How do banks trust each other especially in cross-border situations?

Question

Maybe my question is far too trivial for this community. But let's see. I don't have an economic background.

I wonder how banks trust each other when money gets transferred from one bank to another bank in different countries. Suppose this:

Suppose we have two countries A and B.
A's currency has the symbol  CurA, B'y currency is CurB.

Some bank of A has this accounts: 100 CurA, 200 CurB.
Some bank of B has this accounts: 3000 CurB, 4000 CurA.

Now B's bank transfers 1000 CurrA to A's bank.

First question: Does a global instance exist, which knows about the amount of each currency on each account in each country? Something like a global supervising bank.

Especially if the respective banks of a transaction are in different countries, do all banks need to trust each other to execute a transaction?

What if e.g. B's bank claims to transfer 100 CurB to A's Bank, A's bank then increases an account by 100 - but B's bank claims to decrease the account but actually does not?

If B's bank fakes a transaction in this way, only B's bank would know, other parties would not. Except B's bank is forced to report all account balances to a global supervisor.

And what happens e.g. in conflict situations like wars? Would even in a war situation no bank would behave non-trustworthy? Since if all banks of a war party would behave non-trustworthy, the im- and exports would drop to 0, since no other country wouldn't exchange money against goods any more?

Maybe someone could post a reference to a paper or book, which explains the details of inter bank transactions.

Answer 1

When Bank A transfers money to Bank B, it usually does through in Bank C. The exception would be when Bank A is a client of Bank B. Then it would just move money out of its own account and into Bank B's account. Both banks have to have a relationship with Bank C that causes them to trust it. If Bank A is a client of Bank B, presumably it has already overcome the trust-related hurdles.

There may be a chain of banks involved as well. Bank A trusts Bank C but Bank B does not bank there, but they do bank at Bank E. Bank C does not have a relationship with Bank E but both share a relationship with Bank D, that is trusted by both.

There are multiple networks of competing correspondent banks throughout the world. For example, in the United States, credit unions are not banks and are required by law to maintain balances at national banks. Indeed, when you write a check on a credit union, you are really writing a check on some bank somewhere else via the credit union's bank account.

There are really two types of relationships in correspondent banking. There are official relationships, such as the Federal Reserve clearing checks for national banks and other member institutions, and there are private clearing relationships. It may be faster or a lower cost for banks in a region to have a private clearing arrangement that bypasses the official governmental clearing arrangement.

In the official case, the central bank formally inspects each bank via legal powers and actually walking in and inspecting the place at their premises. In the private correspondent case, they can do additional arrangements beyond those legally required such as a private inspection, plus they can free-ride on the government's inspection.

Wars are a special case. War powers are usually stated in the legal system. For example, under US law, because of Russia's invasion of Ukraine as well as its threat of nuclear war, existing law permits the President to seize without due process all Russian government assets.

Under the US constitution, people, including foreigners have due process rights but governments do not. They are not people under US constitutional law.

So Russian banks that are not owned by the state, retain their property rights though the assets may be frozen. State-owned property can be seized, sold, and even given to Ukraine.

In the case of war, the question is not trust but war powers. If Bank A is in a country that is at war with Bank B's country, it is unwise to keep deposits in Bank B. The mistake Russia made with respect to the invasion of Ukraine regarding its banking assets was that it failed to understand western contract law. There were many intelligence failures on the Russian side and the banking rules were clearly part of it.

The problem Russia would have had, however, is that to protect its assets from seizure, it would have had to have removed all of them from western institutions. That would have been a giant signal that a war was imminent. Most likely, Ukrainian banks have deposits in Russia that they cannot access. It would be surprising if they did not have correspondent relationships because they share a border.

However, in that case, it isn't so much the correspondent that you need to trust so much as the government on the other side of the border.

Answer 2

What if e.g. B's bank claims to transfer 100 CurB to A's Bank, A's bank then increases an account by 100 - but B's bank claims to decrease the account but actually does not?

Well then B's bank's customers have 3000 CurB in their accounts, but B's bank only has 2900 CurB. If everyone withdraws their CurB from B's bank, whoever is last will not get their money back because the bank will be bankrupt. If B's bank's customers hear about this situation, everyone wants to not be last and they all stampede down to the bank all at once and fight each other so they can get to the front of the line. This is a bank run.

Would even in a war situation no bank would behave non-trustworthy? Since if all banks of a war party would behave non-trustworthy, the im- and exports would drop to 0, since no other country wouldn't exchange money against goods any more?

If a bank steals money from its customer then its customer will sue it. If the country's legal system allows that, the bank will lose and will have to give the money back (or the owner will go to jail, or something like that). If the country's legal system says the bank was allowed to steal the money, well, nobody in that country will want to use banks any more, because they're allowed to steal money. We saw that in Russia with everyone trying to take all their money out of the banks.