A risk-based haircut is a percentage reduction applied to a security's or asset's value when determining its acceptable collateral value. It acts as a safety margin against potential losses if the asset's value falls before it can be liquidated.
The size of the haircut depends on factors such as the asset’s price volatility, liquidity, credit quality, and overall market risk. Higher-risk or more volatile securities may attract higher haircuts, while stable, liquid assets may have lower haircuts.
Keep reading to understand how these haircuts work and how they help investors and traders better assess the collateral and margin requirements for different securities.
Key Takeaways
- Pledging allows you to generate trading limits for F&O or margin trading facilities (MTF) without liquidating your long-term core equity holdings.
- A risk-based haircut is a safety discount exchanges apply to your pledged collateral to protect against sudden market crashes and volatility.
- In India, clearing corporations dynamically calculate haircut percentages daily using Value at Risk (VaR) and Extreme Loss Margins (ELM).
- Stable large-cap stocks attract lower haircuts (10% to 20%), whereas volatile small-cap or illiquid shares carry punitive haircuts ranging from 40% to 80%+.
- Pledging is not a sale; you continue to receive all corporate benefits (dividends, bonuses) and incur zero capital gains tax liability when pledging.
What is a Risk-Based Haircut?
A risk-based haircut is a percentage reduction applied to a security's market value when determining its acceptable collateral value for trading or borrowing. It acts as a mandatory safety buffer against potential price corrections before a broker or clearing corporation can liquidate an asset.
For example, if you pledge shares worth ₹1,00,000 and the exchange sets a 20% haircut, only ₹80,000 counts as usable collateral margin. The remaining ₹20,000 serves as a buffer against market fluctuations.
Note: Pledging shares does not mean you have lost ownership of your assets. The underlying stocks remain safely in your demat account under your name, but that specific portion is temporarily locked against active margin utilisation.
| Asset Category | Typical Haircut Range | Primary Risk Driver |
| Government Securities / T-Bills | 2% to 5% | Minimal default and interest rate risk |
| Liquid Mutual Funds / ETFs | 5% to 10% | High liquidity, low tracking error. |
| Large-Cap Blue-Chip Stocks | 10% to 20% | Moderate price swings, high trading volume |
| Mid-Cap and Small-Cap Stocks | 25% to 40% | Higher volatility, occasional lower liquidity |
| Penny or Illiquid Stocks | 50% to 80%+ | Extreme price manipulation risk and thin trading |
How Exchanges Calculate Risk-Based Haircuts?
Risk-based haircuts are not arbitrary broker penalties. Indian clearing corporations (such as NSE Clearing and ICCL) calculate and update them every evening based on SEBI's risk management framework.
In India, exchanges calculate haircuts using a combination of:
- Value at Risk (VaR) margin reflects a stock's historical price volatility
- Extreme Loss Margin (ELM) is an additional buffer for extreme price movements
- Liquidity and market capitalisation considerations
T-1 price is used for valuation. T-day VaR determines the minimum haircut.
Every evening, the Indian exchanges release a file containing updated percentages. Your broker's system ingests this to adjust your collateral limits.
Risk-Based Haircut Formula (for Stocks)
The basic relationship to explain the risk-based haircut for stocks can be expressed as:
Haircut (%) = VaR Margin + Extreme Loss Margin (ELM)
And the collateral value after haircut is calculated as:
Collateral Value = Market Value of Security x (1 - Haircut %)
Points to Note:
- Haircuts are assessed stock by stock, so two shares in your portfolio can have very different haircut percentages.
- Large-cap, highly liquid stocks (like index constituents) usually carry lower haircuts.
- Small-cap or thinly traded stocks can attract much higher haircuts, sometimes exceeding 40–50%.
Example:
Assuming you have ₹1,00,000 worth of large-cap stocks and a volatile small-cap stock each. Here is how your usable margin may look:
| Large-Cap Stock | Volatile Small-Cap Stock |
| Shares pledged: ₹1,00,000 | Shares pledged: ₹1,00,000 |
| Haircut (set by exchange): 15% | Haircut (set by exchange): 50% |
| Reduction Amount: ₹1,00,000 × 0.15 = ₹15,000 | Reduction Amount: ₹1,00,000 × 0.50 = ₹50,000 |
| Usable margin: ₹85,000 | Usable margin: ₹50,000 |
Why the Difference?
A riskier, less liquid stock usually gets a higher haircut, reducing the margin you can use for trading.
Note: Unlike stock circuit limits, the haircut is not an automatic penalty triggered by price movement. The exchange sets it in advance based on factors such as the stock’s historical volatility and liquidity.
Risk-Based Haircut on Mutual Funds
Under NSE Clearing's rules on liquid assets, mutual fund units are valued at their Net Asset Value (NAV). The Clearing Corporation reduces this value by a haircut. Only the amount left after the haircut and any exit load is counted as usable collateral.
Based on SEBI's framework for clearing corporations, haircuts on mutual fund units generally fall into these bands:
- Growth plans of overnight funds, liquid funds, or government securities funds: Around a 5% haircut, since these carry very low volatility.
