Certificate of Deposit

Market
Meaning of Certificate of Deposit

The Certificate of Deposit (CD) is an agreement

between a depositor and an authorised bank or financial
institution. Depositors invest a certain amount for a
pre-decided tenure, while banks and financial
institutions pay an interest on the invested amount. The
fixed pre-decided tenure ensures that the invested
amount cannot be retrieved before the completion of
the pre-determined tenure. The investment amount in
this instrument is easily negotiable.
Depositors, which can be individuals, companies and
corporations, are issued a promissory note by the
relevant bank or financial institution. This amount is
insured by the Federal Deposit Insurance Corporation
(FDIC). The Reserve Bank of India (RBI) presides
over the guidelines regarding investments in CDs.
Certificates of Deposit were introduced in India in the
year 1989 to increase the range of money market
instruments and to enable investors in the country to
manage short term funds more effectively. CDs are
issued in the dematerialised form or electronically.
Once an investment in Certificate of deposit matures, the
depositor gets a grace period of 7 days to decide over the
future course of action with the matured amount. In case
the depositor does not withdraw the amount within the
grace period, he/she is restricted from withdrawing it and
the matured amount is reinvested. The matured amount
can also be withdrawn after the lapse of the grace period
against a payment of penalty or on demand.
Features of Certificate of Deposit
A selective list of commercial banks and financial institutions
have been authorised by the Reserve bank of India (RBI) to
issue Certificates of Deposits. Regional Rural Banks and
Co-operative banks cannot issue CDs.
Individuals, companies, corporations, etc. are eligible
depositors for Certificates of Deposits. Non Resident Indians
(NRI) can also be issued CDs on a non-repatriable basis.
The minimum amount that has to be deposited in a Certificate
of Deposit is Rs. 1 lakh.
The tenure for Certificates of Deposit issued by
commercial banks varies between 7 days and 1 year. The
maturity term for CDs issued by financial institutions
varies from 1 year to 3 years.
Dematerialised or electronically generated certificates can
be transferred by delivery or endorsement, while those in
demat forms can be transferred as per the guidelines set
for demat securities.
Authorised banks and financial institutions cannot
grant loans to depositors against Certificates of
Deposits as these money market instruments are not
accompanied by a lock-in period. The invested
amount cannot be retrieved before the completion of
the pre-decided maturity tenure.
Benefits of Certificate of Deposit

1.Safe investment option

Certificates of Deposits are a comparatively safer
investment plan instrument than other investments that are
vulnerable to the volatility of the capital market like bonds
and stocks. Hence, their returns are not guaranteed. In the
case of CDs, the authorised banks and financial institutions
issuing the CDs invest the amount further in safe
instruments that generate growth.
2.Fixed interest rate
CDs are offered at a pre-decided interest rate that remains constant
throughout the investment tenure, enabling investors to predict their
returns.

3.Higher interest rate than savings bank account

The interest rates of Certificates of Deposits are higher than that of
savings bank accounts and are earned at the pre-determined fixed rate.
4.Short term investment option
CDs are accompanied by a short maturity term, implying
that the invested amount will remain non-retrievable only
for a short period of time.

5.Higher returns for higher maturity term

Staying invested for a longer tenure generates higher
returns, ensuring flexibility.
6.Effective investment for idle capital

CDs are a smart investment for depositors with idle capital that they don’t
know how to utilise presently. This capital can be invested for a short term in
a CD and renewed further, if required.
7.Versatile investment

The features and benefits of Certificates of Deposits ensure that they are well
suited for investors across investment objectives and income groups.
8.Wide range of choices

There is an extensive list of commercial banks and financial institutions that

have been authorised by the RBI to sell CDs. Hence, investors can select the
one that meets their unique investment objectives the best.
9.Grace period

The grace period after the completion of the maturity term, which generally
spans for 7 days, enables the depositor to plan further investments with the
matured amount.
10.CD Laddering

CD laddering is a savvy savings technique that allows you

to keep your money liquid and accessible while taking
interest rate changes into account. When you build a CD
ladder, you’re essentially opening multiple CDs at different
interest rates and with varying dates of maturity.
11. No Monthly Maintenance Fees

