What is an indirect IBAN?

IBAN stands for International Bank Account Number. Despite its name, IBAN is more of a system to harmonize the process of identifying the account number: thanks to this standard, account numbers at all banks in the member countries have the same format and system for protecting against transcription errors. However, the account number recorded in this format is normally only used for cross-border payments, whereas domestic transfers use the number of the (same) account recorded by national standards.

In the IBAN system, each account number consists of 34 characters:

• 2 capital letters (country code);
• 2 check digits;
• 30 characters – basic account number.

The format of the basic account number is determined in each member country by its central bank. It necessarily includes the bank code in the member country and the account number, but may also include a branch code (sort code in the UK and Ireland), BIC, national check digits, account type code, account currency code, and account holder’s identification number.

The IBAN system is a fairly recent invention. The standard harmonizing the account number format for international transfers was first adopted in 1997 by the European Committee for Banking Standards to simplify cross-border payments within the EU. Subsequently, this standard was also adopted by the International Organization for Standardization (ISO*), which placed IBAN under the patronage of the SWIFT society.

*Current standard’s number: ISO 13616:2020

SWIFT is the registration authority for IBAN, the IBAN system is included in the syntax of financial messages exchanged within SWIFT.

The reasons for creating a single standard account number for international payments are obvious: given all the various account identification systems, there is a strong risk that the sending bank will be unable to read all the data necessary for the transfer (bank, branch, routing codes and the account number itself) among the provided details. In addition, national account identification systems contained different mechanisms for protecting against transcription errors (control digits), or did not contain any at all. In the IBAN system, a number alone already contains all the necessary information for the accurate transmission of funds.

Originally introduced as a system to simplify payments within the European Union, IBAN has spread far beyond Europe. Today the system is used by 86 states and territories. Here is a list of the most economically significant of them:

As can be seen from the list, the IBAN system countries are mainly located in Europe and the Middle East, also partly in the Caribbean, Africa, Asia and Latin America.

Nor is the IBAN system adopted in North American countries: Canada, USA and Mexico.

In Russia, IBAN was adopted quite recently. The Russian format was only registered in the IBAN system in May 2022, and the Central Bank recommended that Russian banks provide clients with their account details in this format from 1st of April, 2023.

You can often hear nowadays that a particular payment system or offshore bank provides an indirect IBAN when opening an account. This usually means that the financial institution has an account with another bank or payment system that provides proper IBANs. The details of a client’s account at that financial institution include the IBAN of such financial institution and a code, or number, or other reference that allows transfers to be attributed to the account of a specific client of the financial institution.

To simplify, an indirect IBAN is somewhat similar to a computer folder containing other folders: when you move a file, you first drag and drop it to a general folder, and then to the necessary subfolder. The same applies to payments: a financial institution receives a payment in its account and ensures that the funds are allocated to the respective client account, as agreed between the client and the financial institution.

The reason why this practice has grown so big in such a short time is the advantages it offers to international businesses:

1. It is generally quicker and easier to open an account in such a financial institution than at a traditional bank;
2. Such financial institutions generally operate under a payment system licence (or an offshore banking licence), which allows them to onboard higher-risk clients;
3. Such financial institutions can often act as a hub for making transactions with a market whose participants have no access to international payments (for example, currently sanctioned countries). These payment systems can receive/send international payments using their IBAN, and then send/receive payments to/from hard-to-reach jurisdictions.

For all its advantages, an indirect IBAN is a compromise. The biggest drawback of this system is that, when sending payments, you indicate as beneficiary name of the financial institution that provides the indirect IBAN (i.e. the offshore bank or payment system where the client holds the account). Also, that financial institution can often offer pre-set wording that could be included in the reference line of the payment order.

Clients usually manage to agree with their counterparties the sending or receiving of funds from/to an account with an indirect IBAN. Then, if any problems with payments do arise, they usually come from the sending bank that refuses to make a transfer to a beneficiary other than the contractual party stated in the agreement (under which the payment is made). Often, such banks requires a transaction report form (under their or state’s format) for exchange control purposes.

As a way of getting the sending bank to release payments, most offshore banks and payment systems that provide indirect IBANs suggest issuing a letter from the company that indicated as beneficiary, stating that a payment made using this IBAN, with such and such code specified in the reference of the payment, will actually be credited to the client company’s account.

Also, to satisfy themselves that the payment will be executed to the proper party, banks sometimes ask to prepare a similar confirmation letter from the director of the company for which the payment is actually designated. The director may state in the letter that the transfer of funds with these payment details will be considered proper performance of the agreement.

Of course, an indirect IBAN is a compromise solution with its pros and cons. However, practice shows that offshore banks or payment systems offering indirect IBANs can be an excellent solution for small and medium-sized businesses that need to make international payments, but are unwilling or unable to open an account at a proper bank. Especially if the plan is make payments to a long-time business partner or within a group of companies. In some cases, such as the case of payments with currently sanctioned countries, this payment method can really be a lifeline.