Services provided by a bank custodian are usually the settlement, safekeeping and reporting of customers’ marketable securities and cash. A custody relationship is contractual, and the services that are performed for a customer differs. Banks render custody services to a variety of customers, including mutual funds and investment managers, bank fiduciary, retirement plans, and agency accounts, bank commercial security accounts, insurance companies, corporation, endowments and foundations, and private banking clients. Banks that are not significant custodians provides custody services for their customers through an arrangement with a large custodian bank.
Core Custody Services
A custodian providing core domestic custody services settles trades, invests cash balances as directed, collects income, processes corporate actions, prices securities positions and facilitates record keeping and reporting services.
Global Custody Services
A global custodian offers custody services for cross-border securities transactions. Besides providing core custody services in some foreign markets, a global custodian provides services like executing international transactions and processing tax reclaims. In most cases, a global custodian has a sub-custodian, or agent bank, in every local market to assist in providing custody services in a foreign country. The volume of the global assets under custody has increased rapidly in the past years as investors have started looking to foreign countries for other investment opportunities.
Securities Lending and Other Value-Added Services
A bank may provide securities lending to its custody customers. Securities lending can permit a customer to make additional income from its custody assets by loaning its securities to certainly approved borrowers on a short-term basis. Moreover, a custodian may contract to provide its customers with other value added services such as performance measurement, risk management and compliance monitoring.
Risks Pertaining to Custodial Services
The primary risks related to custody services are
- Transaction Risk
- Compliance Risk
- Credit Risk
- Strategic Risk
- Reputation Risk
Transaction Risk is the current and possible risk for earnings or capital from error, fraud and the inability to deliver services or products, maintain a competitive position and to manage information. The risk is inherent in efforts to gain strategic advantage, and in the failure to keep pace with changes in the financial services market place. Transaction risk is evident in every product that is offered and provided. The risk involves product development and delivery, systems development, transaction processing, the complexity of products computing systems and services and the internal control environment.
Compliance risk is the current and intended risk to earnings or capital arising from violations or non-conformance with laws, rules, regulations, internal policies, prescribed practices and procedures or ethical standards. This risk also occurs in situations where the laws or rules authorised for certain bank products and the activities of a bank’s clients might be ambiguous or untested. The risk exposes the institution to fines, civil money penalties, payment if damages and the voiding of contracts. This also leads to a diminished reputation, reduced franchise value, limited business opportunities, reduced expansion potential and an inability to enforce contracts.
Credit Risk is the current and eventual risk to earnings or capital arising from an obligor’s failure to approach the terms of any contract with the bank or otherwise to perform as agreed. The risk is found in all activities that depend on counterparty, issuer or borrower performance. It arises any time when funds are extended, committed, invested or exposed through actual or implied contractual agreements if it is reflected on or off the balance sheet.
Strategic Risk is the current and possible risk to earnings or capital arising from an adverse business decision, improper implementation of decisions or lack of responsiveness of the industry changes. This risk depends on the compatibility of an organisation’s strategic goals, the business strategies that are developed to achieve those goals, the resources that are deployed toward these goals and the quality of implementation. The resources required to carry out business strategies are both tangible and intangible. They include operating systems, communication channels, delivery networks and managerial capacities and capabilities. The organisation’s internal characteristics have to be evaluated against the impact of economic, technological, competitive, regulatory and other environmental changes.
Reputation Risk is the current and prospective effect in earning and the ca[ital arising from the negative public opinion. This affects the institution’s ability to establish new relationships or services or to continue servicing existing relationships. The risk exposes the institution to litigation, financial loss, or a decline in its customer base. Reputation risk exposures it presents throughout the organisation and includes the duties to exercise an abundance of caution in dealing with its customers and community.
Other minor risks include rate risk, liquidity risk, price risk and foreign currency translation risk.
The Growth of Custodial Services
The Indian fund industry is moving to its next phase of expansion and change, and the intensive competition denotes that the fund houses focus on their core business of investment management and sales and distribution. Therefore it looks at partners with reliable technology and in-depth experience to aid their operational needs. They are seeking partners who can provide them with the benefits of economies of scale. The size of the business in India is more likely to grow at a rapid rate. Apart from providing custodial services, these institutions also offer services like fund accounting, derivative clearing and corporate action reporting.