Advantages of a Digital Depository System

In the previous article, we learned about what a digital depository system is and how it functions. We also understood the roles and responsibilities played by each participant in the system. In this article, we will continue to understand the depository system further. We will have a look at some of the functions which are performed by these depositories. Also, we will list some of the advantages of having the depository system over the older system.

Services Offered by a Depository System

The digital depository system has solved a lot of the problems which are present in the economy. It is aided in the growth and development of an efficient capital market. Some of the services offered by the depository system are as follows:

• The depository institutes are a mechanism to transfer the securities from the physical world to the digital world and vice versa. Generally, people want to convert their physical securities into digital securities. This is done with the help of a process called dematerialization. In some rare cases, people want to convert their digital securities into physical securities. This service is also performed by the depository system and is called rematerialization.

• Depository institutions enable the electronic settlement of all trades. Earlier, physical copies of share certificates had to be exchanged during settlement. However, now, the process has changed. Depository institutions simply need to instruct their participants to transfer the securities from one person to another. This can be accomplished without the use of any paper.

• Depository institutions also provide nomination facilities to investors. This means that investors can make their preference known regarding whom the depository institution should transfer the securities to in the event of the death of the investor.

• Depository institutions also allow seamless crediting of shares in the event of a bonus or rights issue. Since the depository already has a record of all the investors, they can easily adjust the electronic records. As a result, any bonus or rights issue becomes available in the investor's electronic account within a few minutes after the announcement.

• Depository institutions also help law enforcement agencies. This is because they have complete control and ownership of all the securities. As a result, if the government wants a particular account to stop operating, they ask the depository institution to freeze the account. The proceeds which are present in the account may or may not be taken over by the government in such cases.

• Since the depositories are custodians of electronic securities, they also help promoters and other investors to pledge their securities if they want to. This pledging of securities is an important source of funding for promoters as well as for other investors

• Depository institutions also enable short selling. They are the ones who enable the borrowing and lending of stocks which makes it possible for market participants to use short selling feature

Benefits of a Digital Depository System

We have already seen above that digital depositories perform a lot of functions. These functions result in several advantages to investors. Some of these advantages have been listed below:

• The time required for the transfer of securities has come down considerably. Now, the transfer of ownership happens with a mere book entry. Hence, it can happen instantaneously. As a result, capital markets become more efficient. This increased efficiency attracts more investors, including sophisticated foreign investors.

• Paper certificates have some inherent risks. They are prone to loss or mutilation. They are also prone to theft as well as forgery. The above-mentioned risks have cost shareholders millions of dollars in the past. However, with the advent of electronic recordkeeping, all these risks have become redundant. Hence, not only are digital depositories more convenient, but they are also more secure.

• In most countries around the world, depository institutions continue to be the legal owner of securities, even if they are transferred from one person to another. Since the owner does not change, the stamp duty payable reduces. This leads to reduced transaction costs. It needs to be understood that taxation is a country-specific issue. Hence, lower transaction costs due to lower taxation cannot be generalized.

• Since the time required, the effort required as well as the complexity has reduced, the transaction costs which have to be paid have come down in general. This aids faster turnover and increases the utility of the financial markets to the investors.

• The problem of odd lots has also been eliminated with the digital depository system. Since the entire system is electronic, shares do not have to be purchased in lots. The minimum size is fixed at one share. Therefore, if need be, investors can purchase a single share as well!

• The transfer of shares happens in real-time. This allows the entire cycle to be completed faster. The transaction costs charged by the depository institutions for this are also minimal. Also, depositories enable the delivery of shares to any part of the country in real-time. The risks of delay due to geographical distance has been eliminated.

• The issuers also face a drastic cost reduction during the initial public offering. The electronic system is much more cost-effective as compared to the paper-based system, which was in practice earlier.

It would be fair to say that digital depositories are crucial participants in the market-based system. Their presence makes it easier for other investors to conduct their business and improves the overall efficiency of the entire financial system.