A depository is a financial institution or organization that accepts deposits from businesses and individuals and assists in buying and selling financial instruments, such as stocks and bonds. The public can store their valuable assets with such financial institutions to eliminate the risk of holding them.
These organizations offer liquidity and security in financial markets. They utilize the currency deposits accepted by them to offer loans. Moreover, these institutions invest in different financial instruments besides offering a funds transfer system. There are primarily three types of depositories in the U.S. — thrift banks or savings associations, commercial banks, and credit unions.
Table of contents
- Depository definition refers to the financial institutions that accept currency deposits from businesses and individuals and assist them in trading financial assets. In addition, they utilize deposits to provide financial assistance to businesses and individuals.
- There are various advantages of depositories. For example, they ensure economic stability and growth and eliminates the risk of losing financial instruments.
- A crucial difference between a depository and a custodian is that the former legally owns the financial instruments it holds.
- A vital function of depositories is accelerating the process of transferring financial assets.
Depository Institutions Explained
Depository definition refers to an organization, bank, or institution that collects assets from individuals and businesses and keeps them insured and safe. These organizations store financial assets, like stocks, bonds, etc., in electronic or dematerialized form and assist in the buying and selling these financial securities.
These organizations receive a major portion of their funding through the currency deposits accepted by their customers. The customer deposits may include check deposits, cash deposits at an ATM, direct deposits, and electronic transfers from another financial institution. A depository pays interest on these deposits. While holding the amount deposited, such an institution provides loans to individuals and businesses, thus generating more interest than the amount it paid as interest to customers.
A noteworthy advantage of depositories is that federal insurance ensures that all customers get their money back up to a certain limit if the institution shuts down. The NCUA, National Credit Union Administration, and the FDIC or Federal Deposit Insurance Company insure the deposits accepted by credit unions and banks in the U.S.
The customers of these organizations or institutions can make currency deposits whenever they like. They can even withdraw the money at their convenience. For instance, individuals can deposit money into their depository account via an ATM or check payment. These financial institutions must keep a minimum amount in their vault per legal requirements.
Hence, if customers withdraw too much money or disburse too many loans, the institution must borrow sufficient funds from the Federal Reserve or another bank to maintain the minimum amount required in the vault.
There are three main types of depositories. Let us look at them in detail.
#1 – Credit Unions
These organizations are financial cooperatives; members of a particular group own them. For example, credit unions pay interest in dividends to the members every month or every quarter. One has to pay a certain fee to become a member. Such non-profit organizations aim to provide financial services to their community. Typically, they do not need to pay federal or state taxes.
#2 – Savings Associations
Also known as thrift banks or savings institutions, savings associations serve a local community. The offerings of these financial institutions are similar to regular banks. Their products include credit cards, consumer loans, and small business loans. Sometimes, these organizations can be financial cooperatives or corporations, thus enabling the depositors to become partial owners.
#3 – Commercial Bank
Typically, private investors own commercial banks; the main objective of such organizations is to earn profits. Therefore, their range of offerings depends on their size. For instance, if a commercial bank’s size is small, it might offer only small loans and simple deposits. Also, it might offer banking services for small businesses only. One must also note that small banks have a limited market range.
In contrast, global or large banks provide extensive services, including money management, foreign exchange-related offerings, investment banking, etc. These banks may also offer services to large organizations or other banks. Unlike small commercial banks, large banks do not have a limited market range.
Let us look at some features of depositories:
#1 – Fungibility
In depository systems, identifying financial instruments does not occur through unique numbers. Hence, all financial assets belonging to the same class are interchangeable and identical. For instance, equity shares belonging to the fully paid-up shares class are interchangeable.
#2 – Participants
There are four participants in depository systems. They are the depository, issuer, beneficial owner, and depository participant (DP).
#3 – Elimination Of Risk
The system eliminates risks related to the physical certificates, for example, bad deliveries, loss in transit, theft, delays, etc.
