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.
Types of Haircuts includes market, negotiated and regulatory haircuts.
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:
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.
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: Used in lending; reflects risk margin deducted from collateral value.
Discount: General reduction in price, often in bond or stock valuation.