Technology has changed the face of the Indian stock markets in the post liberalization era. Competition amongst the stock exchanges, increase in the volume of activity. The traditional settlement and clearing system proved to be inadequate due to operational inefficiencies. Hence, there emerged a need to place this traditional system with a new system called the ‘Depository System’.
Depository in very simple terms means a place where something is deposited for safe keeping. A depository is an organization which holds securities of a shareholder in an electronic form and facilities the transfer of ownership of securities on the settlement dates. According to section 2(e) of the Depositories Act, 1996, Depository means a company formed and registered under the Companies Act 1956 and which has been granted a certificate of registration under section 12 (1A) of the Securities and Exchange Board of India Act, 1992.
The depository system revolves around the concept of paperless or scrip less trading because to shares n a depository are held in the form of electronic accounts that is, in dematerialized form. This system is similar to the opening of an account in a bank wherein a bank will hold money on behalf of the investor and the investor has to open an account with bank to utilize its services. Cash deposits and withdrawals are made in a bank, in lieu of which a receipt or a bank passbook are given, while in depositories scripts are debited and credited and an account statement is issued to the investor from time to time. An investor in a bank deals directly with the bank while an investor deals through a depository participant in a depository.
An effective and fully developed depository system is essential or maintaining and enhancing market efficiency, which is one the core characteristics of a mature capital market.
Need for setting up a Depository in India:
This need was realized in the 1990s due to various reasons.
1. Large scale irregularities in the securities scam of 1992 exposed the limitations of the prevailing settlement system.
2. A lot of time was consumed in the process of allotment and transfer of shares, impeding the healthy growth of the capital market.
3. With the opening up of the Indian economy, there was a widespread equity cult which resulted in an increased volume of transactions.
4. Mounting fiscal deficit made the government realize that foreign investment was essential or the growth of the economy and that was being restricted due to non-availability of depositories.
5. There were various problems associated with dealing in physical shares such as,
(a) problems of theft, fake and/or forged transfers
(b) share transfer delays particularly due to signature mismatches and
(c) paper work involved in buying, selling and transfer leading to cost of addling storage, transportation, and other back office costs.
To overcome these problems, the government of India in 1996 enacted the Depositories Act, 1996 to start depository service in India.
Depository can be in two forms – dematerialized or immobilized. In dematerialization, paper certificates are totally eliminated after verification by the custodians. In immobilization, initial paper certificates are preserved in safe vaults by custodians and further movement of papers are frozen.
The depository system provides a wide range of service.
(1) Primary market services by acting as a link between issuers and the prospective shareholders.
(2) Secondary market services, by acting as a link between the investors and the clearing house of the exchange to facilities the settlement of security transactions of security transactions through book keeping entries.
(3) Ancillary services, by providing services such as collecting dividends and interest reporting corporate information and crediting bonus rights shares and so on.
These services lead to a reduction in both time and cost which ultimately benefits the investors, issuers, intermediaries and the nation as whole.