the money people hold, plus the trust—the credit—each operative layer is willing to extend. The trust decides how fast your payment goes and part of what it costs.

Who Bears the Risk?

Looking back on the stack, you can see that risk runs both ways along the chain. Each side counts on the other side’s willingness to participate, knowing that the borrower might not pay on time or at all.

They mitigate this risk through credit limits and complex risk modeling, but sometimes that’s not enough.

In June 2008, three months before its collapse, Lehman’s treasury wrote that credit exposure was up, outlining how dependent it had become on intraday loans. This especially impacted currencies that settled outside CLS, as many non-CLS markets lacked real-time settlement information, making credit (which it got through Citi bank) essential for continued operation. Losing that credit would sharply raise the risk of failed settlements, which Lehman just saw happen with Saudi riyals, when another bank pulled its entire intraday line.

We know what happened next; a failure in any part of the system can cascade.

Sometimes a piece of the chain can simply disappear. We wrote about Herstatt risk previously, but here is a reminder.

Bankhaus Herstatt, a bank in Germany, was shut down by regulators in 1974. Accordingly, its New York correspondent stopped all outgoing dollar payments from its account. Counterparties that had already paid Deutsche marks saw their expected dollars vanish.

Trust is never risk free.

Butter Spread Over Too Much Bread

Between 2011 and 2022, correspondent banking relationships fell by about 30%. But even as the number of lenders shrinks, payment volumes keep rising, so all that flow now passes between fewer hands.

When a bank loses its direct line to a correspondent, it falls back on second- and third-tier correspondents, “nested” access through another bank or currency switches. Every fallback adds stress to the chain—cost, scale, compliance risk.

In 2017, a Financial Stability Board survey found that more than half of banks in Latin America and the Caribbean relied on two correspondents or fewer. In situations like that, the counterparties that remain can essentially set the terms.

In Europe, banks increasingly charge each other for credit. A 2017-18 BAFT survey of European banks found 65% were charged for intraday liquidity used to settle FX through CLS, and 35% for settlement outside it. Compare this to Latin America, where a regional study by FImetrix found only 1% of banks were charged explicitly.

The latter price looks small, but it’s compensated by transaction friction: Smaller lines, held payments, earlier cut-offs, balances kept on deposit, and a wider spread. When you’re moving currency in exotic corridors, part of what you pay is the cost of credit.

So let’s go back to your $3 million. Will it land today, tomorrow or in three days?

That depends on how much liquidity your provider is actually holding and how much room is left on the line. If a larger client’s payroll goes out first, your money might get thrown to the back of the queue. You’ll never really find out.

In my next article, I’ll talk about how stablecoins change this equation.