What is Certificate of Deposit and How to Buy It?
To broaden the selection of money market instruments in the country and provide investors with more options for using their short-term investments, India introduced Certificate of Deposit (CDs) in 1989, also known as the bank certificate. This article takes a deep dive into the Certificate of Deposit, its types, eligibility, how to buy CD, its benefits and limitations. Keep reading to know all the details.
What is Certificate of Deposit (CD)?
A certificate of deposit (CD) is a money market instrument issued in a dematerialised form in exchange for money, placed in a bank for a predetermined amount of time. The Reserve Bank of India (RBI) launched the Certificate of Deposit (CD) in India in 1989 to broaden debt and money markets and give investors more options to choose from.
Types of Certificate of Deposit
Listed below are the primary types of certificates of deposit:
• Traditional Certificate of Deposit
The traditional bank certificate has a fixed interest rate, early withdrawal penalties, and federal insurance.
• Bump-up Certificate of Deposit
Bump-up CDs offer the option to boost the CD interest rates if the interest rates rise after the purchase. The depositor must notify the bank in advance if they want to exercise this option. To increase your earnings, you would need to wait for a rate increase from a bank, and you’d be stuck paying the initial rate if the CD rates aren’t raised.
• Step-up Certificate of Deposit
The step-up certificate of deposit works similarly to the bump-up CD. In a step-up CD, you can lock your savings in for a predetermined time while the interest rate on it keeps increasing. It is not necessary for a depositor to individually request a CD rate increase from the bank.
• Liquid or ‘No penalty’ Certificate of Deposit
Liquid CDs enable the depositor to take money out before maturity without any early withdrawal fees. It is adaptable enough to move money from one CD to another that pays more. As compared to a fixed-term standard CD, it offers a lower certificate of deposit rate.
• Brokered Certificate of Deposit
You can purchase broker-dealer CDs through brokerage accounts, where brokers may represent a bank or other financial institution. Sometimes a single brokerage may be working with several banks. Brokered CDs offer better CD rates, but the risk is higher than regular CD because they can be negotiated and exchanged on the secondary market.
Also Read: What is a Demand Deposit Account and How Does It Work?
Features of a Certificate of Deposit
Listed below are the primary features of a certificate of deposit:
- Banks are not allowed to buy back CDs before maturity
- In India, CDs can be issued for a minimum deposit of Rs.1 lakh (and in multiples of that amount)
- A CD can be issued by all financial institutions and Scheduled Commercial Banks (SCBs). The term for CDs issued by SCBs ranges from three months to a year
- A CD cannot be issued by RRBs or cooperative banks
- The terms of financial institution-issued CDs range from one to three years
- Dematerialised CDs can be transferred through delivery or endorsement, similar to dematerialized securities
- A CD cannot be used as collateral for a loan
- According to the Income Tax Act, a certificate of deposit is taxable
- A CD cannot be traded publicly
Benefits of a Certificate of Deposit
Listed below are the primary benefits of a certificate of deposit:
- It is a secure financial instrument and is not impacted by market volatility
- A bank CD comes with an assured amount at the time of maturity
- Certificate of deposit interest rates are also higher on lump sum investments
- CDs offer monthly, yearly, or even lump sum payments during withdrawals at maturity
- There are usually no additional fees or costs associated with certificates of deposit, and you only have to pay the investment amount
Eligibility for a Certificate of Deposit
Certificate of Deposit can be issued to any individual, corporation, fund house, or company. Scheduled commercial banks and a few other financial organisations in India are permitted to issue CDs under certain conditions set by the RBI.
Furthermore, CDs are granted to various entities, including individuals, businesses, corporations, and funds. Non-Resident Indians may also receive certificates of deposit, but only on a non-repatriable basis. It is crucial to remember that banks and other financial organisations cannot offer loans against certificates of deposit.
Also, banks are prohibited from purchasing their CDs before those securities mature. The RBI may, however, waive the requirements mentioned above for a limited time.
How to Buy a Certificate of Deposit?
Buying and selling a bank CD is similar to purchasing shares. The steps are listed below:
Step 1:
The buyer and seller must agree on the transaction’s price and quality
Step 2:
The seller shall authorise the depository participants via the slip with delivery instructions
Step 3:
The slip includes the instructions and steps to debit the funds from the seller’s account and transfer them to the CD to the buyer’s account
Step 4:
You can also get professional assistance to help you complete the process
Who Can Invest in Certificate of Deposit?
- Individual
- Banks
- Corporations
- Trusts
- Financial institutions
- Mutual fund houses
- Non-resident individuals (NRIs) can subscribe only on a non-repatriable basis. However, CDs cannot be endorsed by another NRI in the secondary market
- Regional rural banks and cooperative banks cannot issue the Certificate of Deposit
Limitations of a Certificate of Deposit
The primary drawbacks of a certificate of deposit are:
- Due to the funds being blocked for a specified period, it is not a liquid asset. In most situations, a withdrawal penalty will be associated with any withdrawal of deposits made before maturity
- Lower returns when compared to stocks or bonds
- When CD interest rates are fixed, they do not account for fluctuating inflation rates. It reduces profits relative to costs
Things to Consider Before Investing in a Certificate of Deposit
Here are some of the main points you should keep in mind before investing in a certificate of deposit:
1. Tenure of CD
The tenure of the certificate of deposit determines the certificate of deposit rate. It suggests that the interest rate will be greater and vice versa, depending on how lengthy the maturity period is.
Returns
Before making a certificate of deposit investment, you should research CD rates and returns. Eventually, you may base your decision on the research.
Rate of Interest
Depending on the nation’s economic status, interest rates fluctuate from time to time. As a result, CD interest rates may occasionally change. Investors must, therefore, routinely monitor changes in certificate of deposit interest rates.
Limited Liquidity
Liquidity should be considered before investing in CDs. The investor will be responsible for paying the withdrawal penalty if they decide to withdraw their investment before it matures.
Investment Duration
The investor’s period of investment will affect the rate of interest that the investor receives. The Certificate of Deposit interest rates rises as the investment term gets longer.
Also Read: How To Choose Best Lumpsum Mutual Funds: Benefits & Risks
Final Word
A Certificate of Deposit is a secure investment instrument with a guaranteed rate of return that can be purchased at banks and credit unions. You may have to lock up your funds for a predetermined period. Still, you can receive greater returns than you would with a conventional savings or money market account. Consult your advisor before investing in any financial instruments.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
FAQs
Ans: Banks and other financial entities with authorization may issue certificates of deposit. CDs can be purchased by individuals, banks, corporations, trusts, mutual funds, etc. Depending on how much they plan to invest, a person can choose the type of CD they want to buy. The next step is to decide whether they want to collect interest payments monthly or yearly. Finally, the CD will be in the Demat account once a person has opened the Demat account.
Ans: The bank issues certificates of deposit in multiples of Rs.1 lakh. Depending on their investing ability, the investor may increase the amount by multiples of Rs.1 lakh.
Ans: A dematerialized or electronic certificate of deposit may be transferred through delivery or endorsement. However, the Demat securities regulations may transfer certificates to a Demat account.
Ans: An investor has seven days to withdraw their money from a certificate of deposit after it matures. When the investor’s 7-day withdrawal grace period expires, the CD’s maturity amount is immediately reinvested. In addition, there will be a fee if investors choose to withdraw after the 7-day grace period.
Ans: A negotiable certificate of deposit is a CD guaranteed by banks. It cannot be redeemed before its maturity date and is usually sold in highly liquid secondary markets. Negotiable certificates of deposit are also considered low-risk and low-interest securities.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
