Haircut

What is Haircut in finance?

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

Types of Haircuts

TypeExplanation
Market haircutStandard deduction based on asset class (e.g., equity: 20%-50%)
Negotiated haircutAgreed upon during loan settlements or restructuring
Regulatory haircutPrescribed by authorities like SEBI, RBI, or Basel norms

Why Haircuts Are Used?

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:

  • Asset volatility
  • Liquidity
  • Credit risk
  • Market conditions

Where Haircuts Are Commonly Used

ContextUse of Haircut
Collateralized lendingLoans against shares, bonds, etc.
Repo transactionsHaircuts on securities sold and repurchased
Margin tradingTo cover market risk from pledged securities
Banking regulationsHaircuts on non-performing assets (NPAs)
Credit risk assessmentsRisk-adjusted asset valuation

Example

Suppose you pledge government bonds worth ₹1 crore as collateral to borrow funds. If the lender applies a 10% haircut:

  • Market value of collateral: ₹1,00,00,000
  • Haircut (10%): ₹10,00,000
  • Loan amount sanctioned: ₹90,00,000

Here, the lender deducts ₹10 lakh as a safety margin in case the value of the bond drops.

Haircut in Indian Context

In India, haircuts are especially relevant in:

  • RBI-regulated lending (e.g., repo deals)
  • Loan recoveries under IBC (Insolvency and Bankruptcy Code)
    E.g., if a bank agrees to recover only ₹400 crore of a ₹1000 crore loan, it takes a 60% haircut.
  • Loan against shares/securities provided by NBFCs and banks.

Haircut vs. Discount

  • Haircut: Used in lending; reflects risk margin deducted from collateral value.
  • Discount: General reduction in price, often in bond or stock valuation.