By: Julio Cacho, PhD & Juan Carlos Herrera
Most people are familiar with large commercial banks and common investment banks. Less familiar are with custodian banks. What is a custodian bank, you ask?
Put simply, a custodian bank is a gatekeeper of assets. A custodian bank is a large bank that keeps your assets safe by placing them in a separate account that only you own. The separate account allows for your assets to be separate and distinct from the bank’s assets. This is important because if a bank were to ever go bankrupt, the assets owned in the separate account will not be subject to the creditor claims. Using a custodian bank is one way to guarantee that assets stored there will be returned to the owner of the assets.
Total Assets Under Custody ($ trillion) Q2 2018
A custodian bank doesn’t provide the immediate cash-exchange services like a cash window at a commercial bank for same-day deposits and withdrawals. Instead, custodian banks store many types of investment assets, from cash and commodities to securities and equities, and keep these assets safe. In addition, a custodian bank keeps logs and records of investment activity and resolves trades that are made by a money manager.
If you enlist the help of a money manager for assets kept in a custodian bank, the manager will have limited power to oversee the direction of the investment of those assets. However, the manager won’t have direct access to the assets in the portfolio. This helps keep the assets safe, since only the individual creating the asset account and those who are designated by him or her can fully access and withdraw assets from the bank’s custody.
It is worth noting that brokerage firms that hold your assets do not guarantee that those assets will be returned. According to the book Creative Capital by Gregory Curtis “brokerage firms don't hold our assets in accounts that are segregated from the brokers' own assets. In the event of a bankruptcy, creditors of the brokerage house can seize our assets right along with the broker's own." Curtis also notes that while insurance firms typically cover brokers, many insurance firms exited the business around 2003. As such, you need to be careful if vast family assets are being kept at brokerage firms. Click here for a link to Curtis’s book.
Many investors don’t safeguard their assets in a custody agreement and instead give the assets to whatever firm or person is managing the assets. Consider using a custodian bank to keep your assets fully-retained while potentially paying less in bank fees.