What is a Certificate of Deposit in India?

Do you have a significant amount of liquid money that you want to park in a safe investment instrument for a short time? Are you trying to avoid all risks and obtain a secure, guaranteed return? If yes, a Certificate of Deposit (CD) could be the instrument of choice for you.

First issued in India by the RBI in 1989, its objective has been to strengthen the money market in India and provide investors with an option to park their surplus funds for a short period of time. Read on to learn more about certificates of deposit in India; their features, benefits, and how to invest in them. 

What is a Certificate of Deposit?

A certificate of deposit is a money market instrument issued against funds deposited in a financial institution for a specific period of time. It is an agreement between the depositor and the institution upon any discount at which the certificate can be issued, fixed or floating interest rates on the instrument, and its maturity period. 

The tenure of a Certificate of Deposit varies from seven days to one year. It cannot be redeemed before maturity. There is a grace period of seven days after maturity, during which you can withdraw the amount or reinvest it. If you have not withdrawn during the grace period, the amount gets reinvested, withdrawal of which before maturity attracts a penalty.

A Certificate of Deposit can be issued by selected financial institutions like scheduled commercial banks, Regional Rural Banks, Small Finance Banks and regulated by the Reserve Bank of India (RBI).

Features of a Certificate of Deposit 

1. Eligibility

A Certificate of Deposit is issued by scheduled commercial banks and select financial institutions authorised by the RBI. They cannot be issued by cooperative banks. 

Certificates of Deposits can be issued to individuals, corporations, funds, trusts, associations, etc. They can also be issued to NRIs on a non-repatriable basis. Further, they cannot be endorsed by other NRIs in the secondary market.

2. Maturity period

The maturity period of CDs issued by banks has to be equal to or greater than seven days and not more than one year from the date of issue. 

3. Minimum investment amount

You have to invest a minimum of Rs. 5 lakhs in a CD and then in multiples of Rs. 5 lakhs. 

4. Transferability

You can transfer a certificate of deposit by endorsing and delivering it. If the CD is held in Demat form, the transfer occurs in a manner similar to other Demat securities. 

5. Non-availability of loan

Banks cannot offer any loans against a certificate of deposit. This is probably because, unlike FDs, they can be traded in secondary markets.

6. Discount offered

The certificates of deposit can be issued at a discount to the face value. That is, you can buy a CD with a face value of, let’s say, Rs. 100 at Rs. 98. 

Also, banks and financial institutions can issue CDs on a floating rate basis. However, the rate has to be transparently linked to the market. The rate can be periodically revised as per a preset formula, which is usually a spread over the benchmark rate. For example, it could be like MIBOR* + 50 BPS. This must also be communicated to the investor before the purchase. 

*Note: The Mumbai Interbank Offer Rate (MIBOR) is one iteration of India’s interbank rate, which is the rate of interest charged by a bank on a short-term loan to another bank.

Who Issues a Certificate Deposit in India

Certificates of Deposit are issued by the following entities authorised by RBI: 

1. Scheduled Commercial Banks
2. Regional Rural Banks 
3. Small Finance Banks
4. Select financial institutions that RBI has permitted

Advantages of a Certificate of Deposit

Secure investment: Certificates of deposit are issued primarily by fairly creditworthy institutions. They are also regulated by the RBI. Further, the issuing institutions are mandated to maintain a Statutory Liquidity Ratio (SLR) and a Cash Reserve Ratio (CRR) as per the price of the CD. As an investor, your principal and the returns are incredibly safe in CDs. 

Fixed returns: CDs offer a fixed, predetermined return, which can be a regular income stream. The returns on CDs can be negotiated in terms of the discount at which they are issued. Also, by choosing a relatively longer maturity, you can receive higher CD rates.

Flexibility: CDs have built-in flexibility due to the choice of tenure and the space to decide whether to redeem or reinvest in the grace period. You can also choose a monthly, quarterly, semi-annual, or annual interest payout for your CD.

Who Should Buy a Certificate of Deposit?

If you are looking for a safe instrument to park your funds for a short period of time, you may consider investing in CDs. Also, Certificates of Deposit are a good investment if you want guaranteed returns without having to worry about the risk of default. 

You can also reduce your reinvestment risk and improve your liquidity by laddering your investments in CDs. For example, let’s say you have Rs. 20 lakhs. Instead of putting it on one CD of 1-year duration, you can divide it into four CDs of six months, one, two, and three years, each of which is worth Rs. 5 lakhs. 

At the end of six months, you will be able to withdraw five lakhs and readjust your ladders without any premature withdrawal penalties. You will benefit from the high CD rates earned by longer-duration CDs on the ladder. Through such laddering, you can build a wealth creation plan for yourself.

Difference Between a CD and a Fixed Deposit

A certificate of deposit is a lot like an FD. They also pay a fixed rate of interest on a deposit with a bank. However, the two differ in the following ways:

How to Buy a Certificate of Deposit

You can buy a certificate of deposit using a Demat account, just as you buy stocks. The mechanism is the same: the buyer and seller agree on the price, after which the seller authorises the depository to transfer the certificate to the buyer’s account. The buyer must have an account with the same depository. 

Things to Consider Before Buying a Certificate of Deposit

Tenure: The interest rate offered on a CD increases with an increase in its term. However, you must choose the term very carefully according to your needs, as later on, if you withdraw prematurely, you will have to pay penalties.

Limits to liquidity: Investing in a CD will seriously limit your liquidity. You can choose to ladder your investments in a CD to maintain liquidity and, at the same time, benefit from longer-term interest rates. 

Returns: The return on a CD is the sum of the returns from the discount on the CD and the returns from the interest payments. You must choose the interest payout period (monthly, quarterly, semi-annual or annual) that you think will be most suitable for your needs. 

Also, you must carefully follow the periodic changes in interest rates announced by the government to evaluate your relative returns. Lastly, you must take into account inflation while calculating your real returns. 

Conclusion 

In a nutshell, Certificates of Deposit are extremely safe deposits with authorised financial institutions. They offer guaranteed fixed returns in the form of interest payments and discounts on face value. They are ideal for investors looking to park their funds for a short time period and earn reasonable returns. 

Please note that finding the best CD rates requires analysing multiple offerings because there is a startling variety of products offered by various financial institutions. For instance, even long-term CDs from your local bank may only pay a pittance, whereas those from a smaller bank or local credit union may pay three to five times the national average.

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