Why more banks in Tanzania should offer custodian services

A custodian is an institution (such as brokerage firms or bank) that holds one’s financial assets. Some of the custody clients primarily are institutional investors, high-net-worth individuals, and individual or family trusts.

A bank can be a custodian; A bank custodian has physical possession of its client’s financial assets such as cash, stock certificates, bonds, equities, commodities, mutual funds, and other financial instruments.

This means a bank custodian is responsible for safeguarding these types of assets. To facilitate the provision of custodial services, custodians operate securities accounts and cash accounts for their clients.

Security accounts are used for recording and safekeeping of securities made by the clients while cash accounts are used to reflect the client’s cash holdings which are put as deposits by the custodian.

Some of the services offered by custodian banks are facilitating receipt of dividends payments, stock splits, and buyback of the securities.

In this article, I will discuss the importance of offering custodian services for our economic welfare and why more banks should offer custodian services.

The provision of custodian services is critical to the functioning of financial markets and helps to assist the infrastructure investment and physical capital formation necessary for economic growth; it also helps to develop and grow retirement and long-term savings.

It is good to note that, custodian banks can customize their services to fit the particular needs of different clients.

Few banks in Tanzania offer custodian services and I believe the opportunity for custodian services is in great demand as Tanzanians are exploring other investment vehicles other than government securities. I believe more banks should offer custodian services because of these reasons.

Minimal risks for banks and investors

Assets/securities held in custody by a bank that acts as a custodian bank (custodian) are not in the bank’s assets book. Client securities are never reflected on a custodian’s balance sheet because the bank is not the beneficial owner of its clients’ securities and does not bear the credit or market risk relating to those securities.

By the same token, because custodians do not own their clients’ securities, clients do not have any credit exposure from custodians arising from their safekeeping of the securities.

Hence the failure of a custodian bank would not result in the potential loss of the underlying securities. Also, the client’s interest earned will not be affected even when the client moves his/her securities to another provider of custody services.

On the other hand, custodian banks are exposed to different kinds of risk; they are exposed to some operation risks because the provision of custodial services is largely dependent on the successful execution of large volumes of transactions through sophisticated systems.

It can be argued that the operational risks are primarily a function of the quality and capacity of operational systems and controls but they are not directly a function of the custodian bank’s balance sheet, hence do not affect the performance of the balance sheet of a custodian bank.

In addition, custodian banks can be exposed to credit risks if they decide to extend overnight or short-term credit to their clients to facilitate the settlement of securities transactions, however, the extent to which custodians are exposed to credit risk from such activities is generally limited.

Revenue growth

In general, banks generate most of their income from deposits and loans and earn income from the difference in interest rate spreads between lending and borrowing. Custodian banks will add another stream of revenue (non-funded revenues) by offering custodial services.

The custody-related revenues are primarily driven by fees collected for the custodial services offered to clients and are not dependent on the custodian’s balance sheet activities.

For example, when a customer of a bank wants to sell/buy certain shares of a public traded company on the stock exchange, a custodian bank can charge that customer a transaction fee to complete the buy/sale on behalf of that customer.

In addition, because of the large volumes of clients’ cash, custodian banks generally do not rely significantly on interbank borrowings, therefore, managing their interest expenses effectively.

In conclusion, we have seen that the custodian banking provides minimum risk to the bank and the clients (since the client’s assets being held do not count towards the bank’s balance sheet), and that helps the bank grow its revenues through fees and commission for offering custodian services.

As Tanzanians are exploring other investment vehicles beside government securities, there is a great opportunity for banks to offer the custodian services because people are looking for alternatives to government securities.