Certificate of deposit: Meaning, features & benefits

Investors have varying risk appetites. While some may be willing to take higher levels of risk, others may prefer a more conservative approach. Such investors tend to invest cautiously, focusing on relatively stable return potential while aiming to manage downside risks. Certificates of Deposit (CDs) are one of the money market instruments that may be relevant in this context.

In the Indian market, Certificates of Deposit (CDs) are money market instruments primarily issued for institutional investors, such as banks, mutual funds, and corporates. Retail investors generally do not have direct access to CDs due to high minimum investment sizes and issuance practices and may gain exposure to them indirectly through debt mutual funds or, in some cases, through select bond or fixed-income platforms.

This article explains Certificates of Deposit in India, covering their meaning, characteristics, benefits, taxation, and related aspects.

Table of contents

• What is a certificate of deposit (CD)?
• Definition and core characteristics
• How do certificates of deposit work in India?
• Types of certificates of deposit (CDs) available
• Benefits of investing in certificates of deposit
• Comparing certificates of deposit with other investment options
• Taxation of certificates of deposit in India
• How to choose a suitable certificate of deposit for your portfolio
• Mutual funds and CDs

What is a certificate of deposit (CD)?

A Certificate of Deposit (CD) is a money market instrument issued by scheduled commercial banks and eligible financial institutions in accordance with Reserve Bank of India (RBI) guidelines. It is a time-bound instrument, typically issued at a discount or at a fixed interest rate, and held until maturity, subject to the issuer’s credit profile.

The return on a CD is generally known at the time of issuance if the instrument is held until maturity. In India, CDs cannot be redeemed before maturity with the issuer and may only be transferred in the secondary market, subject to market liquidity.

CDs are issued for specified maturities as prescribed by RBI regulations, which may vary based on the type of issuing entity.

Also Read: Fixed Deposit (FD) vs. Ultra-Short-Duration Fund

Definition and core characteristics

The key characteristics of Certificates of Deposit are outlined below:

1. Minimum deposit amount: The minimum investment amount for a CD is Rs. 1 lakh, and investments are made in multiples of Rs. 1 lakh. Due to this relatively higher initial requirement, CDs are more commonly accessed by institutional investors or through pooled investment vehicles.
2. Authorised issuers only: CDs are issued exclusively by scheduled commercial banks and all-India financial institutions that meet RBI eligibility criteria. Issuance is governed by a defined regulatory framework prescribed by the RBI.
3. Flexible maturity options: As per RBI guidelines, CDs issued by banks must have a maturity period of not less than seven days and not more than one year from the date of issue. CDs issued by eligible financial institutions may have maturities ranging from one year to a maximum of three years.
4. Easy transfer in demat form: When held in dematerialised form, CDs are transferable in the secondary market through standard settlement mechanisms. Such transfers are subject to market liquidity and prevailing prices.
5. Liquidity check: CDs cannot be prematurely redeemed with the issuing bank or financial institution. Liquidity prior to maturity depends on the ability to sell the instrument in the secondary market, which may vary based on demand.
6. Tax treatment: Potential returns earned from CDs is fully taxable as per the Income Tax Act, 1961. The income forms part of the investor’s total taxable income and is taxed according to the applicable income tax slab. Tax treatment may vary based on investor category and prevailing tax rules.

How do certificates of deposit work in India?

Certificates of deposit follow a structured issuance and holding process governed by RBI guidelines. From investment and tenure selection to returns and exit options, the way CDs function differs from traditional bank deposits in several important ways. The broad process involves the following steps:

• Investment: A fixed amount is invested with the issuing bank or financial institution.
• Tenure choice: The maturity period is chosen in line with RBI guidelines and issuance terms.
• Interest earnings: Potential returns are earned through the difference between the issue price and the maturity value, or through a fixed coupon payable at maturity, depending on the structure of the CD.
• Transferability: CDs are negotiable instruments and may be transferred in the secondary market, subject to liquidity and market demand.
• Taxation: Any potential income from CDs is taxed as per the investor’s applicable income tax slab.

