Beyond Correspondent Banking: A Case for Domestic Foreign-Currency Settlement in India

Beyond Correspondent Banking: A Case for Domestic Foreign Currency Settlement in India Can India create a domestic multi-currency settlement infrastructure for EEFC-to-EEFC transactions?

By Vinod Olickal Venugopal Senior Treasury & Forex Professional Centre for Cross-Border Payments Innovation (CCPI)

Introduction India has built one of the world's most advanced domestic payment ecosystems.

The evolution from traditional banking instruments to NEFT, RTGS, IMPS and UPI has fundamentally transformed the way money moves within the country. Domestic Indian Rupee payments can be initiated and settled rapidly through highly automated infrastructure, with standardized messaging, central settlement mechanisms and increasingly sophisticated liquidity management.

However, there is an interesting asymmetry in India's financial infrastructure.

While an INR payment between two Indian banks can be settled domestically through India's payment infrastructure, a domestic transfer involving foreign currency can continue to depend on international correspondent banking arrangements.

This raises a fundamental question:

If both the payer and beneficiary are in India, and both hold permitted foreign currency accounts with Indian banks, does the foreign currency settlement necessarily need to rely on an overseas correspondent banking chain?

This article explores that question, particularly in the context of Exchange Earners' Foreign Currency (EEFC) accounts, and proposes an area for further policy and industry investigation: the development of a domestic multi-currency clearing and settlement infrastructure for permitted domestic foreign currency transactions.

The objective is not to replace correspondent banking for genuine cross-border transactions. Correspondent banking will remain essential for international payments.

The objective is narrower:

Can India reduce unnecessary dependence on correspondent banking for foreign currency transactions where both sides of the underlying transaction are within India?

1. India's Domestic Payment Infrastructure Has Already Solved the INR Problem India's payment infrastructure demonstrates what can be achieved when settlement is brought closer to the participants.

For INR transactions, banks do not need to route every domestic payment through an overseas correspondent banking network.

RBI's RTGS provides real-time gross settlement infrastructure, while NEFT, IMPS and UPI provide different payment capabilities for banks, businesses and consumers.

The underlying principle is straightforward:

Domestic transactions should ideally be settled through domestic infrastructure wherever the regulatory and risk framework permits.

The same principle deserves examination for foreign currency.

India has significant foreign currency activity arising from:

• exports,
• imports,
• IT and professional services,
• international business,
• remittances,
• foreign currency deposits,
• EEFC accounts,
• treasury operations,
• international financial services.

The question is whether India's foreign currency settlement infrastructure has evolved at the same pace as its INR infrastructure.

2. The EEFC Ecosystem An EEFC account enables eligible residents to maintain certain foreign exchange earnings in foreign currency with an AD Category-I bank in India. RBI describes the EEFC facility as intended, among other

things, to enable exchange earners to save on conversion and transaction costs when undertaking foreign exchange transactions.

This is important because the EEFC ecosystem creates a substantial pool of foreign currency balances within the Indian banking system.

Consider a simplified example.

Customer A maintains USD 10 million in an EEFC account with Bank A.

Customer B maintains USD 8 million in an EEFC account with Bank B.

Both customers and both banks are located in India.

If Customer A has a permitted USD payment obligation to Customer B, the economic transaction is fundamentally domestic from the perspective of the two account holders.

Yet the settlement architecture may involve international correspondent banking infrastructure.

3. The Existing Settlement Chain A typical bank-to-bank foreign currency settlement flow can be represented as:

EEFC Account Holder A │ ▼ Bank A │ ▼ Bank A's Correspondent Bank │ │ SWIFT / Bank-to-Bank Payment Instruction │ ▼ Beneficiary Bank's Correspondent Bank │ ▼ Bank B │

▼ EEFC Account Holder B

For bank-to-bank funding and settlement, the relevant messaging architecture may involve instruments such as MT202/MT202 COV and, increasingly, ISO 20022 pacs.009, depending on the banks and payment infrastructure involved.

The important point is that the settlement asset is USD, but the settlement infrastructure may be located partly outside India.

4. Where Does the Cost Arise? Correspondent banking is a critical component of global finance. It should not be viewed negatively.

It enables banks without direct access to particular foreign currency clearing systems to participate in international payments.

However, correspondent banking also creates costs.