With savings accounts or money market accounts, you may

get charged a monthly maintenance fee to use the account,
which can quickly eat into your interest earnings.
Certificate of deposit accounts, on the other hand, typically
don’t charge a monthly maintenance fee.
Disadvantages of certificate of deposit

Limited Liquidity: The owner of a CD cannot

access their money as easily as a traditional savings
account. To withdrawal money from a CD before the
end of the term requires that a penalty has to be paid.
This penalty can be in the form of lost interest or a
principal penalty.
2. Inflation Risk: CD rates may be lower than the rate
of inflation. This means that your money may lose its
purchasing power over time if interest gains are
outdone by inflation rates.
Typically earns less than stocks and bonds can over
time
Earns a fixed rate of return regardless of whether
interest rates rise during the term
Eligibility for issuance of a certificate of deposit

Reserve Bank of India has laid down the following specifications for both
investors and lenders for Certificate of deposit –
Only selected financial institutions and scheduled commercial banks issue
Certificate of deposits CDs in India within a specific limit. The Federal
Deposit Insurance Corporation (FDIC) insures it.
Certificate of deposit is issued to depositors. With this, depositors are
individuals, companies, corporations and mutual fund houses.
Certificate of deposits CDs can also be issued to
Non-Resident Indians (NRIs) on a non-repatriable
basis. However, one cannot endorse CDs to another
NRI in the secondary market.
Banks and financial institutions cannot provide loans
against Certificate of deposits. Also, banks cannot
buy their CDs before the latter’s maturity.
However, cooperative banks and regional rural banks
cannot issue the Certificate of deposits.
As per RBI guidelines, banks have to maintain their
Statutory Liquidity Ratio (SLR) and cash reserve
ratio (CRR) on the price of Certificate of deposit.
Eligibility

As per RBI guidelines, the following can invest in

Certificate of deposits.
• Individual
• Banks
• Corporations
• Trusts
• Financial institutions
Mutual fund houses
Non-resident individuals (NRIs) can subscribe only
on non-repatriable basis. However, one cannot
endorse CDs to another NRI in the secondary market.
But cooperative banks and regional rural banks
cannot issue the Certificate of deposits.
Types of certificate of deposit

Traditional CD – It is an age-old type of CD that

comes with a fixed rate of interest, strict penalty on
early withdrawals and federal insurance. Think of it
as a fixed deposit.
Bump-Up CD – Under this type, if the CD interest
rates increase after buying a CD, then Bump-up CD
gives an option to raise the interest rate. To exercise
this option, the same needs to be informed by the
depositor to the bank in advance. Bump up CD also
pays lower interest compared to the Standard CD.
Step-Up CD – The step-up Certificate of Deposit
works similar to the bump-up type. Although the
incremental interest rate hikes happen on their own
accord from the bank’s end. A depositor doesn’t need
to personally ask the bank to raise the rates up. Hikes
may be given effect with six months, nine months, or
even one year in case of long term CD.
Brokered CD – Brokered CDs is acquired through
brokerage accounts. Brokers could represent a bank or
financial entity. Sometimes multiple banks collaborate
with a single agency. They offer ease in acquiring a CD
since a broker takes care of the process. This CD offers
better rates, but the risk is more as compared to a standard
CD as they are negotiable and can be traded in the
secondary market.
Liquid or “No penalty” CD – The liquid CD allows
the depositor to withdraw the money during the
tenure without payment of any early withdrawal
penalty. It is flexible enough to shift the funds from
one CD to a higher paying CD. Liquid CDs pay less
interest compared to the fixed period standard CD.
Factors considered for comparing CDs

If the investor decides to open a CD, start by

comparing CD options from different banks. The
current bank may seem like the logical choice for
opening a CD, but that doesn’t mean it’s the best
option. Generally, online banks are the way to go if the
investor is looking for a higher interest rate and lower
fees.
While comparing CDs, consider:
Minimum and maximum maturity terms
Minimum deposit requirements
Whether specialty CDs are available
Interest rates and APY
Early withdrawal penalties
CD renewal policies
Compounding schedule
Accessibility
Customer experience
Digital banking—online and mobile banking services