Regulated by the Reserve Bank of India, a Certificate of Deposit is a type of money market instrument issued against the funds deposited by an investor with a bank in a dematerialized form for a specific period of time.
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Understanding Certificate of Deposit
- The Certificate of Deposit (CD) is an agreement between the depositor and the bank where a predetermined amount of money is fixed for a specific time period
- Issued by the Federal Deposit Insurance Corporation (FDIC) and regulated by the Reserve Bank of India, the CD is a promissory note, the interest on which is paid by the bank
- The Certificate of Deposit is issued in dematerialised form i.e. issued electronically and may automatically be renewed if the depositor fails to decide what to do with the matured amount during the grace period of 7 days
- It also restricts the holder from withdrawing the amount on demand or paying a penalty, otherwise. When the Certificate of Deposit matures, the principal amount along with the interest earned is available for withdrawal
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Features of Certificate of Deposit
Before you invest in a certificate of deposit, it is necessary that you are entirely aware of what this money market instrument is all about-
- Eligibility: Not all institutions or banks are allowed to issue Certificates of Deposit and not every individual or organization can purchase one. There are certain conditions laid down by the RBI that allow the purchase of CDs
- Maturity Period: A Certificate of Deposit issued by the commercial banks can have a maturity period ranging from 7 days to 1 year. For financial institutions, it ranges from 1 year to 3 years
- Minimum investment amount– A CD can be issued to a single issuer for a minimum of Rs.1 Lakh and its multiples
- Transferability: Certificates that are available in Demat forms must be transferred according to the guidelines followed by Demat securities. While dematerialised/electronic certificates can be transferred by endorsement or delivery
- Non-availability of loan: Since these instruments do not have any lock-in period, banks do not grant loans against them. In fact, banks cannot even buy back certificates of deposit before maturity
- Discount offered– Certificate of deposit is issued at a discounted rate on the face value. Moreover, banks and financial institutions can also issue CDs on a floating rate basis
Advantages of Investing in Certificate of Deposit
- Since these are government-backed securities, the investor’s principal amount is kept safe. Hence, it can be said that CDs are a less risky investment option than stocks or bonds
- Certificate of Deposit is known to offer a higher rate of interest and better returns in comparison to the traditional savings accounts
- Investments in CD grant a grace period of 7 days to the investor to decide whether or not he/she wants to reinvest the matured amount
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The Reserve Bank of India has laid down the following specifications for the lenders and investors of the certificate of deposit-
- Scheduled commercial banks or financial institutions in India that have been granted the permission by RBI can issue certificates of deposit
- CDs can only be issued to individuals, companies, fund houses, and such
- Co-operative banks and regional rural banks cannot issue these certificates
- It must be noted that CDs can be issued to Non-Residential Indians (NRIs) on non-repatriable basis
- However, banks and financial institutions cannot provide loans against the certificate of deposit. Moreover, banks cannot buy their own CDs prior to the latter’s maturity
- As per RBI, banks are bound to maintain the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) on the price of a certificate of deposit
How to Choose which Certificate of Deposit to Invest in
- Before you invest in a CD, it is mandatory that you are clear of your investment goals, specifically investment horizon
- Once you are sure of the time period you wish to stay invested for, look for the banks/institutions that offer certificates of deposit
- Go through the rates of interest offered by these institutions within the specified time frame
- If the interest rate is expected to rise in the future, you may consider investing for a shorter time period so as to renew it at a higher rate of interest. In case the interest rate does not rise, your invested money will still be safe from unnecessary fluctuations in the interest rate
Who should Invest in a Certificate of Deposit
As per the guidelines by RBI, the following can invest in a certificate of deposit-
- Ordinary individuals
- Financial institutions
- Mutual fund associations
- NRIs (they are not allowed to repatriate on maturity)
Things to be Considered
- Duration of the CD- The maturity period of the Certificate of Deposit is one of the most important determinants of the rate of interest. Longer the maturity period, higher will be the rate of interest
- Current Rate of Interest- Since the Reserve Bank of India regulates the certificate of deposit, there are changes in the interest rates from time to time. Hence, it is advised that you keep a track on the changes regularly
- Expected Rate of Returns- Before investing in a CD, you must track the previous returns delivered by various banks and then make a wise and informed choice
- Limited Liquidity- While investing in a CD, the investor is supposed to specify the time duration for which s/he wants to stay invested. If, in any case, the investor wishes to withdraw the amount before maturity, s/he will be liable to pay a penalty
- Fluctuating interest rates– Interest rates on CD are not dependent on the rate of inflation and are renewed by banks at regular intervals. Hence, the value of money may even decrease with the increasing inflation while the investor is still invested
- Investment horizon– The rate of interest that an investor will get on his/her investment in a CD is dependent on the time period for which s/he stays invested. Longer the duration of investment higher will be the interest rate offered
How to Buy or Sell a Certificate of Deposit in India
- Buying or selling of dematerialised certificate of deposit is similar to buying or selling of shares
- The sellers and buyers begin with agreeing upon the price and quality of the transaction
- After this, the seller authorizes its depository participants (DPs) through delivery instructions slip
- The slip includes the instructions to debit the seller’s account and transfer the Certificate of Deposit to the account of the buyer
- In case of any confusion, one can also get help from a professional for better assistance
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Frequently Asked Questions (FAQs)
Q. Can I transfer money between my Online CD and other accounts?
A. Yes. You can make a one time transfer between your Online CD and other accounts in the grace period. Grace Period is a certain duration of time given to investors for transfer/one-time deposit, withdrawal or renewal of Online CD. The grace period ends on the day you perform the transaction or give instructions to change the term.
Q. Can I withdraw money from my Online CD?
A. Yes, you can withdraw but only once in the grace period (without any withdrawal penalty). If you withdraw before the maturity period, you will be charged a penalty for early withdrawal depending on the term of Online CD.
Q. Am I notified when my Online CD is maturing?
A. Usually the banks/credit unions/financial institutions notify the investors when Online CD is maturing. However, it is requested to be alert and proactive. Sometimes, in case you miss to transfer/withdraw the money in a given grace period after the maturity, then the CD is renewed automatically i.e. rolled on to a new CD as a default action. The rates and maturity date of the new CD may also differ from the previous CD. Also, the deadline to transfer the money into a Savings Account may be missed.
Q. Does my Online CD automatically renew at maturity?
A. There Is a grace period after maturity of an Online CD in which you can transfer or withdraw the money. In case you do nothing, then the bank may renew the Online CD automatically but perhaps with a different rate of interest for the next tenure. The renewal term may be the same as the original one.
Q. How do I transfer money out of my mature Online CD account?
A. You can transfer through Internet Banking if the account is held in the same bank or go for bank transfer if the Savings Account is in some other bank. The other option is to withdraw the whole amount and deposit it into your bank account if you do not have access to online banking.
Q. What if I need to close my account before maturity?
A. You can close your account either online or by informing your bank/financial institutions by directly visiting them or calling them. Investors can track their account by logging in to the website of the concerned institution. On call, certain details will be required. Even if you visit them, you may need to fill a form and finish formalities like giving personal details (Account details, phone number, etc.) before closure. Early closure/withdrawal will be penalized accordingly.