In finance, a haircut refers to the reduction in the value of an asset used as collateral when determining how much can be borrowed against it. It acts as a risk buffer for lenders to protect themselves against a drop in the collateral’s value.
In simple terms:
Haircut = % deduction from the market value of an asset to calculate its loanable value
Type | Explanation |
---|---|
Market haircut | Standard deduction based on asset class (e.g., equity: 20%-50%) |
Negotiated haircut | Agreed upon during loan settlements or restructuring |
Regulatory haircut | Prescribed by authorities like SEBI, RBI, or Basel norms |
Haircuts are applied due to the risk that the value of the collateral may decline before the lender can sell it in case of a default. Factors influencing a haircut include:
Context | Use of Haircut |
---|---|
Collateralized lending | Loans against shares, bonds, etc. |
Repo transactions | Haircuts on securities sold and repurchased |
Margin trading | To cover market risk from pledged securities |
Banking regulations | Haircuts on non-performing assets (NPAs) |
Credit risk assessments | Risk-adjusted asset valuation |
Suppose you pledge government bonds worth ₹1 crore as collateral to borrow funds. If the lender applies a 10% haircut:
Here, the lender deducts ₹10 lakh as a safety margin in case the value of the bond drops.
In India, haircuts are especially relevant in: