Low rates and rising liquidity risks are challenging the economics of custodian banks with more costs likely to be pushed onto clients, Morgan Stanley has warned.

The investment bank, which partnered with Oliver Wyman for a study entitled ‘Learning to Live with Less Liquidity’, described the current climate as “heavy going” for custody players.

Global banks, including State Street and BNY Mellon, dominate the market and specialise in safekeeping, settlement, asset administration and banking services to institutional investors.

The five largest global custodians hold more than $100trn in assets under custody and administration, the top four are all based in the US.

Ultra-low interest rates in recent years have hit fees and Morgan Stanley says the current macro-economic conditions suggest that a reprieve is unlikely in the near term and the pain may even increase.

“More costs will have to be passed on to clients, but the market does not appreciate how great an impact that could have, in our view,” said Huw van Steenis, managing director at Morgan Stanley.

Operational deposits are particular concern. Their impact on liquidity ratios is making them costly for custodians to maintain, and many are seeking to actively reduce them. 

"At a time when many clients are being pushed to hold more cash to weather liquidity risks and volatile markets, this could be a material challenge for the buy-side as the full impact of the lower liquidity percolates through the system," adds Van Steenis.

The study suggests there is still plenty of scope for custodians to rationalise service provision, tackle outdated infrastructure and get to grips with cottage industries such as reporting frameworks.

Core to this is pushing clients towards more standardised services; injecting more discipline around pricing; and revenue capture for non-standard services and risks. However, this imposes costs on service users.

Opportunities

The study goes onto say there is an opportunity for custodians to enter the race for data services by better leveraging their unique and captive access to static data.

However, they need to act fast as greater attention is being paid to the next generation of innovators and start-ups, and the core value proposition of custodians as ‘stable and trusted’ institutions is no longer seen as essential.