Defining Custodian Bank and How it Relates to Investments

Key Takeaways

• A custodian bank is a financial institution that keeps safe customers’ assets and securities so that they are not lost or stolen. 

• In addition to safekeeping assets, many custodian banks provide services such as management of clients’ accounts and transactions, and the settlement of financial transactions, in addition to ensuring compliance with tax regulations and accounting for assets’ status.

• Because custodial banks must keep safe billions of dollars of assets and securities, they are usually expansive and reputable. 

Custodian banks play a key role in holding and protecting the assets of individuals and institutions, so it is important for investors to know about them. Here is an overview of these banks and how investors can use them.

What is a Custodian Bank?

This is a financial institution that keeps safe customers’ assets and securities so that they are not lost or stolen. 

In addition to cash, such assets could include stock certificates, bonds, and other financial instruments, and may be held electronically or in physical form.

Custodian banks serve a variety of customers including investment managers and advisory firms, mutual funds, bank fiduciary and agency accounts, insurance companies, retirement plans, endowments and foundations, corporations, and private bankers.

These institutions are important since financial securities must be properly cleared and settled, using various accounting and regulatory procedures. Investors often find such activities too complicated or time consuming.

How Do Custodian Banks Work?

Because custodial banks must keep safe billions of dollars of assets and securities, they are usually large and reputable. 

Primarily, these banks provide and charge for services in addition to asset safekeeping.

Examples of Custodian Banks

Some of the better-known U.S. banks are custodian institutions, and include JP Morgan, Mellon, Bank of New York, Chase, Citigroup, and State Street. Overseas, the best-known custodian banks include BNP Paribas (France), Barclays (England), Deutsche Bank (Germany), UBS and Credit Suisse (Switzerland).   

How Does a Custodian Bank Make Money?

Custodian bank service fees tend to be a la carte and can depend on the value of the assets held and are the banks’ primary revenue source. That’s contrasted with traditional banks, which gain most of their income from loans and deposits.

For example, Bank of New York Mellon, which manages $1.9 trillion in assets, produces most of its revenue from asset and issuer servicing, investment services, asset and wealth management, treasury services, and clearance and collateral management.

How are Custodian Banks Different from Mutual Fund Custodians?

While custodian banks and mutual fund corporations perform similar roles, they do so for different clientele. It is the responsibility of the latter to secure and manage the securities held in a mutual fund.

Technically, mutual fund custodians are under the classification of custodian banks. However, when referring to investor clients, it is more common to broach custodian banks – not mutual funds.

How Does a Custodian Differ from a Depository?

In the U.S., the three primary types of depository institutions include credit unions, commercial banks, and thrifts, which include savings banks and savings and loan associations. In addition to safeguarding assets, depositories have more control than custodian banks over the assets they hold. They also have more liability and responsibility.

Custodian banks generally focus more on the operations involved with the safekeeping and settlement of securities.

What Services are Offered by Custodian Banks?

In addition to safekeeping assets, many of these banks provide services such as management of clients’ accounts and transactions and the settlement of financial transactions, in addition to ensuring compliance with tax regulations and accounting for assets’ status.

Additional services may include account administration, tax support, foreign exchange management, and the collection and distribution of dividends. They may also handle customers’ investment activities such as placing orders or transferring funds.

How to Analyze Custodian Banks? 

To determine a custodian bank’s viability, the following metrics are commonly used, in addition to fee margins and fee profits:

• Price-to-earnings ratio. Comparing a stock’s price to its earnings is a way to value a company. 
• Price-to-book ratio. This is the company’s current stock price per share divided by the company’s book value per share.
• Price-to-free cash flow. This metric is used to assess and compare a company’s single-share market price with its per-share price of free cash flow.
• Net interest margin. This is a gauge of the difference between bank-generated interest income and the total interest distributed to lenders, compared with their asset amount.

What are Alternatives to Custodian Banks?

A primary benefit of custodian banks is that they provide protection of assets such as stock certificates and bonds.

However, there are alternatives to using custodian banks including putting capital into investments and funds such as the — highly vetted — opportunities offered by Yieldstreet.

Yieldstreet’s platform, on which nearly $4 billion has been invested to date, offers a variety of alternative investments, including private credit, art, real estate, legal finance, and more. In fact, it is the leading platform for private-market investing and has the broadest selection of alternative asset classes available.

Alternative assets – basically any asset other than stocks and bonds – are increasingly popular due to their low correlation to the stock market as well as for their protection against inflation and potential for secondary income.

They are also popular as a way to achieve portfolio diversification, a crucial pillar of long-term investing success. Holdings that include varying asset types can mitigate overall risk and potentially improve returns. 

Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

The services offered by custodian banks are needed by investors and other individuals as well as institutions, particularly asset and account holders who do not seek an active, day-to-day role in account transaction management.

Remember, too, that while every investment carries risk, vetted opportunities in alternative asset classes can mitigate portfolio exposure and volatility through diversification.