A transaction may involve:

• correspondent bank fees,
• SWIFT-related charges,
• intermediary bank charges,
• lifting charges,
• investigation charges,
• reconciliation costs,
• Nostro liquidity requirements,
• operational overhead.

The actual cost depends on the banks, currencies, corridors, arrangements and transaction types.

Therefore, the question is not:

"Is correspondent banking expensive?"

The more relevant question is:

"Is it economically efficient to use the international correspondent banking infrastructure for a permitted domestic foreign currency transaction where both the payer and beneficiary are in India?"

That is a question that should be tested with data.

5. Speed Is Not the Only Issue It would be tempting to argue that a new settlement infrastructure is required simply because it can settle faster.

That would not be a sufficient argument.

Modern correspondent banking is already highly automated.

SWIFT messaging, ISO 20022 migration, straight-through processing, correspondent-bank automation and real-time payment capabilities have significantly improved the speed and transparency of cross-border payments.

Therefore, speed alone should not be the primary justification for a domestic foreign currency settlement system.

The stronger case is:

Cost

Can correspondent and intermediary charges be reduced?

Liquidity

Can banks reduce fragmented foreign currency liquidity requirements across Nostro accounts?

Settlement efficiency

Can domestic foreign currency obligations be settled directly between participating banks?

Operational efficiency

Can reconciliation, exception handling and investigation processes be simplified?

Transparency

Can participants obtain better visibility of domestic foreign currency settlement?

These are much stronger economic arguments.

6. A Different Way of Thinking About Foreign Currency Settlement India already has a domestic infrastructure for INR.

Why not examine the feasibility of a similar architecture for selected foreign currencies?

The proposed model could be:

BANK A │ USD EEFC │ ▼ ┌─────────────────────┐ │ │ │ Domestic Multi- │ │ Currency Settlement │ │ Infrastructure │ │ │ │ USD | EUR | GBP | │ │ AED | JPY | Others │ │ │ └─────────────────────┘ │ ▼ BANK B │ USD EEFC

The key difference is that the foreign currency does not necessarily have to travel through an overseas correspondent chain for every eligible domestic settlement.

The settlement infrastructure would maintain a multi-currency ledger, with participating banks maintaining settlement balances.

7. A Domestic Multi-Currency Settlement Bank Model The architecture could potentially build on a model similar in principle to the settlement-bank arrangement used in the Foreign Currency Settlement System (FCSS) in GIFT IFSC.

CCIL IFSC has been authorized by IFSCA as a system provider to operate FCSS, a payment system for settlement of foreign currency transactions in GIFT IFSC.

The published FCSS operating notification provides an interesting example of how settlement liquidity can be organized.

It specifies a start-of-day process involving transfer of funds from members' settlement bank accounts to the FCSS Pool Account, followed by an end-of-day transfer from the FCSS Pool Account back to members' settlement bank accounts.

The concept could be studied for a much broader domestic application.

For example:

Bank A Settlement Account │ │ Start-of-Day Funding ▼ Multi-Currency Pool │ │ Domestic Settlement │ ▼ Bank B Settlement Account

A participant could fund its settlement position, after which eligible domestic transactions could be settled through the common infrastructure.

8. The Critical Difference: Funding Versus Settlement This distinction is fundamental.

A new system does not need to eliminate correspondent banking completely.

International correspondent banking could remain the mechanism through which foreign currency enters or exits India's domestic settlement ecosystem.

The objective would be to avoid using correspondent banking repeatedly for transactions that are entirely domestic.

Conceptually:

INTERNATIONAL FLOW

International Bank │ Correspondent Banking │ ▼ Domestic FX Settlement Infrastructure │ ├──────── Bank A ├──────── Bank B ├──────── Bank C └──────── Bank D

The correspondent network becomes primarily an entry/exit mechanism, while domestic foreign currency obligations can potentially settle within India.

This distinction could materially change the economics of the system.

9. Liquidity Efficiency Could Be More Important Than Speed The most important design question is liquidity.

If a bank has to repeatedly send foreign currency through correspondent banking every time its settlement balance falls, the benefit of a domestic settlement system would be limited.

A more efficient system could explore:

Liquidity-saving mechanisms

Offsetting incoming and outgoing obligations before requiring external funding.

