What is a Depository?
A Depository refers to a place or entity that holds financial securities in a dematerialized form. A bank, organization, or any institution holding and assisting in security trading is referred to as a depository. Depository accounts hold securities in the same way that bank accounts hold funds.
A depository can also be a place where something is held for safekeeping or storage. Hence, a depository can be an institution, a building, or a warehouse, that enables individuals and businesses to deposit any valuable asset for safeguarding. The money deposited in a depository is used for investing in some other securities and lending to other people or businesses; thus, providing liquidity in the exchange market.
- A depository refers to a place or entity that holds financial securities in a dematerialized form, eliminating the risk related to holding physical financial securities.
- A depository functions as a connection between the public companies that issue financial securities and the investors or shareholders.
- A depository holds the securities of customers and gives them back when the customers want.
Functions of a Depository
1. Serves as a link between public companies and investors/shareholders
A depository functions as a connecting link between the public companies that issue financial securities, and the investors or shareholders. The securities are issued by agents associated with depositories, who are known as depository participants. The agents are responsible for transferring the securities from the depositories to the investors. A depository participant can be a bank, an institution, or a brokerage.
2. Eliminates risk related to owning physical financial securities
A depository allows traders and investors to hold securities in dematerialized form; thus, eliminating the risk related to holding physical financial securities. The buyers and sellers now do not need to check whether the securities have been transferred successfully without any loss or theft. The depository system reduces such risks by allowing the securities to be held and transferred in electronic form.
3. Allows the provision of loans of mortgages to interested parties
A depository holds the securities of customers and gives them back when the customers want. The customers receive interest on the deposits, while the depository earns even more interest by lending the deposits to other people or businesses in the form of loans or mortgages.
4. Reduced paperwork and accelerates the process of transferrng securities
When a trade occurs, a depository transfers the ownership of securities from the account of one investor to another. It helps in reducing the paperwork associated with the finalization of a trade and accelerates the process of transfer of securities.
Types of Depository Institutions
The following are the three main categories of depository institutions:
1. Commercial Banks
Commercial banks are for-profit organizations and generally owned by private investors. The range of services offered by commercial banks depends on the size of the banks. For example, the services offered by the smaller banks are limited to consumer banking, small mortgages and loans, simple deposits, banking for small-business, and other services. The market range is also limited in the case of smaller banks.
On the contrary, larger banks and global banks offer a wide range of services such as foreign exchange-related services, money management, and investment banking. Some larger and global banks may also offer services for other banks and large organizations. The services offered by the large banks is the most diverse among all depository institutions.
2. Credit Unions
Credit unions are financial cooperatives implying that these depository institutions are owned by members of a particular group. The profits earned are either paid to the members as dividends or reinvested into the organization. The members of the credit unions are the ones that own accounts in the institution; hence, the depositors are also partial owners and receive dividends.
Since credit unions are non-profit institutions, they pay no federal or state tax. Hence, the interest rate charged by credit unions on loans is lower, and they pay a higher interest rate on deposits.
3. Savings Institutions
The banks serving a local community and loan institutions are called savings institutions. The local residents deposit money in the banks, and their money is offered back in the form of mortgages, consumer loans, credit cards, and loans for small businesses.
Savings institutions can sometimes be set up as corporations or as financial cooperatives allowing the depositors to get an ownership share in the organization.
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
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