Certificate of Deposit

Also called: CD · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A Certificate of Deposit (CD) is a short-term deposit that a bank turns into a paper, or security. The holder can sell this security to someone else before it matures, which is what negotiable means. A CD is usually issued at a discount, meaning it is sold below its face value (the amount the bank pays back on maturity). It can also carry a fixed or floating interest rate [2].

Banks use CDs to raise large sums quickly. CDs are also part of the money market (the market for borrowing and lending for up to one year), where the RBI's policy rate changes first reach the economy.

Discount yield formula (for a CD issued at a discount): Yield (%) = [(Face value − Price) ÷ Price] × (365 ÷ Days to maturity) × 100

Explanation

How a CD works

• A deposit you can sell. A CD is a bank deposit made into a security, so it can be traded.
• If an ordinary fixed deposit (FD) holder needs cash early, the only choice is to break the FD with the bank.
• A CD holder can sell the CD in the secondary market (the market where existing securities are bought and sold) to another investor.

• The bank's money stays locked in until maturity. The buyer simply takes the place of the first holder.

• Discount pricing. A discount CD pays no coupon (regular interest payment).

• The investor pays less than face value today and gets the full face value on maturity.

• The gap between the two prices is the investor's return.

• Other pricing options. A CD may also be issued at a fixed rate or at a floating rate [2].

• A floating rate is linked to a benchmark (reference rate) published by a Financial Benchmark Administrator [2].
• NCERT describes CDs only as "issued at a discount", but the RBI rules allow all three types.

Worked example (illustration)

• A bank issues a 90-day CD with a face value of ₹5,00,000 (the minimum size) at a price of ₹4,90,000.
• Gain to the investor = ₹10,000.
• Yield = (10,000 ÷ 4,90,000) × (365 ÷ 90) × 100 ≈ 8.28% a year.
• Lower price means higher yield. The payment at maturity is fixed, so a buyer who wants a higher return must pay a lower price today.

What makes CD rates rise or fall

• RBI policy rate.
• When the RBI raises the repo rate (the rate at which the RBI lends to banks for a short time), overnight money-market rates rise.
• CD, CP and T-bill yields then rise as well.

• The reverse happens when the RBI cuts the rate.

• Bank's need for funds.

• When loan demand grows faster than deposits, banks issue more CDs to raise bulk deposits (large deposits raised at one go).

• To attract enough buyers, banks must offer higher yields, so CD rates go up.

• Liquidity in the system.

• When banks are short of cash, all short-term rates rise, including CD rates.

• When there is surplus cash, they fall.

• Existing CDs in the market. When market rates rise, the price of CDs that are already issued falls. When rates fall, their price rises.

In India

• Regulator and rules: the RBI regulates CDs through the Master Direction – Reserve Bank of India (Certificate of Deposit) Directions, 2021, dated 4 June 2021 [2].
• Who can issue: Scheduled Commercial Banks, Regional Rural Banks (RRBs) and Small Finance Banks (SFBs) [2].

• All-India Financial Institutions (AIFIs, such as NABARD, SIDBI and EXIM Bank) are not covered by these bank Directions. Under the scaffold rule, AIFIs issue CDs for 1 to 3 years.

• Tenor: at least seven days, and it "shall not exceed one year" [2].

• Minimum size: ₹5 lakh, and then in multiples of ₹5 lakh [2].
• Who can invest: "all persons resident in India" [2].
• Form and settlement: CDs are issued only in demat (electronic) form [2].
• Primary issues (the first sale by the bank) settle on T+1, one working day after the trade [2].

• Secondary trades settle on T+0 or T+1, on a DvP (Delivery versus Payment) basis, meaning the security and the money change hands at the same moment [2].

• Buyback: a bank may buy back its own CD before maturity, but only after 7 days and on the same terms for every investor [2].

• No grace period: the bank must repay on the maturity date, with no extra days allowed [2].
• Trading hours: 9:00 AM to 5:00 PM on business days [2].

Don't confuse with

• Fixed Deposit (FD): both are bank deposits, but a CD is negotiable and can be traded in the secondary market. An FD cannot be sold; it can only be broken with the bank.
• Commercial Paper (CP): a CP is an unsecured promissory note (a written promise to repay) issued by companies, NBFCs, AIFIs, InvITs, REITs and other body corporates, and it needs a minimum rating of 'A3' [1]. A CD is a deposit issued by banks. Both have a minimum size of ₹5 lakh and a tenor of 7 days to 1 year.
• Treasury bill (T-bill): a T-bill is debt of the Government of India, issued for 91, 182 or 364 days, and carries zero default risk. A CD carries the credit risk of the issuing bank, so it usually yields more than a T-bill of the same tenor.
• Term money: term money is interbank lending without security for 15 days to 1 year, and only banks and primary dealers can take part. A CD is a tradable security, and any person resident in India can hold it [2].

Prelims Hooks

• CD = negotiable short-term deposit; an FD is not negotiable. The rules are the RBI CD Directions, 2021 (4 June 2021) [2].
• Issuers: Scheduled Commercial Banks, RRBs and Small Finance Banks [2]. Trap: companies issue CPs, not CDs.
• Bank CD tenor: 7 days to 1 year [2]. AIFI CDs: 1 to 3 years (scaffold rule).
• Minimum ₹5 lakh, then multiples of ₹5 lakh, which is the same as for CP [2].
• "CDs are issued only at a discount" is a trap. A CD may be issued at a discount, or at a fixed or floating rate [2].
• Demat only, secondary settlement on T+0/T+1 on a DvP basis. Buyback is allowed after 7 days, and there is no grace period for repayment [2].

Mains Points

• Bank funding and credit growth.
• When loan demand runs ahead of deposit growth, CDs let banks raise bulk funds quickly.
• The trade-off is cost and stability. CD money is market-priced and can leave quickly, unlike ordinary savings deposits.

• If a bank leans too heavily on CDs, its funding costs rise and it becomes more exposed when money-market conditions tighten. The IL&FS episode of 2018 showed this danger for CP-funded NBFCs.

• Monetary policy transmission (GS-III).

• The RBI changes the repo rate → call and TREPS rates move → CD, CP and T-bill yields follow → bank loan and deposit rates change.

• CD rates respond quickly because they are set in the market. A deep, active CD market therefore helps RBI rate changes reach borrowers faster and supports inflation targeting.

• Market-linked pricing and trust in benchmarks.

• Floating-rate CDs linked to a Financial Benchmark Administrator's rate [2] depend on that benchmark being honest.
• India's move from polled MIBOR to traded FBIL-MIBOR (2015) [3], and then to a secured rate (the SORR decision, 2024) [4], makes the prices of such instruments harder to manipulate.

Related concepts

• Money market
• Call money market
• Treasury bills
• Cash Management Bills
• Commercial Paper
• Tri-party repo
• MIBOR
• LIBOR

Read more

• Money market: call money, T-bills, CPs, CDs and repo