How custodian banking can mitigate risk in Indian banking system
Rajesh M Sharma​, CEO, Orbis​​ Financial​

Indian capital markets have come a long way from trading and settlement in physical securities to nearly 100% trading and settlement in the electronic form. This has led to an increase in volume as well as requirements of foreign and domestic investors, who are investing in various types of assets such as equities, corporate debt, government securities and derivatives.

The role of the custodian has changed from trade processing and settlement to faster processing of information as well as providing value-added services like efficient cash management and foreign exchange services. Most investors started looking for a one-stop solution across asset servicing and banking, with banking becoming an important part of the consolidated offering for investors.

In India, domestic investors have been investing in the market since the setting up of UTI and LIC. After liberalisation in 1991, a number of foreign investors started investing in Indian capital markets through portfolio investment schemes. There were non-bank custodians who provided settlement and physical safe-keeping services to foreign and domestic investors. Interest from foreign investors and setting up of new mutual funds increased investments in the capital markets in India.

As more and more foreign investors entered India, the need for a composite offering including banking services arose. A number of foreign and domestic universal banks started providing custody and banking services as well as foreign exchange services to facilitate these transactions. The increase in foreign and domestic investments encouraged some non-bank institutions to apply for a custodian’s licence to the Securities and Exchange Board of India (SEBI).

Type of investors

Today, a large number of foreign investors such as sovereign funds, pension funds, university funds and multilateral funds are investing in India where they use the services of global custodians. These global custodians have a market share of 55-65% of the total foreign portfolio investments in India. These global custodians appoint local custodians in various markets for providing services to these large foreign investors. There are other investors who appoint local custodians directly.

While appointing local custodians, the global custodians have certain prerequisites, one of which is that the local custodian should be a bank. In India, most global custodians have been primarily using foreign banks for custody and banking services.

These foreign banks are universal banks that provide an entire range of services including lending and derivatives, have proprietary positions on government or corporate bonds, and foreign exchange services. These services are open to market, credit or liquidity risks.

Custodian banking

An important question that the regulators face is to de-risk the entire ecosystem, which includes custody and banking services. This can be achieved through specialised institutions like custodian banks. Custodian banks will focus purely on providing custodian and banking services to foreign and domestic investors without undertaking any lending or borrowing activities, proprietary trading and deposits. Any product which has risk attached to the activities, including derivatives clearing, can be kept outside the ambit of custodian banking activities.

Internationally, there are global custodians who are offering banking services to their global clients and are not involved in universal banking. There has been demand from the global custodians to partner with the local players in India to offer services to their clients as well as bring the best technology and know-how to India.

We have set an example in terms of payment banks where the Reserve Bank of India has issued guidelines for these new lenders to provide banking services to unbanked populations. The regulator can propose similar regulations for custodian banking with a change to cover foreign exchange trades, wherein the custodian bank can enter into forex trade purely for customer transactions either with the RBI or any other authorised dealer banks.

What if focused and dedicated players are allowed to enter the custodian banking segment and offer specialised services to investors, including foreign entities who need a bankable partner? Custodian banking will go a long way in developing the Indian capital markets with focus on new products and services to make India more investor friendly.

Rajesh M Sharma is CEO at Orbis Financial Corporation Ltd, which provides custodial services to foreign and domestic investors.

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