Functions of a Certificate of Deposit

As its name indicates, the primary function of a CD is to certify that the depositor named in the document has made a deposit of a certain amount with the institution named. It “certifies the deposit,” hence the name “Certificate of Deposit.” This certification enables the depositor to prove to third persons who might be interested, such as lenders, that he or she has that amount on deposit with the institution. Since institutions generally require the depositor to present the CD in order to cash it, a lender could lend money to the depositor on the security of the deposit and take possession of the certificate to ensure that the depositor doesn’t cash it while the loan is outstanding. On the other hand, the depositor may simply need cash and may want to sell the certificate rather than borrow money on the security of the CD. The buyer of the CD would give the depositor cash and would require that the depositor give him or her the certificate and indorse it so that the buyer, rather than the original depositor, could cash it when it matured. In short, a CD is basically proof to the world that the institution owes the depositor the amount shown on the certificate, and the depositor can use this proof to either borrow money or obtain cash.

The value of being able to prove to the world that you have a time deposit with an institution is reduced somewhat in the case of most time deposits, however. This is due to the “nontransferability legend” most institutions have on their CD forms. A “nontransferability legend” is simply a statement that the owner of the time deposit may not transfer ownership of it.

Most institutions want this legend on their CD forms because if it were not there, the time deposit would be considered “nonpersonal” under Federal Reserve Board Regulation D. (Regulation D establishes the “reserve” requirements to which depository institutions are subject.) Prior to December 1990, short-term nonpersonal time deposits were subject to higher reserve requirements than were personal time deposits. In December 1990, the Federal Reserve Board lowered the reserve requirement on nonpersonal time deposits to 0 percent, matching the reserve requirement on personal time deposits. However, the distinction between personal and nonpersonal time deposits still exists for early-withdrawal penalty and reporting purposes. Therefore, it is still advisable to have a time deposit be nontransferable. (Note: Factors other than transferability can cause a time deposit to be considered a nonpersonal time deposit; see 12 CFR 204.2(f) for the definition of “nonpersonal time deposit.”)

In order for a time deposit to be considered nontransferable, it must, according to Regulation D, “…contain a specific statement on the certificate, instrument, passbook, statement or other form representing the account that it is not transferable.” [12 CFR 204.2(f)(1)(iv)] Once you put this on your CD or account signature card, the time deposit will not be considered a nonpersonal time deposit for reasons of transferability (although it may for other reasons), and the depositor will not be able to sell the CD (although he or she can still use it as collateral for a loan). Most institutions routinely include the nontransferability legend on their certificate forms and, in doing so, eliminate one of the functions of the CD, which is to prove the existence of the deposit to a third person so the depositor can sell the CD to the third person.

Since the depositor cannot sell a nontransferable CD, the only third persons who might be interested in it are lenders. The depositor can still turn over the certificate to a lender, even if the CD is nontransferable, to enable the lender to perfect its security interest in the deposit. So the CD continues to serve that function.

Also, CDs serve a rather nonlegal but important function from the standpoint of customer relations. Many customers simply expect to get official-looking certificates when they open time deposits and commit sums of money to the institution for a fixed period of time. They think of time deposits not as deposits of money, as they do with other sorts of accounts, but rather as “purchases” of certificates. So CDs function also as a means of meeting these customers’ expectations.

A number of institutions have begun to offer “certificate-less” or “book entry” time deposits. These are simply time deposits that are not evidenced by a certificate. However, some sort of documentation that spells out the terms of the time deposit is still necessary.