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 If you have not withdrawn during the grace period, the amount gets reinvested, withdrawal of which before maturity attracts a penalty.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
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.
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:
- Scheduled Commercial Banks
- Regional Rural Banks
- Small Finance Banks
- 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:
|Parameters||Certificate of Deposit||Fixed Deposit|
|Term||7 days – 1 year usually||Usually longer|
|Return||Usually more than FDs||4 – 8% per annum|
|Loans||Cannot be availed against CD||Can be availed against FD|
|Minimum Investment Amount||Rs. 5 lakhs in India||Rs. 5,000 for most major banks|
|Tax rebates||No tax rebates on investment in CD||Rebates on investing in FDs of tenure > 5 years under section 80C of the IT Act|
|Issuing Institutions||Limited institutions permitted by RBI can issue CD||FDs are available at nearly all bank branches.|
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.
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.
What are the minimum and maximum amounts for investing in a certificate of deposit?
You have to invest a minimum of Rs. 5 lakh in CDs. There is no upper limit to it. However, you can only invest in multiples of 5 lakh.
Is automatic renewal available for a certificate of deposit?
When a CD matures, the investor receives a grace period of 7 days. During this period, you can decide to reinvest in a CD or withdraw the funds. If you do not withdraw or reinvest by the end of this period, the bank automatically renews this CD, usually for the same term. The interest rate, however, might vary.
Can I transfer money between my online CD and other accounts?
Yes. During the grace period after the maturity of your CD, you can move funds between the online CD and other accounts. You cannot withdraw or transfer any funds during the term of a CD without attracting a withdrawal penalty.
How much money can you put into a CD?
There is no upper limit to the amount of money you can put into a CD. The only condition is that it should be in multiples of Rs. 5 lakhs, and the minimum investment amount is Rs. 5 lakhs.
Can I withdraw money from my online CD?
At maturity, during the grace period, you can withdraw your money from your online CD. If you withdraw before maturity, you will be charged a withdrawal penalty.