What is foreign exchange transaction
For better understanding what is Foreign exchange transaction, we need to understand first what is ‘home currency’ and what is ‘foreign currency’.
Home currency means the Currency which is circulated or used in a particular Country for example Rupee is circulated and used in India so it is home currency of India similarly Pound Sterling is circulated and used in UK, US Doller is circulated and used in USA so it is Home currency of UK and UAS respectively.
Foreign currency means any other currency other than the home currency, so if we say with reference to the above example foreign currency means any other currency other than Rupee for India, Pound Sterling for UK and US Dollar for USA.
What is Foreign exchange
Foreign exchange means taking at one centre a particular Currency and giving out at the other centre in other Currency. For example to take USD 100000 from Dubai against Export Bill (export invoice) rose from India and give out the US Dollars 100000 in Rupee in India. In other words, conversions of one currency taken from one centre into other currency by giving at other centre.
Usefulness of any foreign Currency can be had only if it is converted in to home currency because, foreign currency is not used or acceptable in India if we take example of India. For giving usefulness to any foreign currency the said currency needs to be converted in to the home currency.
Home Currency of one country is foreign currency for other country. Conversion of foreign currency in to home currency is the fundamental of foreign exchange. Therefore in order to put through the foreign exchange transaction, the bank which is authorized to deal in foreign exchange, maintains an account with its overseas Bank to keep stocks of foreign currencies. Normally, such account is a current account in the books of the overseas Bank. For example, an Indian bank authorized to deal in foreign exchange maintain an account with overseas bank in USA in US Dollar such account maintained in the foreign currency at foreign center by Indian bank is said as ‘Nostro Account’ . Nostro is an Italian word which literally means ‘Our’. So the ‘Nostro Account’ of the Indian bank with its branch/correspondents in USA is said as ‘Our Accounts with You’.
For the similarly reason, foreign bank of other country authorized to deal in foreign currency maintains an accounts with overseas Bank to keep stocks of foreign currencies (home currency of the country in which the overseas branches/ correspondents is situated) for the purpose of putting through the foreign exchange transactions. For example XYZ bank of USA maintains an account with a Bank in India in Indian Rupee such account maintained in the foreign currency at foreign center by Foreign bank is said as ‘Vostro Account’. ‘Vostro’ is an Italian word which literally means ‘Your’. So the ‘Vostro Account’ of the foreign bank with Indian bank in India is said as ‘YOUR Accounts with Us’.
The terms Nostro (Our) and Vostro (Your) are used in the bilateral correspondence between the concerned two Banks ie the Bank maintaining the account and the Bank in whose book the account is maintained. But in such correspondence when third bank account is referred it is said as LORO account. For example when XYZ bank of India is maintaining an account with ABC Bank in New York USA in USD when PQR bank of India refers the said account in correspondence with XZY Bank, Now YORK it is said LORO account . LORO is an Italian word which literally means ‘Their’. Loro account means ‘Third Party Account’.