Why Banks Need Money Sitting Everywhere

These are mirror terms for the same account, viewed from different perspectives.

Example:

JPMorgan opens an account at BDO (a major Philippine bank). JPMorgan deposits $100 million worth of Philippine pesos into this account.

• From JPMorgan's perspective: This is their nostro account (our money in your bank)
• From BDO's perspective: This is JPMorgan's vostro account (your money in our bank)

Same account, different viewpoint.

Let's go back to Maria's payment. Here's the problem that nostro accounts solve:

Pre-funding eliminates settlement risk. The Philippine bank isn't extending credit to JPMorgan—they're debiting an account that already holds JPMorgan's money.

This is why the correspondent banking system exists. Small banks don't have relationships (or nostro accounts) with banks in every country. Instead:

Maria's regional bank doesn't need its own account in the Philippines. It has an account with JPMorgan, and JPMorgan has an account in the Philippines. The trust chain connects.

Estimates of global nostro/vostro balances vary widely:

Why such a wide range?

• Different definitions of what counts as a nostro account
• Major currencies only vs. all currencies
• Large banks only vs. entire banking system
• Point-in-time measurements vs. averages
• Some include central bank reserves, others don't

A reasonable working estimate: $10-20 trillion in clearly identifiable nostro/vostro accounts, with potentially more in related pre-funded positions.

• $15 trillion is roughly the GDP of China
• It's larger than the GDP of every country except the US and China
• It could fund the entire US federal budget for 2.5 years

The capital is highly concentrated. The 30 largest global banks hold the vast majority of nostro balances. This makes sense—they're the ones routing payments for everyone else.

Money sitting in a nostro account earns little or nothing. It's held in liquid form, ready to fund payments at any moment. It can't be:

This is dead capital—economically unproductive.

Let's do some rough math:

• $15 trillion in nostro balances (middle estimate)
• Could earn 4% if invested in safe assets (conservative assumption)
• Currently earning ~0.5% (optimistic for operational cash)

Annual opportunity cost:
$15 trillion × (4% - 0.5%) = $15 trillion × 3.5% = $525 billion per year

Half a trillion dollars annually—just from the interest that's not being earned on money sitting idle.

This isn't money someone is "losing" in a visible way. It's an invisible tax on the entire financial system—higher fees, lower returns, reduced lending capacity. Everyone pays for it, but nobody sees the bill directly.

If the opportunity cost is so high, why do banks maintain these balances?

Reason 1: Settlement Risk
Without pre-funding, banks face settlement risk. What if the counterparty doesn't pay? Pre-funded accounts eliminate this risk entirely.

Reason 2: Regulatory Requirements
Basel III and other regulations require banks to maintain liquidity buffers. Nostro accounts count toward these requirements, reducing the "wasted" perception.

Reason 3: Competitive Necessity
Banks that can offer fast, reliable international payments attract business. Pre-funding enables speed. Banks without adequate nostro balances can't compete.

Reason 4: It's Priced In
Banks don't eat this cost—they pass it to customers. Those wire transfer fees? They're partly paying for the opportunity cost of nostro balances.

Here's the core dilemma: any one bank reducing its nostro balances would slow its own payments while competitors maintain speed. The first mover is punished.

For the system to change, banks would need to collectively agree to a new model—while competing with each other fiercely. Classic coordination problem.

These rules assume (and entrench) the nostro model. Changing the rules requires convincing regulators across multiple jurisdictions that a new model is safe. That's a multi-year, multi-billion-dollar undertaking.

Changing the underlying model means changing all these systems—an enormous IT undertaking for large institutions.

Even if banks wanted to change, what would they change to?

Until recently, there wasn't a credible alternative to pre-funding. You either had money in place before the payment, or you had settlement risk. There was no third option.

(Spoiler: This is where blockchain technology enters the conversation. But we'll get there.)

Trapped capital affects bank returns. A bank with $50 billion in nostro balances has $50 billion that's not generating full returns. This shows up in lower return on equity (ROE) and return on assets (ROA).

Why does Maria pay $45 to send $500? Partly because her bank (and the banks in the chain) are recovering the cost of maintaining the infrastructure that makes her payment possible—including nostro balances.

If nostro accounts could be reduced or eliminated, those savings could theoretically flow to customers as lower fees. (Whether they actually would is a different question.)

For many developing country corridors, the answer is no. So banks exit those relationships—a process called "de-risking."

When banks de-risk, people in those regions lose access to the international financial system. They're forced into more expensive alternatives or excluded entirely.

TRADITIONAL CROSS-BORDER PAYMENT (USD → PHP)

Before Payment:
├── JPMorgan maintains PHP 5 billion in Philippine nostro account
├── This capital sits idle, waiting for transactions
└── Opportunity cost: ~PHP 175M per year (3.5% × 5B)

When Maria Sends $500:
├── Maria's bank debits her account ($545)
├── Maria's bank sends instruction to JPMorgan
├── JPMorgan debits its PHP nostro at Philippine bank
├── Philippine bank credits Maria's mother (₱25,000)
└── Settlement complete

The nostro balance was essential—without it, no trust, no payment.
```

GLOBAL NOSTRO ACCOUNT STRUCTURE

[US Banks]
$4T in foreign nostro
│
┌────────────────┼────────────────┐
▼ ▼ ▼
[EU Banks] [Asian Banks] [UK Banks]
$3T foreign $2T foreign $1T foreign
│ │ │
└────────────────┼────────────────┘
▼
[Emerging Market Banks]
$2-4T in relationships

Each arrow represents pre-funded accounts
Total: $10-20 trillion, mostly idle
```

Nostro accounts represent genuine inefficiency—trillions in capital doing less than it could. But they exist because they solve a real problem: settlement risk in a world without real-time, trustless value transfer.

Any alternative must solve the same trust problem a different way. "Just eliminate nostro accounts" isn't a solution—it's describing an outcome. The question is: what mechanism could make that outcome possible?

Nostro Account: An account that a bank holds at a foreign bank, denominated in the foreign currency. "Our money in your bank."

Vostro Account: The mirror image—an account held by a foreign bank at your bank. "Your money in our bank."

Pre-funding: Placing money in accounts before it's needed for specific transactions, ensuring instant availability.

Settlement Risk: The risk that one party to a transaction will fail to deliver after the other party has already performed. Pre-funding eliminates this.

De-risking: Banks exiting correspondent relationships due to compliance costs or risk concerns, often in developing countries.

Opportunity Cost: The returns foregone by using capital for one purpose (nostro balances) instead of another (lending or investing).

We've established that moving money internationally is expensive, slow, and requires trillions in trapped capital. But why hasn't anyone fixed this? Lesson 3 examines the network effects, regulatory barriers, and coordination problems that make payment infrastructure so resistant to change. Understanding these barriers is essential for evaluating whether any alternative can succeed.

Lesson 2 Complete. Continue to Lesson 3: Why This Problem Is So Hard to Solve →