- Other plans of overnight mutual fund schemes: Around a 10% haircut.
- Other mutual fund schemes (including equity and hybrid funds): Haircut based on the scheme's VaR margin calculated using six standard deviations, subject to a minimum of 9%.
How to Calculate Risk-Based Haircut: Step-by-Step Method?
Here's a simplified step-by-step approach to understand how a haircut affects your collateral value:
- Step 1: Determine the market value of your holding
Multiply the number of shares by the current market price. Example: 500 shares x ₹200 = ₹1,00,000 - Step 2: Check the applicable haircut percentage
Exchanges publish this and update it periodically based on volatility. Assume the haircut for this stock is 25%. - Step 3: Calculate the haircut amount
Haircut Amount = Market Value x Haircut %. ₹1,00,000 x 25% = ₹25,000 - Step 4: Subtract the haircut from the market value
Collateral Value = Market Value - Haircut Amount ₹1,00,000 - ₹25,000 = ₹75,000 - Step 5: Use the collateral value for margin
Only ₹75,000 will be considered as usable margin for trading, not the full ₹1,00,000.
Factors Affecting Risk-Based Haircut
Several factors influence how high or low a haircut is for a given security:
- Price volatility: Stocks with sharp, frequent price swings carry higher haircuts.
- Liquidity: Thinly traded stocks are harder to sell quickly without affecting price, so they attract higher haircuts.
- Market capitalisation: Large-cap stocks are generally more stable than small-cap stocks, so they receive lower haircuts.
- Sector-specific risk: Sectors prone to sudden regulatory or business shocks may see higher haircuts.
- Overall market conditions: During periods of high market volatility, exchanges may revise haircuts upward across the board.
- Regulatory review cycles: SEBI and exchanges periodically reassess and update haircut percentages based on changing market data.
Why is Risk-Based Haircut Important for Investors?
Understanding risk-based haircuts matters because they directly affect how much margin you can access.
- Margin planning: Knowing the haircut on your holding gives you a better idea of your usable margin.
- Risk awareness: A high haircut often signals that a stock is considered volatile or less liquid. This information can help inform your trading decisions.
- Avoiding margin shortfalls: If you do not account for haircuts, you may end up with less margin than expected. This can risk penalties or forced position closures.
- Portfolio collateral decisions: If you frequently pledge shares, choosing stocks with lower haircuts can help you get more margin.
Haircuts in Pledging and Loan Against Shares
Here is how haircuts show up in derivatives margin trading and loans against shares:
Margin for Futures and Options (F&O) Trading
When you trade derivatives, you pledge your demat holdings to meet margin requirements. Exchanges recalculate your usable margin at every market close, not just when you place a trade. This means your available margin is not fixed.
If the broader market slides, the value of your pledged collateral drops after the haircut is reapplied, and you may face an instant margin call if your positions do not have sufficient backing.
In India, the exchanges require that 50% of the margin for F&O positions must be in cash or cash-equivalent collateral. This means:
- Shares alone, however low their haircut, cannot cover your entire margin requirement.
- Even if you pledge shares worth ₹10 lakh after haircuts, you must still bring in 50% of your total margin in cash or cash equivalents (such as liquid mutual funds or G-Secs).
- If you fall short of this cash component, you will be charged interest on the shortfall.
Loan Against Shares
Margin against shares (also known as a loan against shares or margin pledge) lets you borrow money or get trading limits from a lender or broker. You do this by locking your existing stocks as security. Banks are more conservative than stockbrokers.
Loans against shares are limited to a maximum of 60% LTV (loan-to-value), as per the latest Reserve Bank of India’s guidelines. This means that you can borrow up to 60% of the shares’ value.
Individuals can borrow up to ₹1 crore system-wide against demat shares.
If the loan value is above ₹5 lakh, generally only select categories of highly liquid, frequently traded stable stocks are accepted as collateral.
Mistakes to Avoid
- Treat pledged equity as a floating margin: Pledged shares are not free money. Their value changes with the share price, so your available margin can also rise or fall.
- Watch out for sudden haircut revisions: Another overlooked risk is sudden haircut revisions. Exchanges frequently hike these percentages during times of severe market stress, such as surprise policy rate hikes or geopolitical conflicts.
- Maintain a cash buffer: Your margin can vanish overnight. If an exchange bumps a specific stock's haircut from 20% to 40% following sudden turbulence, your available margin shrinks by 20% instantly, even if the underlying share price did not drop at all. That gap triggers automated square-offs. You get very little warning before your broker closes active trades to cover the shortfall. Keeping a cash buffer is the safest path.
Conclusion
A risk-based haircut is a practical tool used by exchanges and brokers to ensure that collateral value reflects real market risk. While haircuts are not a measure of a company's fundamental quality, they are an important part of managing risk when you use securities as collateral for trading. Tracking these shifts helps you manage collateral rights and dodge sudden margin calls when prices drop.