#4 – Free Transferability Of Financial Instruments
The transfer of financial instruments held by the institutions in electronic form occurs freely via the electronic book-entry system. That said, this system ignores the various procedural requirements concerning the transfer of financial assets.
The functions of depositories are as follows:
These institutions are a connecting link between public companies issuing financial instruments and shareholders or investors. The agents associated with the institutions are the DPs. They are responsible for transferring the financial assets from the depositories to shareholders. Brokerages and banks are two examples of DPs.
#2 – Offers loans to individuals and businesses
An institution accepts currency deposits from customers who can withdraw the amount anytime. The organization pays interest on the deposits while it earns a higher interest income by lending the money in the form of mortgages or loans.
#3 – Reduces paperwork and facilitates the faster transfer of securities
When a trade takes place, depositories transfer the ownership of the financial instruments from one investor’s account to another. This reduces the paperwork involved in a trade’s finalization, thus accelerating the securities transfer process.
#4 – Enables traders to store financial instruments in dematerialized form
Traders do not have to bear the risk of holding the financial instruments as the institutions allow them to store the financial assets electronically.
Let us look at this depository example to understand the concept better.
Suppose XYZ is a clearing house serving as a securities depository for various organizations that trade on multiple stock exchanges in Europe. Its customer base primarily comprises banks, brokerages, and other organizations that hold a wide range of financial assets and engage in market-making and other activities.
XYZ settles international and domestic transactions involving financial instruments, such as bonds, stocks, and derivatives. In addition, its system accepts domestic financial assets from over 35 markets, which include equities, convertible securities, and stock warrants.
The advantages of depositories are as follows:
#1 – Interest Income
Besides storing their customers’ money safely, the institutions may pay interest on the deposits. Typically, individuals can earn the most interest on time deposits, for example, certificates of deposits. On the other hand, one earns the least interest on their demand deposit accounts, for example, savings and checking accounts.
#2 – Low Risk Of Losing Assets
Individuals can deposit their assets at commercial banks and savings associations to eliminate the risk of losing money due to theft or damage. In addition, federal insurance ensures that every depositor gets their money back (up to a certain amount) if the institution ceases to exist for some reason.
#3 – Ensures Economic Growth
After accepting deposits, the institutions lend out the money through loans and mortgages. They earn interest income on the amount lent out. From that income, they pass on a small portion to the depositors. The transfer of funds from depositors to borrowers ensures economic growth and stability.
Depository vs Custodian
Activities of custodians are similar to depositories, and their roles overlap owing to the evolution of the financial world. Nevertheless, one must remember some key differences between these two. Let us look at them in detail.
|These institutions hold financial instruments in dematerialized form. Moreover, they allow for the settlement and clearing of the securities besides facilitating their transfer.
|Custodians only hold the financial assets for safekeeping.
|Such an institution is the custodian and legal owner of the financial assets held by it.
|These financial institutions do not legally own the assets held by them.
|All such institutions serve as custodians.
|All custodians do not serve as a depository.
|Serving as a custodian is one of the functions of these financial institutions.
|Custodians have only one function — custody.
Frequently Asked Questions (FAQs)
It serves as an intermediary between investors and depositories. Such an institution is responsible for maintaining the financial instruments in electronic or dematerialized form. Moreover, it facilitates the process concerning the trading of financial assets.
The charges refer to any tariff, compensation, or fee that a depository imposes on its customers for processing deposits or any other related administrative activity. Such charges typically vary from one financial institution or organization to another.
An international central securities depository or ICSD is an organization that settles international and domestic transactions involving financial instruments like stocks, bonds, etc. Moreover, these institutions may offer additional services like collateral management and securities lending.
Typically, a common depository is a credit institution that provides the ICSDs with the following two services:
– Asset servicing for physical papers.
This article has been a guide to Depository and its meaning. We explain its types, features, functions, advantages, an example, and a comparison with custodians. You may also find some useful articles here –