CERTIFICATE OF DEPOSIT (CD)

By Pankaj Mishra

Introduction

Certificates of deposit are short term deposit instruments issued by banks and financial institutions to raise large amount of money.

This scheme was introduced in July 1989, to enable the banking system to mobilise bulk deposits from the market, which they can have at competitive rates of interest.

Features

Who can issue Scheduled commercial banks (except RRBs) and All India Financial Institutions within their `Umbrella limit’. 

Maturity Min: 7 days Max : 12 Months (in case of FIs minimum 1 year and maximum 3 years). 

Amount Min: Rs.1 lac, beyond which in multiple of Rs.1 lac 

Who can subscribe CDs ?

Eligibility, Maturity, Issue Price

The Certificate of Deposits may be issued at a discount on face value. Banks and Financial Institutions are permitted to issue these on floating rate basis.

The interest rate on floating rate Certificate of Deposits will have to be reset periodically.

Banks must keep Statutory reserve on the issue price of Certificate of Deposits.

Lock In, Loans/Buyback, Repayment

In case of Certificate of Deposits, there is no lock in period. Banks and financial institutions can not grant loans against Certificate of Deposits and

they can’t even buyback their own Certificate of Deposits before maturity. The Certificate of Deposits are due on the date stated on the instrument. There is no grace period. If the maturity day is a holiday, the issuing bank must make payment on the preceding

day. The physical Certificate of Deposit must be presented for payment by the last holder. Payment of Certificate of Deposit should only be by crossed cheque.

Transferability, Loss of Certificate, Security

The physical Certificate of Deposits are freely transferable by endorsement and delivery.

In case of loss of Certificate of Deposits, duplicate certificate may be issued only after: - A notice is given in at least one news paper. - There has been lapse for 15 days from the date of notice - Investor has to executes an indemnity bond

Advantages

Certificate of deposits are the most convenient instruments to depositors as they enable their short term surpluses to earn higher return.

CDs also offer maximum liquidity as they are transferable by endorsement and delivery. The holder can resell his certificate to another.

From the point of view of issuing bank, it is vehicle to raise resource in times of need and improve their lending capacity. The CDs are fixed term deposits which cannot be withdrawn until the redemption date.

This is an ideal instrument for the banks with short term surplus found to invest at attractive.

Problems Hindering CD Market

Absence of secondary market:-this appears due to the fact that CDs are priced high & holder in primary market prefer to hold them to maturity.

Although the scheme for CDs has been in operation for quite some time, it has yet to gain ground & its usage has remained confined to only few corporations & banks.

Say Amar wishes to borrow Rs. 30 Lakhs for his new business venture.

He goes to bank & ask for the loan.

But though the bank agrees to provide a loan, it realizes that it has only Rs. 20 lacs at present.

Now the bank does not wish to lose him to another bank.

So the bank asks him to come back later to collect the loan amount at let’s say 15%.

The bank has corporate relationships from whom they can borrow.

In order to borrow, they issue ‘Certificates of Deposit’ to these corporate relationships who in turn subscribe to them.

Obviously the rate of interest offered by the bank to the corporate institutions would be higher than the regular fixed deposits.

Thus money comes into the bank and is offered to Amar.

So how does the bank provide the additional Rs.10 lakhs?

How CDs Work!

Bank Lends Money

Borrower Approaches Bank

Corporates Put

Money in Bank