Multilateral netting

For example:

Bank A owes Bank B USD 100m Bank B owes Bank C USD 90m Bank C owes Bank A USD 80m

Rather than requiring gross funding for every obligation, a multilateral mechanism can potentially reduce the liquidity required to settle the overall network, subject to the applicable legal and risk framework.

Queue optimization

Transactions can be prioritized and released based on available liquidity and settlement rules.

Intraday liquidity

Participants could potentially access appropriately structured intraday liquidity against eligible collateral, subject to regulatory approval and risk controls.

Liquidity forecasting

Banks could use real-time data to forecast settlement requirements and optimize their foreign currency balances.

10. The Role of CCIL CCIL could potentially play an important role in such an architecture.

The role would not simply be to move payment messages.

A market infrastructure could potentially provide:

• centralized clearing,
• settlement,
• liquidity management,
• multilateral netting,
• risk management,
• settlement finality,
• participant management,
• reconciliation,
• reporting,
• default management.

CCIL's existing experience as a financial market infrastructure makes it a natural institution to study for such a role.

However, the exact institutional structure would require policy and regulatory consideration.

11. The Proposal Is Not to Move Everything to GIFT IFSC This distinction is important.

The proposal is not to route all Indian foreign currency transactions through GIFT City.

GIFT IFSC and FCSS have a separate and important role in developing India's international financial centre.

The proposal here is different:

India's mainland banking system should also examine whether a domestic foreign currency clearing and settlement layer can be created for eligible transactions between Indian banks.

In other words:

GIFT IFSC FCSS and a potential mainland domestic foreign currency settlement infrastructure can be complementary rather than competing initiatives.

12. Potential Scope The initial scope should be deliberately narrow.

Phase I

EEFC-to-EEFC

This provides a relatively clean test case.

EEFC A │ Bank A │ Domestic FX Settlement

│ Bank B │ EEFC B

The objective would be to determine:

• Can the transaction settle domestically?
• Can the foreign currency remain within the Indian banking system?
• What regulatory permissions are required?
• What settlement asset should be used?
• What liquidity model is appropriate?
• What correspondent charges can be eliminated?
• What operational costs can be reduced?

Phase II

Other permitted domestic foreign currency transactions.

Phase III

Trade-related settlement and corporate treasury flows where appropriate.

Phase IV

Interoperability with international settlement systems.

13. A Practical Pilot Before creating a nationwide infrastructure, India could consider a controlled pilot.

For example:

Participants

• 5–10 major banks
• One settlement institution
• One or more currencies, initially USD

Transaction type

Permitted domestic EEFC-to-EEFC transactions.

Pilot period

6–12 months.

Metrics

The pilot should measure:

1. Average transaction cost. 2. Correspondent bank charges avoided. 3. Settlement time. 4. Liquidity requirement. 5. Nostro utilization. 6. Reconciliation cost. 7. Failed transactions. 8. Operational exceptions. 9. Settlement risk. 10. Participant satisfaction.

This would turn the proposal from a conceptual discussion into a measurable policy experiment.

14. What Should Be Tested First? The first question should not be:

"Can we build the technology?"

Technology is unlikely to be the biggest challenge.

The first question should be:

"What is the measurable economic cost of the current model?"

A structured industry study should collect data from participating banks on:

• number of EEFC-to-EEFC transactions,
• currency,
• transaction value,
• correspondent banks used,
• SWIFT message type,
• correspondent charges,
• other intermediary charges,
• settlement time,
• Nostro funding requirements,
• reconciliation effort.

This will establish the baseline.

15. A Simple Economic Illustration Suppose an eligible domestic foreign currency payment is USD 5 million.

Under the existing model:

USD 5m │ Bank A │ Correspondent │ International Settlement Infrastructure │ Correspondent │ Bank B

Assume, purely for illustration, that the combined incremental cost of the correspondent chain is USD 25.

For one transaction, USD 25 may appear insignificant.

But consider:

10,000 transactions × USD 25 = USD 250,000

At:

100,000 transactions = USD 2.5 million

And this calculation excludes:

• liquidity costs,
• operational costs,
• reconciliation,
• exception handling,
• Nostro management.

The actual economics must of course be established using industry data rather than assumptions.

16. What Happens to SWIFT? The proposal does not make SWIFT irrelevant.

SWIFT would continue to be extremely important for:

• international payments,
• cross-border messaging,
• correspondent banking,
• trade finance,
• securities transactions,
• global financial communication.

