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What You Need to Know about Certificate of Deposit in India?

  • Akshatha Sajumon
  • 23 Feb
  • 6 minutes

The Government of India requires funds to cater to various financial needs, and one of the ways to raise funds easily is to approach the common public in the country. The government often raises funds by issuing various financial instruments for short term and long term financial needs. One of the short-term money market instruments issued by the government to raise money from retail investors is the Certificate of deposit. 

Since there is very limited awareness about CDs among investors, here, we will explain everything that an investor needs to know about this debt instrument. 

What is a Certificate of Deposit?

Certificate of Deposit or CD is:

  1. a fixed-income instrument 
  2. issued in a dematerialized form
  3. issued under the governance of the Reserve Bank of India (RBI) 
  4. issued by any scheduled commercial bank or any other government-nominated financial institution
  5. issued at a discount to face value

The final amount to be received at investment maturity of CDs is assured while making the investment. The CD denotes in writing that the investor has deposited money with a bank for a predetermined fixed period and the bank will repay the deposit amount along with interest applicable.

What are the features of Certificate of Deposit?

Before investing in a certificate of deposit, investors should be aware of some of the key features of this money market instrument:

  • Eligibility: Only select banks or financial institutions are allowed to issue Certificates of deposit. Also, the RBI allows corporations, individuals, companies, banks, funds, trusts, associations to invest in Certificate of Deposits.
  • Maturity
    • If issued by commercial banks – maturity period ranges from 7 days to 1 year
    • If issued by financial institutions – maturity period ranges from 1 to 3 years
  • Minimum investment: As per an announcement by RBI in 2021, CDs can be issued with a minimum denomination of Rs. 1 lakh and multiples of further Rs 1 lakh. 
  • Transfer: CDs available in Demat formats can be transferred as per the guidelines applicable to Demat securities. 
  • Loan against CDs: Since CDs do not come with any lock-in period, banks do not provide any loans against them. Also, banks are not permitted to buy back certificates of deposit before their maturity.
  • Discount: Certificate of deposits are issued at discount to their face value. Some banks and financial institutions may issue CDs on a floating rate basis.

When do banks issue a Certificate of Deposit?

Some banks may issue a CD in case:

  • There is a low deposit growth 
  • There is a high demand for credit
  • Stiff or tight liquidity conditions prevail in the market 
  • Cash is trapped in non-liquid assets

Recent announcements by RBI on Certificate of Deposits

RBI announced that all resident Indians can invest in CDs. These can now be issued even by Regional Rural banks and Small Finance banks. Also, CDs can now only be issued in Dematerialised form. 

What are the benefits of investing in Certificate of Deposit?

Here are some of the benefits of investing in CDs:

  • Since CDs are government-backed securities, an investor’s capital or principal investment is safe, making them one of the least risky investment options.
  • CDs offer a comparatively higher interest rate and better returns than traditional bank savings accounts.
  • Investors can have a grace period of 7 days to decide whether to withdraw or reinvest the maturity amount from CD investment.

How to pick the right Certificate of Deposit for investment?

Before investing in a CD, investors must be clear about their investment goals and, more importantly, their investment horizon. Here are some tips that can help investors pick the right CD for investment:

  • Investors must begin by looking for the banks or financial institutions that offer certificates of deposit.
  • It is important to consider and compare the interest rates offered by different institutions for the chosen investment period.
  • In case interest rates are expected to rise in the long term, investors can explore a shorter investment period so that they can renew the CD at a higher interest rate. Even if interest rates do not rise, the capital will still remain unaffected by interest rate fluctuations.

Factors to note before investing in Certificate of Deposits

Here are some of the factors to bear in mind while investing in CDs:

  • Duration: A CD’s maturity period is one of the most crucial elements that impacts the interest rate to be earned from it. Longer the maturity duration, higher the interest earnings.
  • Ongoing interest rate: The Reserve Bank of India regulates the certificate of deposit and announces any interest rate changes from time to time. Therefore, inventors must look out for RBI announcements to be updated about ongoing interest rates.
  • Investment returns: Before investing in a CD, investors can look at the historical returns delivered by CDs of various banks. This can help in making a wise and informed investment decision.
  • Liquidity: Investors are required to mention the duration for which they want to invest in a CD. In case the investor wants to withdraw the investment before maturity of the CD, they have to pay a penalty for the same. This results in limited liquidity.

Conclusion

Investors looking for less risky investment options can explore CDs since these are government-backed. They are also good alternatives to traditional bank savings accounts due to comparatively higher returns. However, investors must note that the money invested in CDs will be locked until maturity and they may not have sufficient liquidity to cater to any urgent financial needs. Therefore, it is important for investors to carefully consider their risk tolerance, liquidity preference, and financial goals before investing in these.

FAQs

What is the difference between the certificate of deposits and commercial paper?

CDs are issued by banks and financial institutions, whereas commercial paper is issued by corporates and all-India financial institutions.

How is a certificate of deposit different from a fixed deposit?

Both FDs and CDs have similar features, except that FDs can be offered by all types of banks in India, whereas CDs can be offered only by RBI-designated banks.

Can NRIs invest in certificate of deposits?

As per the latest RBI circular, NRIs can invest in certificate of deposits with certain restrictions around repatriation.

Are returns from certificate of deposits taxable?

Yes, returns from certificate of deposits are taxed as any other debt investment returns.

What investment horizon are certificate of deposits ideal for?

Certificate of deposits are ideal for a medium to long-term investment horizon of 3-5 years.

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Akshatha Sajumon

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