A custodian bank holds securities on behalf of an institutional investors.
The main reason for custodian banks to hold assets, rather than the institution that owns or manages the assets are cost cost savings. The cost economies come from that fact that custodian banks usually act as custodians for many institutional investors. As a result of this, they are able to invest more in systems that provide lower costs and to exploit economies of scale in general.
The cost savings are particularly large where investors invest in markets in which they themselves do not have local operations. In these markets, custodians have the systems and expertise to deal with issues such as local withholding taxes.
Because large investors invest globally, many large banks offer global custody services that, as the name suggests, allow fund mangers to use a single custodian across all (or nearly all) the markets they invest in. They usually use sub-custodians in for at least some markets.
In addition to the traditional safekeeping and administrative services, many custodians now offer higher margin value added services such as performance and risk measurement and reporting to regulators.
The benefits of using custodians are similar to those of other forms of outsourcing.