Correspondent banking system is developed to remove the difficulties in unit banking system. It is the system under which unit banks are linked with bigger banks. The big corre­spondent banks are linked with still bigger banks in the financial centres.

The smaller banks deposit their cash reserve with bigger banks. The bigger banks with whom such deposits are so made are called correspondent banks.

Therefore, correspondent banks are intermediaries through which all unit banks are linked with bigger banks in financial centres. Through correspondent banking, a bank can carry-out business transactions in another place where it does not have a branch.

This system is very common in international banking transactions. For example, if an Indian bank does not have a branch in Japan; it may find it difficult to carry-out Japan-related import/export transactions for its customers.

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In such a case, the Indian bank may choose a bank in Japan as its correspondent bank to put through all its Japan-related financial trans­actions. This arrangement avoids the need of opening a branch in another country. Hence, it is cost effective also.