Overview: What makes custodian banks different from other banks?

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Aug. 7 2014, Updated 9:55 a.m. ET

Custodian banks

Custodian banks are very different from commercial or investment banks. They don’t provide any services that directly help their customers. Instead, they act like a warehouse and store other financial institutions’ and individuals’ assets. They help in keeping financial instruments safe. They also administer all services that occur as a result of corporate actions. Many such banks use their expertise and superior technical knowledge to operate across many countries. The Bank of New York and Mellon (BK) and State Street Corp. (STT) are largely pure play custodian banks. Full service banks like JPMorgan (JPM) and Citi (C) are also big players in custodian banking. An exchange-traded fund (or ETF) like the Financial Select Sector SPDR FD (XLF) contains many custodian banks.

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These banks may hold a variety of financial instruments for their client. Most of the financial instruments are electronic and dematerialized. Custodian banks hold equities, bonds, commodities, foreign exchange, and their derivatives. They also hold mutual funds and ETF units. They arrange for settlements when these instruments are traded.

Corporate actions like dividends, stock splits, and buybacks require adjustments or payments to be made to accounts. Certain events like annual meeting, shareholder voting, and proxies require holders to be informed. These banks provide all such services. The banks may also provide services like fund accounting as well as legal and compliance requirements fulfillment.

All of their revenue is derived from charging a fee for assets under their custody. The major expense for such a bank is the staff cost and the cost of the technology needed for providing custodian services.

Custodian banks definitely carry much lower risk than commercial and investment banks. However, their growth hinges on the growth of commercial and investment banks and other financial institutions because they need to grow assets under their custody to keep growing as a whole.

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