The proposed architecture would simply introduce an additional domestic settlement layer.

The distinction is:

SWIFT is primarily a messaging network; a domestic foreign currency settlement system would be settlement infrastructure.

India would continue to use SWIFT for international connectivity while potentially reducing its use for eligible domestic foreign currency settlement.

17. What Happens to Correspondent Banks? Correspondent banks would continue to play an essential role.

They would remain critical for:

• international liquidity,
• cross-border payments,
• foreign currency clearing,
• global financial connectivity.

However, the potential opportunity is to change the role of correspondent banking from:

"Settlement route for every transaction"

to:

"International liquidity and connectivity layer."

That could be a meaningful evolution.

18. Regulatory Questions Any such proposal must be examined carefully under India's existing legal and regulatory framework.

Important areas include:

• Foreign Exchange Management Act, 1999.
• Foreign Currency Account regulations.
• RBI regulations governing AD Category-I banks.
• Payment and Settlement Systems Act, 2007.
• Payment system authorization.
• Settlement finality.
• Participant default management.
• AML/CFT requirements.
• Reporting and monitoring.
• Foreign currency liquidity management.

EEFC accounts themselves operate within a defined RBI/FEMA framework. RBI's current material describes EEFC accounts as foreign currency accounts maintained with AD Category-I banks in India and specifies conditions governing their use.

Therefore, the proposed system should initially focus only on permitted transactions and should not be viewed as creating a new avenue for unrestricted movement of foreign currency between residents.

19. The Broader Opportunity The long-term opportunity extends beyond EEFC.

India has a significant foreign currency ecosystem comprising:

• exporters,
• importers,
• banks,
• corporates,
• service exporters,
• global capability centres,
• financial institutions,
• treasury centres,
• international investors.

A domestic foreign currency settlement infrastructure could potentially become a foundational layer for India's next generation of cross-border financial infrastructure.

It could eventually support:

Multi-currency settlement

USD | EUR | GBP | AED | JPY | SGD and other permitted currencies

Real-time liquidity management

Multilateral netting

Payment-versus-Payment settlement

Treasury APIs

Real-time reconciliation

Cross-border interoperability

20. The Strategic Question for India India has already demonstrated that it can build world-class payment infrastructure.

UPI demonstrated that a country can create a scalable, interoperable payment ecosystem.

RTGS demonstrated that high-value INR settlement can be operated through domestic financial market infrastructure.

The next question is whether India can develop similar capabilities for foreign currency settlement.

The objective should not be to isolate India from the global financial system.

Quite the opposite.

The objective should be to connect India to the global financial system more efficiently, while ensuring that transactions which can be settled domestically do not unnecessarily depend on external infrastructure.

Conclusion The question is therefore not whether correspondent banking should disappear.

It should not.

The question is whether correspondent banking should remain the settlement mechanism for every eligible foreign currency transaction involving two Indian banks when both the payer and beneficiary are located in India.

India's experience with RTGS, UPI and other domestic payment systems demonstrates the value of building appropriate domestic infrastructure.

The introduction of FCSS in GIFT IFSC is an important development in foreign currency settlement infrastructure. CCIL IFSC's published operating framework demonstrates that foreign currency settlement can be organized through a common pool and settlement-bank structure within an appropriate regulatory framework.

The next opportunity could be to examine whether a similar concept can be adapted—under RBI's regulatory framework—for eligible domestic foreign currency transactions on the Indian mainland.

The starting point should be simple:

EEFC-to-EEFC.

Test the current cost.

Measure the correspondent banking charges.

Measure the liquidity requirement.

Measure the settlement time.

Then compare it with a domestic settlement model.

If the evidence demonstrates meaningful savings in correspondent costs, liquidity and operational overheads, India would have a strong basis for considering a National Multi-Currency Clearing and Settlement Infrastructure.

The opportunity is not merely to make foreign currency payments faster.

It is to make them more efficient, less expensive and more liquidity-efficient.

A question for the industry

If two permitted foreign currency accounts are maintained with two Indian banks, and the underlying transaction is between parties in India, should India explore the possibility of settling that foreign currency obligation domestically rather than relying on an overseas correspondent banking chain?

This is a question worth researching, testing and debating.

Vinod Olickal Venugopal Senior Treasury & Forex Professional Centre for Cross-Border Payments Innovation (CCPI)