Types of certificates of deposit (CDs) available

1. Bank-issued CDs: These CDs are issued by scheduled commercial banks and are commonly used by institutional investors and money market portfolios.
2. Financial institutions-issued CDs: These CDs are issued by eligible all-India financial institutions and typically have longer permitted maturities compared to bank-issued CDs.

CDs may be issued at a discount to their face value or with a fixed coupon rate, depending on the issuance terms. Floating-rate CDs are permitted, provided the floating rate is linked to an objective and transparent market benchmark, in line with RBI guidelines.

The issuing entity determines the applicable discount or coupon structure at the time of issuance. In the case of floating-rate CDs, the yield may be reset at predefined intervals based on a predetermined benchmark-linked formula. Investors may review the rate structure, reset frequency, and benchmark reference when evaluating such instruments.

Also Read: FD vs FMP vs Debt Fund: Which Is Better for Your Goals?

Benefits of investing in certificates of deposit

• Suitable for short-term investment: CDs typically have short to medium tenures, which may align with certain short-term allocation requirements.

• Clarity on potential returns: The yield structure is specified at issuance, subject to the condition that the CD is held till maturity and issuer credit conditions remain unchanged.
• Relatively higher potential interest than savings accounts: In some market conditions, CD yields may be relatively higher than savings account interest rates, depending on the tenure and the issuer’s credit profile. However, unlike savings accounts, CDs involve market-linked pricing and limited liquidity before maturity.

Comparing certificates of deposit with other investment options

To understand CDs better, it may help to view them in comparison with other commonly discussed instruments.

CD vs. fixed deposit (FD)

CD vs. Mutual Funds

Taxation of certificates of deposit in India

Income earned from Certificates of Deposit is taxable as per applicable income tax provisions in India. Such income is added to the investor’s total taxable income and taxed according to prevailing slab rates. CDs do not qualify for indexation benefits.

Also Read: Fixed Deposit vs SIP: Which One Should You Opt For?

How to choose a suitable certificate of deposit for your portfolio

When evaluating CDs, factors such as the credit profile of the issuing bank or financial institution, remaining maturity period, and prevailing interest rate environment may be relevant. Liquidity conditions and the intended investment horizon may also influence how CDs fit within broader short-term allocation considerations.

Mutual funds and CDs

Certificates of Deposit (CDs) are commonly used as underlying instruments in certain debt mutual funds, particularly money market funds, liquid funds, and short-duration funds. Fund managers may invest in CDs to manage short-term liquidity, earn returns aligned with prevailing interest rates, and diversify credit exposure within the portfolio. For retail investors, mutual funds provide an indirect and diversified way to gain exposure to CDs, along with other short-term instruments, without the need to participate directly in the primary or secondary market. Investors considering mutual funds may explore Bajaj Finserv AMC’s various debt, hybrid and equity schemes.

FAQ

Are Certificates of Deposit insured in India?

CDs are not covered under deposit insurance schemes.

What is the minimum investment required for a Certificate of Deposit?

The minimum investment is generally Rs. 1 lakh, with additional investments in multiples of Rs. 1 lakh.

Can I sell my CD before its maturity date?

Yes, CDs are transferable and may be sold in the secondary market, subject to availability of buyers and prevailing market conditions.

How often is interest typically paid on a Certificate of Deposit?

Certificates of Deposit do not pay periodic interest. Returns are typically realised at maturity, either through the difference between the issue price and face value (in the case of discounted CDs) or through a fixed coupon payable at maturity.

Do certificates of deposit align with long-term financial goals?

CDs are generally used for short-term allocation requirements and may not align with long-term wealth-building objectives.

How do CD yields compare with fixed deposit interest rates?

CD yields vary based on market conditions and issuer requirements. Fixed deposit interest rates are predetermined by banks, while CD yields may fluctuate in the secondary market before maturity.