Call-Notice-Term Money, Certificate of Deposits, Commercial Papers, ICD

Borrowing and lending is an ever-growing business. This is the money business, making money by lending money. This is how the entire banking system works, not only today in the modern era, but since the oldest banking family of the House of Rothschilds in the late 18th Century. The age-old concept is still the same. However, new terms have been added like Call notice, certificate of deposits, commercial papers or Inter-corporate deposits.

All these complex-sounding terms are based on the same principle, that is, lending money at one given point of time and then collecting it back with an added interest. Due to the massive size of the world economy, the ways of lending out money have become very diverse. Let’s get a clear understanding of how these instruments work and, more importantly, what these instruments mean.

Call-Notice-Term Money

The simple act of borrowing money for a short period of one day is called Call Money. When the same act is repeated, but for a period of two to fourteen days, then it is called Notice Money. Term Money, on the other hand, is the borrowing of money for a period extending fourteen days.

In finance and banking, there may be situations when the borrower has enough funds to pay back the taken amount within a limited period of days, and for this purpose, the bank lends money with an interest rate ranging from as little as 2% and going up to 6%. The reason the interest rates are so low is that these are short-term loans.

Certificate of Deposits (CD)

What is a certificate of deposit? Looking at what the name suggests, certificates of deposits or CDs are certified proof of remittance between two financial entities. Certificates of Deposits (CD) is an investment option that holds a fixed amount of money for a fixed amount of time, for example, 6 months, 1 year, 2 years or 5 years, in return for interest paid by the issuing bank. Certificates of Deposits are considered to be one of the safest investments in the market.

A Certificate of Deposit is issued by certain commercial banks and financial institutions, and their limits are set by the RBI, which is the central bank of India. Certificates of deposit are issued between individuals and corporations or any entity that requires immediate short-term funding.

There are mainly only two categories in Certificate of Deposits, that are

1. Fixed interest CD: In this type of CD, the interest rates are fixed throughout the period. The interest rate that was promised by the issuing bank will be locked in for the whole tenure.
2. Variable interest CD: In this type of CD, the interest rates fluctuate based on various parameters like the prime rate, consumer price index (CPI), treasury bills or market index.

Commercial Papers (CP)

Majorly used for funding the payroll of corporations and other liabilities, a commercial paper, similar to certificates of deposits, is a short-term debt instrument that is very commonly used. Commercial papers are much more common than most people tend to think. Here are a few examples that are used by citizens and not only corporations, in their daily lives:

• Cheques: A cheque is issued by the customer’s bank and is used by regular people all the time. The concept of a cheque is a commercial paper, i.e., it is written proof for future payment by the drawer to the drawee.

• Promissory Notes: The daily-use bank notes backed by the RBI that we use are all promissory notes. As the name suggests, the notes in our wallets are a promise made by the Governor of RBI to us, the citizens, stating that the value of the note is what it is. After the gold standard for the currency notes was removed by the World Governments, all banknotes simply became promissory notes.

• Banker’s Draft: Similar to a cheque, a banker’s draft is also a commercial paper with written proof of money transactions between three parties; the drawer, drawer’s bank and drawee’s bank. This is acquired by a bank for remittance purposes.

Inter-Corporate Deposits (ICD)

As the name suggests, an Inter-Corporate Deposit is a short-term debt instrument between corporations or private financial institutions only. This may not concern any government entities. However, it is still monitored slightly by the RBI for legality issues.

The corporate entities that come under the Companies Act 1956 can participate in this form of borrowing transaction. Some corporations may have surplus funds, and there are corporations still that may be facing a temporary loss or shortage of funds. In this scenario, the former would lend to the latter with an interest rate decided between the two parties. The interest rates on ICDs usually vary from 4% p.a. to 6% p.a., depending on what deal has been struck between the corporations.

Conclusion

From this article we have learnt about various financial instruments like Call-Notice-Term Money, Certificate of Deposits, Commercial Papers, ICD. It is important to have a good knowledge about these as it is one of the most common topics covered in banking exams.